THE ANATOMY OF A BUBBLE More than 400 years of market bubbles reflect a recurring pattern. In 2008, a Canadian scholar named Jean-Paul Rodrigue published a model that defines the stages of a bubble... Stealth Phase: In the stealth phase of a bubble, early so-called smart-money investors sense a new market opportunity or paradigm. They start to buy discreetly, careful not to show their hand. Euphoric and increasingly irrational investors extrapolate recent price gains into the future. Enthusiasm spreads like a virus, and a feedback loop ensuses. Awareness Phase: As market prices rise, more investors are drawn to the new investment story. The media begins to cover it – perhaps egged on by “Oops, I didn’t say that out loud, did I?” leaks from the smart money who participated in the stealth phase... adding to the momentum. Regular investors – the early-adopter types, the stock market equivalent of people who camp out overnight to get the latest iPhone – sense that something is rustling in the jungle. Mania Phase: Now everyone notices the rising prices. The media is touting “the investment of a lifetime.” Prices detach from underlying economic reality. Euphoric and increasingly irrational investors extrapolate recent price gains into the future. Enthusiasm spreads like a virus, and a feedback loop
THE ORIGINAL MARKET BUBBLE It’s a story almost as old and familiar as Romeo and Juliet . And tales of bubbles and star-crossed lovers have at least one thing in common: They don’t end well. In the early 17th century, the Dutch fell head over heels for flame-colored tulips. Demand spiked, and the value of tulip bulbs shot up. Word of profitable speculation spread, and more people piled in. Prices went up and up and up.
From December 1636 to February 1637, the price of
premium tulips surged by 200%. (That kind of appreciation is just another day at the office by today’s standards... Back then, it was real money.) At the height of the mania in 1637, a single prized bulb could purchase one of the grandest homes on the most fashionable canal in Amsterdam – which at the time were among the most expensive in the world. Needless to say, the prices didn’t accurately reflect the true value of a tulip bulb. And in February 1637, buying tipped over into selling, triggering a devastating domino effect. Prices plummeted. With the spell broken, speculators realized they had spent vast sums on glorified onions, and quickly liquidated their tulip-bulb holdings. Wealth evaporated and pandemonium engulfed Holland. A deep economic depression followed. And since then, history has repeated itself... again and again and again.
American Consequences
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