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Clif Droke

Clif Droke

Clif Droke is the editor of the two times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock…

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Bring on the Bubbles!

Everywhere we turn it seems we keep hearing of some bubble or another that threatens to engulf our country and hurl us headlong into a major financial catastrophe. Around every corner there lurks a bubble in the wings just waiting to be popped...and make no mistake about it, it *will* take you and your life savings with it! (At least that's what the bubble-mongers in the financial media would have you believe.)

In a commentary last week by Tim Lee of the FT newspaper I couldn't help noticing that once again writers are focusing attention to the so-called "global credit bubble." Lee chided skeptics of the bubble in calling out their "failure to understand the unique nature of this global credit bubble and the consequences of its inevitable collapse." To further emphasize his point, Lee concluded his commentary with these words: "...global deflationary collapse will be inevitable once the credit bubble bursts."

Here we have an example of yet another commentator parroting the party line that follows virtually every discussion of financial bubbles: the idea that bubbles are always bad and must always end in collapse. Many of these bubble antagonists then go on to cite references to past bubbles that ended in disaster, e.g. the infamous Mississippi Bubble or Tulip Mania. Never mind that these bubbles occurred hundreds of years ago and that today's financial system is a thousand times more intricate and complex than the systems of yester-year. And while it's always politically correct to point out that "men never learn from history," isn't it remotely possible that, in the area of money, the monetary regulators maybe -- just maybe -- have actually learned from history? Who says that any of today's bubbles have to end in unmitigated disaster?

The implication behind statements like the one above is that financial bubbles must inevitably pop. This isn't always true, however. It's true that a bubble can't expand indefinitely. But an existing bubble can be slowly deflated and then judiciously reflated before reaching the collapsing point, much as we've seen happen countless times in our economy. So far it has held up pretty well in the face of any number of crises that have come up in the past 30 years. If we're living in a bubble economy then this bubble is made of strong stuff!

When was the last time we saw a bubble pop on the scale of the Mississippi Bubble or Tulip Mania (or even the 1929 stock market bubble) that actually carried with it devastating long-term consequences? Have we not rather seen a partial and temporary deflation of the bubbles that have occurred in the past 30 years or so, or in other cases, "bubble transference"? (This refers to the migration of liquidity from one "hot" sector to another when the former sector has reached its apex. An example would be the bubble that developed in real estate following the tech stock bubble of the late '90s.) It would appear that the engineers of today's bubbles have learned much from bubble history and that they have achieved a level of control over financial bubbles that John Law and his bubble-minded colleagues would envy.

Due to the complex and unique nature of our present day economic and financial system, the monetary authorities (a.k.a. "bubble makers) have embarked on a new system of finance that we'll call Bubblenomics. The best way to describe this system of finance is to imagine an inflatable air mattress that has developed a slow leak. The leak in our mattress answers to the forces of global deflation that are brought on by the 120-year Kress Cycle and K-wave. Rather than allowing the air mattress to collapse outright, it's possible to feed a continuous supply of air into it to maintain a relatively stable air distribution. At some point there will be too much air building up in one corner of the mattress which will have to be pushed to another part of the mattress. This answers to the financial bubbles that develop periodically in various sectors of the financial system. Through an oscillating series of cycles of inflation/deflation/reflation the mattress (i.e. the economy) is kept buoyant. This isn't the most ideal way to run an economy but it's what we're stuck with today and so far it has worked (a few close calls notwithstanding).

This shouldn't be construed as an argument in favor of turning our country a bubble-ocracy, as some would have it. It's merely a recognition of the fact that bubbles can and do provide extended periods of relief from the forces of K-wave global deflation that periodically are seen in various countries, including ours.

We live in a world where the middle course is almost never give to us as an option. We're constantly forced to choose between one extreme or the other by our masters, something which can be easily seen in the realm of politics. In finance this is also the usual course and the choice always seems to be between inflation or deflation instead of the moderate path of stability between the two extremes. With that being the case, if given only one of two choices, which path would you rather travel: the slow-grinding, bumpy road of deflation (as the bears would have it)? Or would you rather have the high road of a bubble-spawned bull market? Before you answer that question, let's take a walk down memory lane...

In 1996-1999 the entire country was in the midst of a massive "feel-good" era with a white hot economy, a booming stock market and job creation (particularly in the tech sector) unlike anyone could remember. The tech bubble was in full swing and all an investor had to do was throw a dart at the NASDAQ listings in the Wall Street Journal and his "pick" was sure to pay off. Every one (with the possible exception of the super bears) was having a good time and thoroughly enjoyed the benefits of this late '90s bubble.

Internet and other tech startups were showing up every day and there was no lack of work for anyone who wanted a job. Money was plentiful and the economy was strong. We saw massive improvements in the technological infrastructure and the economy got a shot of momentum that to this very day hasn't completely faded. Of course the tech "bubble" popped in 2000 and ended in disaster (for some companies) but the benefits of that late '90s bubble were to be lasting ones and we're still enjoying the fruits from those heady days of 10 years ago.

"Bubble Mania" didn't end there, however. Soon after the tech bubble deflated, the flow of funds was diverted to another emerging bubble in the commodities sector. The starting gun to the commodities boom occurred with the massive rally in the natural gas price in 2000 along with a huge spike in the palladium price that same year. Both of these anomalies were blamed on shortages in these two industrially important commodities. Others blamed large speculators for creating the unusual spikes. Whatever the reason, it sent a signal to the long-since dormant commodity speculators that the time was ripe for a return to the hard assets arena. And so began round two of Bubble Mania. It was soon expanded to include major bull markets in the prices of gold, silver, platinum, copper and other metals.

Although they won't openly admit it, the natural resource bugs enjoyed every minute of the commodities bubble of 2000-2006. They rail incessantly against the "bane and scourge" of bubbles, all the while wishing for a return to the super inflated asset prices of yester-year where many of them made their fortunes. Indeed, many a commodities trader would love to see another expansion of the bubble that always produces a rip-roaring speculative frenzy.

Round three of Bubble Mania was underway by 2001 with the real estate boom. It succeeded in creating a vigorous demand for housing and property and made millionaires out of many before it began deflating in 2005. Yet it still, despite the naysayers, hasn't formally "popped". The real estate market has yet enough air to remain inflated for some time, though we may never again see a return to the super-inflated years of 2001-2005.

That brings us to today as we await the start of round four of Bubble Mania. What sector(s) are likely to receive the attention of the bubble makers in their creation of the next major financial boom? My guess is that we'll see a return to the area of technology. The NASDAQ stock arena is long overdue another boom period and already there are preliminary signs of a soon commencement. Short interest in the semiconductor sector alone is through the roof! That implies there are too many bears in this highly sensitive area of the tech arena, and many a tech stock boom has begun with a short covering rally in semiconductors. Then there's the developing field of nanotechnology which has yet to hit its stride. I also believe we'll see a nanotech bubble before all is said and done.

The foundation for the next financial bubble has already been laid. MZM growth this year has been explosive, right up until last week's release of this important monetary statistic. The massive increase in money supply can only be interpreted as bullish for the future outlook of the stock market. It will also ensure the economy's resuscitation from its present somnambulant state. The MZM chart shown below is screaming "bull market in stocks!" and "economic strength ahead!" It also argues in favor of round four of Bubble Mania to soon begin.

"But," someone protests, "liberal money supply growth only encourages speculative excess." Unfortunately, that's true for some people. Some individuals simply have the gambling impulse so deeply imbued within that they can't resist the speculative urge when money is flowing freely. Such impulsive gamblers have always existed throughout history and will continue to exist until the end, but that won't stop bubbles from occurring, nor is it of paramount consideration. There are enough investors with sound business sense to take full advantage of bubbles and increase the general business level, and by extension, the general level of prosperity. Who can deny that a "rising tide floats all boats"? This alone argues for a policy of aggressive monetary expansion.

I'm afraid, however, that many of our well-meaning friends in the financial community have developed a severe case of bubble-phobia. I actually had someone send me an e-mail recently chiding me for wanting to see a further expansion in money supply as well as my explanation that, in our current economy, there can never be too much liquidity. He had the audacity to write, "Please refrain from encouraging such notions." Please refrain indeed! If more people would "encourage such notions" we might convince the monetary authorities to chuck their hyper-conservative monetary policies and let the spigots run full force like they did in the late '90s. That would usher in times of economic prosperity the likes of which this country has never seen.

Most of the anti-bubble sentiment comes from the staunchly conservative, well-to-do, over-50 crowd. Truth be told, the bubble-phobia displayed by this group is an outgrowth of the fear of change that people over the age of 50 often develop. Bubbles bring rapid technological change and progress and the bubble-phobes among us are afraid of this. The ones that are in a position to actually benefit from bubbles and are flexible enough to take advantage of them are typically under 50. They haven't yet become set in their ways and are able to recognize the opportunities that bubbles bring and have no problem taking advantage of them. The under-50 crowd, in most cases, hasn't built up a solid nest egg yet and they're more likely to appreciate the immense opportunities for securing their financial futures.

Bubbles can indeed be used by the wise and prudent to get their financial houses back in order before the dire results of Kress Cycle deflation hits the financial systems of the world. They were used to great effect by many in the late '90s as many individuals were able to extricate themselves from debt before the bear market and recession of 2000-2002 came along. Bubbles can also be used to raise funds for retirement or to lay up an emergency reserve for the next recession. Smart business owners will use bubbles to their advantage by making needed investments in equipment and inventories ahead of the next business cycle downturn, as well as to increase cash reserves.

Another point worth mentioning is that with all the bearish psychology out there right now, even if we are in a bubble economy, you can expect the bubble to remain inflated and un-popped for a good long while. Bubbles don't pop when everyone is crying "Beware the bubble!" Investor sentiment is so horrendously bearish right now with short sales and put options near record levels that the stock market's "Wall of Worry" is certain to remain strong, and with it the economy. The present case of bubble-phobia is just what the market needs to remain firm in the face of all manner of internal and external pressures.

Like it or not, bubbles are an integral and permanent fixture of our modern day economy. You can vilify them all you want but that will do nothing to negate their presence or their magnitude. You may as well take the following tact and join me in saying, "Give me one more bubble before it all ends." And to the bubble makers: Make it a good one -- a bubble for the ages!


Bring on the Bubbles

Everywhere the talk, it seems, centers on one them:
"Financial bubbles everywhere!" all the pundits scream.
But while the pundits cower, there's one thing they ignore.
Those bubbles bring prosperity all across our shores.

"They're filled with air!" I hear one say in response to me.
But air's the most essential of all commodities.
Liquidity is the air and life of which I speak.
Without it our economy would be forever weak.

The Internet that each of us has come to depend,
Was brought in by a bubble which paid a dividend.
Technology was a bubble, too, if you will recall,
And one that brought enrichment to every one and all.

"But bubbles pop!" another says, and that sometimes is true.
But they do a lot of good for us 'ere their work is through.
Hot air balloons lift heavy loads, that much we can see.
Financial bubbles do the same, I think you will agree.

When money flows then companies can bring to their employ,
Great numbers of producers amid economic joy.
Bubbles make this possible, spreading dollars everywhere,
And every sector prospers -- the bubble doesn't care!

"Bring on the bubbles!" is my response to the bubble bears.
Return, ye bubble bashers, to your dark and gloomy lairs.
So don't direct your hatred against our bubble friends.
They'll lift you if you let them and help you to the end.



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