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Investors Having Difficult Time Identifying Bubbles Again

"Facts do not cease to exist because they are ignored."

- Aldous Huxley, author of Brave New World

The novel, Brave New World, introduced the author's anticipated development in the fields of reproductive technology, sleep-learning, and psychological manipulation in general. While people like H.G. Wells wrote about a more utopian future, Huxley promoted a scarier version of the future.

While I am not trying to depict a scarier version of the future, the "facts" of the market seem to be ignored. That is the problem with speculative bubbles. Facts are conveniently overlooked. I discussed the nature of speculative bubbles in my book. Whether it was the tulip bulb craze in Holland, Beanie Babies, real estate, and now the stock market (again), bubbles have common features. Something called absence blindness prohibits us from identifying those things we cannot see - a common bubble characteristic.

For example, while watching a football game, how many of you spend time observing the blocking of the offensive linemen? If you were watching live, my guess is you simply track the ball. If you were watching TV, you have no choice but to follow the ball. Now when the quarterback gets sacked, we notice the linemen don't we? No one sees all of the intricacies of the offensive line play until something bad happens.

That is the behavior of a speculative bubble. As long as the market keeps going up nobody cares why, though when the market fractures, we have the post-bubble reaction (collapsing markets, recriminations of "guilty" parties, government attempts to restore confidence) [E$caping Oz, Chapter 8]. Regular readers of this column understand the "why" of a speculative bubble (favorable public psychology, herding instinct, means to speculate with credit).

The favorable public psychology is quite evident. See recent headlines.

"Waiting for a 10% correction? Don't hold your breath"

- USA Today, 11/12/13

"Many scoff at notion stock bubble exists"

- Associated Press, 11/19/13

"Stocks not near a bubble"

- CNN Money, 11/15/13

"Another bear falls by the wayside"

- MoneyBeat, 11/26/13

"In Silicon Valley, partying like it's 1999 once more"

- NY Times, 11/26/13

"Former Fed Chairman Greenspan sees no bubble as Dow tops 16,000"

- Bloomberg, 11/27/13

"Profit warnings reach peak"

- USA Today, 12/12/13

The last headline would seem to argue against my commentary. Within the story, however, we read how CEOs are warning of profit misses the likes not seen since 2001 (remember the recession at that time?). Despite these red flags from those in the know, absence blindness persists and the facts are ignored. A purely rational investor would heed these warnings and proceed cautiously, if at all, towards stocks. The bubble psychology suggests that since the Fed Wizards are still in control, the facts announced by CEOs are inconsequential. If you ever doubted that psychology drives markets, hopefully this will clear it up!

My fear is that we are squarely in the middle of stock bubble 2.0. As this bubble deflates, and it will, the public's mood will be decidedly more hostile than it was in 2008-2009. As the old saying goes,

Fool me once, shame on you.
Fool me twice, shame on me.

Investors are hoping for the Bushism from 2002 when he said,

Fool me -- you can't get fooled again.

Unfortunately, that is the consequence of the bubble - the speculative investor gets fooled again.


Jim Mosquera is a Principal at Sentinel Consulting and is the author of E$caping Oz: Protecting your wealth during the financial crisis.


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