You would know a bursting bubble if you saw it?  Right?

Take a look at the following chart and tell me what you think.  Doesn’t it look a little suspicious?

Has a bubble formed, or even worse, has it just popped?  Take a good look and tell me what you think.

I know… you’re about to say No Fair!

I’ve purposely left the chart without the company’s name and withheld the share price (time vs. price appreciation) just so you can sit back and actually look at the chart’s trendlines.  Sometimes, too much data can overload your gut instincts, so it can be quite helpful to look at something from a different point of view.

We’ve got a slow and steady build up during the first half of the chart.  Followed by a nice trendline accelerating upwards at a 45 degree angle.  There are a few bumps along the way, but such sell offs happen when bad news surfaces.

Soon thereafter, the chart enters a parabolic or exponential growth phase where massive profits are made, and everyone is happy as a clam.  Like all bubbles, the stock reaches it’s zenith, sells off sharply, only to see another huge wave of buying, pushing the price even higher than the previous apex.  Finally, we’re left with one final round of selling… and a boatload of nervous investors!

So what is this company?  I’ll give the answer in just a moment, so please bear with me.  [Scroll down if your ADHD is kicking in.]

Bubbles from the Last Decade

It would appear that we’re a little sensitive when someone shouts bubble! Justifiably so considering the financial crisis of 2008.

Just in the last decade, we’ve had at least three well popularized bubbles form, only to burst in our proverbial faces.

1. The tech/dot com bubble that peaked in 2000.  Most of them are bankrupt or still below their peak stock price.
2. The oil bubble (light sweet crude) that peaked in July 2008 at $147/barrel.  Love those speculators!
3. The housing bubble that popped in 2007-2008.  Unfortunately, the jury is still out on this one but the aftershocks don’t look pretty.

But it’s not like we didn’t know the bubbles were there.  Right?

CNBC ran a story almost every week in 2007 talking about the real estate bubble.  Market mavens and long time investors like Warren Buffett wouldn’t touch an internet stock in 1999 because they were massively overvalued, never mind he admittedly couldn’t understand their true business model.  Even I bought into the housing market only to cash out five years later because my home skyrocketed in value and I was happy getting a stand up double, instead of trying to hit a home run (a common baseball analogy).

So, instead of playing it cautiously and being wary of such bubbles, it would appear that most of us prefer running blind… until we slam headfirst into a brick wall.

If you think that I’m wrong, ask yourself how many people you know whose retirement accounts lost half their value or the amazing statistic where 1 in 6 homeowners are now underwater on their mortgage because they bought a home at the peak of the housing bubble.

What Causes Bubbles to Form & Burst?

Greed, then fear.  In that order.  You always hear the markets are controlled by Fear & Greed, but I’ve always said it in the order it actually occurs.

A bubble forms innocently enough because they tap into the herding effect that all animals come pre-programmed to do (yes, humans are animals to).  Everyone gets wind that a hot new stock is about to soar, so we all buy as much as we can, and watch as our profits shoot the moon.  Problem is, we get so excited that we forget to do one very important thing — Sell!

Stock market analysts and business pundits love to pitch their latest stock picks, or as some people call them – financial porn.

Otherwise, they wouldn’t have anything to write about.  They throw lots of complex research your way, show a few flashy charts, but always forget to tell you one little detail.  When you should actually sell, and take your profits.

So by the time the information has filtered it’s way down the grapevine or made it’s way to the water cooler, it’s probably time that you should either sell the stock, or avoid it all together.

And that’s precisely what the traders on Wall Street are doing.  After the stock has doubled in value, they’re beginning to unload their shares and cash in some of those unrealized, paper only profits.  By that time, the peak has been reached, the snowball gains momentum as it rolls downhill, and the panic selling begins.

That’s when everyday buy & hold investors get fed up, curses the market, and stomps away like an angry child only to come back again when the market psychology has improved. The lure of the positive messages (perhaps even an illusion of euphoria) from the business section is just too seductive to ignore, and they repeat the same mistakes by investing at the top once again after the second bubble has formed.

If you need further evidence, take a look at past investment bubbles once they burst. Now that you’ve got hindsight and history on your side, can you see the similarities?

The Identity of The Mystery Chart

It’s actually a group of 500 stocks.  You might know it as the S&P 500.

Surprised?

Don’t be, because the data actually goes back to 1950, and on a long enough time line, the S&P 500 certainly looks different doesn’t it.

Now before the index fund lovers call me a black sheep for speaking ill of the S&P 500, just know I’ll likely suffer in a downturn with you since I own a few index funds myself.

I’m merely pointing out that it is remotely possible that the “reversal to the mean” principle may be in full effect, and the great bull market of the 1990s may have actually been a credit induced, ultra leveraged bubble in disguise.

Which could mean (my apologies for the pun), a further decline in the stock market.

Again, don’t shoot the messenger, but you have to admit, looking at that chart does make the hair on the back of your neck stand up a bit.

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