Sunday, July 17, 2005

Speculators are Doomed to Forever Blow Bubbles

This Washington Post article makes some good points:
...the theoretical argument over what constitutes a bubble doesn't help ordinary investors much. No matter how many I-told-you-so stories we hear now, a clear consensus identifying the recent tech-stock experience as a bubble didn't emerge until after its collapse -- satisfying a famous rule of thumb that bubbles are known only by their bursting.

In the making of investment decisions such as whether to buy a house in Malibu or a technology mutual fund, after-the-fact information comes too late. That's a problem, because nobody who makes those decisions can afford to ignore the issue.

In the absence of better answers, investors can at least imprint on their minds the idea that bubbles represent a separation of the market price from the basic purpose of the asset in question.

So investors can begin an informal test for bubble conditions by examining their own motives for buying a stock. If we are working from some reasoned appraisal of what the company might earn in five or 10 years, based on a study of its business model, we can hope we are on solid ground. If it's because "they're talking about a price target of $500," probably not.

So, too, with houses, which in their essence are places for people to live, not price-appreciation vehicles. It's a reasonable certainty that people will always need a roof over their heads; price appreciation is a wish, not a need.

There was a time, just a couple of generations ago, when the standard advice given to new homeowners was to depreciate one's investment by, oh, 3 to 5 percent a year in doing one's family accounts. Like cars and many other consumer durable goods, houses lost value as they aged.

How quaint, I thought even then. Time had already given the younger generation a different set of expectations about the economics of houses.

Then again, we also say "how quaint" today when looking back on assertions, widely advanced less than a decade ago, that stocks in the New Economy were going to behave differently from the way they did in the Old.

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