A Bubble of Liquidity
By Yours Truly

Last December we wrote an article on the concept of financial “Bubbles”. We explained simply what they are:

A state of booming economic activity (as in a stock market) that often ends in a sudden collapse”

We’ve seen many bubbles come and go throughout the centuries. But they never cease to amaze me. Not the bubble itself, but the general sentiment that generates one.

Rock Bottom. In order to create a bubble you must first create an image, a promise, a vision that has thus far been unfruitful. Investors see its future risky and complicated. This is reserved for keen contrarian investors who look for unloved, undervalued opportunities.
Think stocks and financial risk in 1980.

Phase #1. The Denial Stage. Next the buying begins but only for very few. Many have no idea of what is being bought or what gains have been made, nor are they interested in asking why. No news, No hype, No record highs. Just consistent, gradual gains. The way many value investors like it.
Think stocks in the early 80s, with the Dow breaking properly over 1000 only few had been able to buy below that.

Phase #2. The Speculative Stage. Word has already begun to leak out. Word on the street shows life and a simmer of hope presents itself. A few daring institutions and small investors buy in small quantities, while newspapers show “dodgy” ads on the back page advertising the next “Secret To Millions”. All said, the wave comes and goes, few buy in but later sell disappointed by its false promises and record highs come into view and then disappear again. For the most part the “general public” sits on the sidelines.
Think Stocks after the Crash of 87′ when anyone who held anything of the sort was easily convincing themselves that the end of equities had truly come.

Phase #3. The Bubble. The third wave of speculators begin to buy in. Usually institutions interested in making a quick buck off of an easy trade. But before long, speculative margin traders, smaller institutions, momentum investors and every Tom, Dick and Harry is on-board.
Think Tech Stocks in 1997-98 when even sharp declines in the Dow could not waver the people’s optimism.

Phase #4. Euphoric Blow-off. Speculation becomes most rampant and the wave attains full strength, easily convincing any rationale or emotion that the laws of economics have become secondary and that good things do last forever.
Think Cisco even after the Dow was in trouble when shareholders were still buying in at over 100 times earnings.

The Pop. Like a raging tidal wave the trend has drawn every last sucker into the fold, it then begins to give. Easily at first, the in jolts and finally with the ultimate crash that sends every man, woman and child running for cover – with or without their positions.
Think the day when the falsies of man came crumbling down together with the stock of their first love, Enron.


Let us adjust this to nowadays. I remember that in late 2005 Steve Forbes wrote in an editorial regarding the housing market that bubbles can only occur when people are not aware that its a bubble. Well we indeed did see housing prices rise for about another year before finally showing any sign of a slowdown.

So where are we? Where aren’t we looking that many should be. In my humble opinion the answer is simple: Money. The greatest investor of our time is known for his famous saying “Be Fearful when other are Greedy and Greedy when others are Fearful”. We live in times when the average man is definitely greedy. Market-Beating Returns, Day Trading, Speculation, Inflation and a fine lack of an understanding in the concept of an o’ so important word: Risk.

Many analysts in the stock market, even after the sell-off last month now see no chance of a major crash, nor do economists see any chance of a recession.

But let me tell you, It’s far more probable than Ben Bernanke and Henry Paulson are telling you, and they know it. The United States and most of the world now faces a Credit Crunch that many have not seen probably since the Great Depression. Few nations will be saved.

We live in a bubble of credit, in an age laden in debt – Public as well as private, held up by a bubble of liquidity and easy money, supported by a group of baseless appeasing bureaucrats and heading into a deflationary cycle (credit deflation) that will either make the nation’s currency worthless (through monetary inflation of its supply) or its inhabitants broke (through defaulted loans and strengthening qualifications for re instituting new ones).

We live in a world of misleading promises and uncompromising leverage and vulnerability. Investors have purchased stocks that trade for 20 times their earnings, the unemployed bought homes with exotic mortgages they could never afford and credit cards and paper IOUs have replaced the currency of exchange.

We live in a bubble of credit, in an age laden in debt – Public as well as private, held up by a bubble of liquidity and easy money, supported by a group of baseless appeasing bureaucrats and heading into a deflationary cycle (credit deflation) that will either make the nation’s currency worthless (through monetary inflation of its supply) or its inhabitants broke (through defaulted loans and strengthening qualifications for re instituting new ones).

We live in a world of misleading promises and uncompromising leverage and vulnerability. Investors have purchased stocks that trade for 20 times their earnings, the unemployed bought homes with exotic mortgages they could never afford and credit cards and paper IOUs have replaced the currency of exchange.

When it will implode nobody knows, but when it does, and implode it shall, those that doubted the very laws of nature that created their fortunes will grasp the sincerity of its force when it follows through on those very laws.

What to do:

Rule #1 – Minimize Debt. Before investing another dime use all monies to pay back as much of your credit cards and mortgage as possible.
Rule #2 – Cut back on spending. Don’t buy things you can’t afford with money you don’t yet have.
Rule #3 – Just Save. Many markets are far too risky to be buying into right now (yes, even in the long-term). Keep holdings in safe, hard assets and in short-term treasuries.

And remember… in Credit Crunches every extra dollar that has been produced in vain will ultimately be sucked dry.

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