Saft on Wealth: Bubble-Spotting, Like Genius Parenting, Is RareSaft on Wealth: Bubble-Spotting, Like Genius Parenting, Is Rare

By James Saft

April 19 (Reuters) - “Is this market a bubble?” and “Is mykid a genius?” are two questions which are asked far more often,and with less profit, than they should.

Financial advisors probably dread the asking of the one,just as much as teachers fear the other.

That’s because both questions, when asked by the typicalinvestor or parent, embed both a delusion of detective skill anda wrong-headed idea of the point of the exercise.

You will very likely not be able to work out the answer, andwill be prone to make the wrong move even if you do.

Moreover, and this applies equally to bubble hunting orgenius cultivating, you make the cardinal error of puttingyourself firmly at the center of an operation in which youbelong well on the periphery.

Your kid probably isn’t a genius and won’t be helped, andmay well be hurt, by your interest in the matter.

The market probably isn’t in a bubble and your considerationof the matter sets you on a path to do more harm then good.

“The bubbles that did not burst are just as important forinvestors to know about as the bubbles that did burst. Placing alarge weight on avoiding a bubble, or misunderstanding thefrequency of a crash following a boom, is dangerous for thelong-term investor because it forgoes the equity risk premium,”Yale finance professor William Goetzmann wrote last year in astudy of bubbles in financial history. ( http://www.cfapubs.org/doi/pdf/10.2470/rf.v2016.n3.1)

“In simple terms, bubbles are booms that went bad but notall booms are bad.”

What Goetzmann found is that booms are more likely to befollowed by another boom than by a bust.

Looking at 21 national stock markets since 1900, 14 percentof the time stocks doubled in real terms over a three yearperiod, or what we might call a boom.

Subsequent to this markets which doubled halved 3.37 percentof the time in the following year but doubled again 8.37 percentof the time.

Stretch that out to five years and post-boom markets doubleagain a bit less than 50 percent of the time but only halveabout 8.0 percent of the time.

Get out after a boom and you are more likely to miss anotherboom than a bust.

Clearly, unless you are exceptionally good at bubbledetecting you are playing with fire in attempting to pick themout.

FOREVER BLOWING BUBBLES

Of course bubbles, those artificial and unsustainableincreases in asset prices, like geniuses, exist and of coursethey make a big impression when they come around.

Bubbles happen for a complex and fascinating set ofreasons.

A short list of causes would need to include humanpsychology and the fear of missing out, monetary policy and itslate tendency to see asset price rises as a means to achieveaims previously met by genuine innovation and fiscal policy.

It is also true that the fact that we benchmark the managerswe hire to steer our mutual and pension funds means they have anin-built motivation to chase irrational market valuationshigher. If they sit out bubbles they are more likely to getfired.

That helps to drive both genuine booms and bubbles alike.The person who can determine which is which, especially theperson who is simply managing their own retirement or long-termsavings risk, is a rare bird and unaccountably in the wrong job.

So, sure, an optimum execution of investment would avoidbubbles, but a typical investors’ main risk isn’t that theymight be subject to a downdraft but that they, in seekingshelter, may miss out on equity gains while doing so.

Investors, like parents, should aim to do reasonably welland act cautiously, and with a proper respect for how littlethey know about the future and what will be for the best.

Exceptional phenomena, like crashes or child geniuses arejust that, exceptional, and best left to worry about themselves.

Bubbles, therefore, are a problem, but one which individualsare in a very poor position to mitigate. Policy makers shouldworry about bubbles, which can be more destructive to human andeconomic capital then they tend to be to portfolios.

Better fund management incentive systems and moresymmetrical monetary policy around potential market bubbleswould be a good thing.

You, on the other hand, are more than likely to do yourself,and your portfolio, damage by trying to time bubbles(James Saft)