Why We Love to Call Everything a Bubble

I wanted to give you an update and share some good news: The Bubble Opportunity Hedge Fund is up more than 22% this year thanks to our significant holdings of long-term government bonds, Bitcoin, and urban real estate.

Alright, I don’t really run a hedge fund. But back in 2017, I did joke on Twitter that someone should create a portfolio consisting solely of assets that pundits love to warn are in a bubble. The premise was that people always call things that have gone up a lot a bubble, and most of the time those calls are wrong (or at least very premature), so it makes sense to buy them all as a basket.

Paul McNamara, who runs an actual nonpretend hedge fund at GAM, went ahead and constructed a hypothetical bubble portfolio a few days later, consisting of things such as Netflix, Tencent Holdings, Tesla, a Canadian apartment REIT, a London property company, the Grayscale Bitcoin Trust, the Argentine century bond, Japanese government bonds, long-term zero-coupon U.S. Treasuries, and so forth—you know, all the things people have been calling overd for years. Some of the positions have blown up (thanks, Argentina), but by and large, performance has been robust.

OK, enough horn tooting about my own fake abilities at constructing a portfolio. It’s a fact, though, that ever since the financial crisis, people have been claiming nonstop that we’re in one bubble or another. In 2010 you could find warnings that a new dot-com bubble was forming or that Canadian real estate was in one. In 2011 there were postmortems (LOL) of a Bitcoin bubble—hardly the last of those. Thanks to Google searches, I could go on, but you get the point. Calling bubbles is a popular sport, even if winning is tougher than it looks.

But why is making those calls so popular? Well, for one thing it allows you to feel sophisticated. You can furrow your brow, shake your head sagely, talk about how “history always repeats itself,” and then cite something you once read in Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds. And as pointed out by Mark Dow, a longtime trader and the brains behind the Twitter account @BehavioralMacro, there’s a nice element of unfalsifiability to bubble calls. “You can’t prove something isn’t a bubble,” he says, “because tomorrow ‘could be the day.’ And there’s always a tomorrow.” Furthermore, the world has, in Dow’s words, “disaster myopia.” With the business cycle increasingly being driven by financial markets and with the crisis of 2008 still seared into people’s minds, a bubble is the easiest, most vivid metaphor to use.

Helene Meisler, a stock market columnist who’s been active in the market for four decades, offers a similar explanation for the current obsession with bubbles: “I have often thought that we are all products of when we ‘grew up’ in the market. So, for example, folks who grew up in the ’70s are always looking for inflation. Those who grew up in the ’80s are always on alert for a crash.”

When I ask McNamara what prompted him to play along with the joke about a portfolio of bubble positions, he tells me, “As someone who works in markets, I’ve learnt the hard way that an awful lot of the time when the market is pricing something seemingly strangely, either a) the market is right or b) even when the market is wrong, it’s really hard to profitably take the other side.”

He also sees a very heavy moralistic element to the bubble callers—its no fun to watch sinners enjoying themselves. And there’s a reason the gloomy chorus keeps getting louder as the financial crisis fades further into the past. Bubble talk, says McNamara, is “especially common in the (non-tiny) group of people who got ’08 right, but then got hosed in ’09 because they were waiting for the other shoe to drop in the form of mass defaults, depression, and hyperinflation.” In the view of those people, the high asset valuations of today can only be sustained because the market is rigged by the Federal Reserve and other central banks.

McNamara’s comment about the temptation to call something a bubble just because the market is pricing it strangely brings us perfectly to today and the world of negative interest rates and bond yields. The concept of loaning money and getting paid back less just feels wrong. It hurts the head. Since bond yields fall when prices rise, negative rates mean people are paying a lot for bonds. So is the bubble for real this time? The problem, according to Dow, is that for as much as bonds have rallied, you don’t see many people buying them to get rich (like they’ve done with stocks, houses, and Bitcoin). There’s not much of a bond FOMO trade.

Now, I have to admit when asked to do this piece, I was nervous. I didn’t want it to be about the folly of endless bubble warnings—and then the next day it all blows up, and I look like the economist Irving Fisher, who proclaimed in mid-October 1929 that stocks would remain permanently high. The Great Crash started about a week later.

So this isn’t to say that there aren’t risks. William Cohan recently wrote a piece for the New York Times arguing that there’s a gigantic debt bubble and that the Fed urgently needs to hike rates to prick it before it gets further out of hand. He likened the current situations to mortgages before the financial crisis.

Yet it isn’t clear that “bubble” is the most useful term here. Srinivas Thiruvadanthai, a strategist at the Jerome Levy Forecasting Center, says the risks are real but the description is wrong: “Is there an unsustainable increase in leverage? Yes. Why not say it that way?” His definition of a bubble is simple. It occurs when people are “buying an asset purely on expectations of rising prices and where the potential for price appreciation is several fold.” Because bonds have a fixed end point and a more-or-less predictable return if you hold them to maturity, it’s hard for them to generate the same bubble dynamics you see with Bitcoin or internet stocks.

Of course, it’s probably a lost cause to get people to stop using the word “bubble” every time they see prices going up. Bubbles are undeniably fascinating. My personal favorite is the Florida land boom of the 1920s, which got so out of hand that the railways clogged. Maybe just having a favorite bubble is part of the problem. People love to say, “Those who do not learn history are doomed to repeat it.” But another relevant truth for investors is, “Those who learn their history are doomed to think it’s repeating.”

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