Bubble 2.0

Wait for the pop!

Yes it’s happened again. Our memories must last about ten years. We have a new bubble in Internet stocks.

Well one does hear that a typical stockbroking career lasts around 10 years before the person is burnt out and moves onto a slower pace of life. So that means that the majority of the market participants weren’t around, or were only in very junior jobs, when the last bubble happened, and certainly they would not have been in a position to recognize the signs of the bubble starting. Hence they are not in a position to recognize the signs repeated this time (hopefully some are smart enough to recognize them for the first time though).

And Ben Bernanke is helping the bubble develop. Last autumn he hinted that more quantitative easing could be introduced. In a “heads I win, tails you lose” market, Bernanke’s offer can only do one thing.

David Porter and Vernon Smith have simulated asset bubbles (for example, see http://www.cs.princeton.edu/courses/archive/spr08/cos444/papers/porter-smith03.pdf) and concluded inter alia that

These bubbles diminish with experience; trades fluctuate around fundamental values when the same group returns for a third trading session. Thus, common information is not sufficient to induce common rational expectations, but eventually through experience in a stationary environment, the participants come to have common expectations. If we suppose that investors are more “inexperienced” the longer it has been since the last stock market crash, the laboratory results are corroborated by a study showing a 98% correlation between the severity of declines in the Standard and Poor index and the length of time since the last crash.

Vernon Smith and Steven Gjerstad have written an interesting article in the Wall Street Journal.

So sorry folks, it looks like the combined wisdom of the market is just too young. Time to put your fingers in your eyes to reduce the impact of the pop!

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