In a recent Wall Street Journal article, columnist Jason Zweig argues, “Rather than regarding overvalued assets as a bubble, we might consider them a fire. The more it expands and the hotter it gets, the more havoc it can wreak.”
“The image of a bubble is itself a misnomer,” Zweig argues, noting that bubbles often “barely expand before bursting.” Alternatively, financial markets, he says, can expand five- or ten-fold “and then collapse at least 50% in a flash, burning millions of speculators and sometimes charring entire economies.”
To support his thesis, Zweig cites a new book titled “Boom and Bust: A Global History of Financial Bubbles” by finance scholars William Quinn and John Turner (of Queen’s University Belfast), that outlines analysis of 300 years’ worth of market movements using what the authors describe as a “fire triangle” metaphor. Market manias, they explain, are sustained by the following three components equivalent to oxygen, fuel, and heat:
- Oxygen = marketability, or the ease of buying and selling an asset.
- Fuel = money and credit. “Low interest rates make investing with borrowed money cheaper, while paltry yields on safe savings compel people to invest in riskier alternatives.”
- Heat= speculation. “When prices go up, more people buy, inflaming prices even more and attracting another rush of speculators.”
The book contends that while these three components are necessary, a market “fire” also requires a “spark” which can come in the form of new technology, government intervention or a combination of both. Zweig writes, “The stock-buying binge of the late 1990s was sparked by euphoria over the potential of the internet. China’s more-recent market booms have been stoked by government policies and propaganda.”
Regarding today’s markets, Zweig notes concern that “a fire among a few giant stocks can set the neighborhood ablaze,” adding that “after the technology-heavy Nasdaq collapsed in 2000, the broader S&P 500 also tumbled.”
He concludes by noting that recently, smaller and cheaper “value” stocks have begun showing signs of recovery which, “could reduce the market weight of blazing-hot giants like Amazon. That might be the firebreak that this market needs.”
