Yet, the high levels of investments or even relatively high valuations are not by themselves signs of a bubble. By definition, a bubble must burst to exit. Thus, many bubble-looking trends may simply turn out to be sector corrections or simply valuation excesses that are subsequently corrected, but not wiped out.
However, the fact that we don’t have a similar situation to 2000, whether in number of IPOs, in P/E ratios, etc., does not mean that we are not in a bubble. In fact I believe that we have had several bubbles since 2000, and we have just experienced another one this year. Furthermore, I believe that these are healthy patterns and there is no reason for investors to be alarmed about having a bubble. Let me explain both of these assertions.
Economic bubbles or broad-based speculative bubbles of the kind we had in 2000 usually arise due to external catalysts and fertile environment. The key characteristic is a disassociation of asset prices from the intrinsic value of the assets. Broad-based speculative bubbles are often quite destructive and asset prices rarely reach the bubble peak ever again.
By contrast, what I would call “Industry Bubbles” occur more frequently and are comparable to normal “business cycles” in the broader economy, and help advance the growth of a sector. I define Industry Bubbles as excessive valuations and asset prices that reflect an overly optimistic scenario, based on projections of recent growth patterns. Industry Bubbles are also useful in eliminating sectors and companies that are not sustainable in the long term. This happens because during the ascension phase of a bubble, both strong companies and unsustainable models rise together.
Over the past ten years, we have witnessed a number of industry bubbles or bubble-looking events.
Three more recent examples are:
One thing that both broad-based speculative and industry bubbles have in common is how they develop, which is one reason people often lump them together. There are five stages in a typical bubble:
1. Early interest
2. Momentum gaining
3. Late comers join in
4. Interest peaks
5. Bubble is burst
Investors of both private companies and public equities are best served not by worrying about bubbles constantly but focusing on the companies that have a substantial consumer value proposition and try to invest with valuations that are sustainable even if optimistic. This is because nearly most bubbles can only be recognized once the bust has happened.
So are we in a bubble? Yes, and that’s a good thing.