Asset Bubbles - Looking out for the Red Flags
Asset bubbles are not a new phenomenon in the financial markets though they have become more popular in the last two decades due to the significant market crashes of 2000 (Dot-com crash) and 2007 (Sub-prime mortgage induced crash). The first asset bubbles in the history of financial markets date as far back as the 17th century with the “Tipper and See-Saw Time” and “Tulip Mania” bubbles in 1621 and 1637 respectively.
According to the Federal Reserve Board of San Francisco, an asset (price) bubble describes a situation in which an asset price has risen above the level justified by economic fundamentals, as measured by the discounted stream of expected future cash flows that will accrue to the owner of the asset. This results in over-inflated asset prices fuelled by excess and persistent demand for assets as investment vehicles.
Unfortunately, bubbles do not last forever, and are typically followed by busts, more commonly described as market crashes. Indeed, the bubblebust cycle makes for
two possible outcomes – an exponential growth in wealth of investors, or a devastating erosion of capital leaving investors frustrated.
It is therefore important for investors to be able to identify the warning signs of asset bubbles in order to avoid being caught on the wrong side of the tide. This is even more important for investors who do not have an overly strong appetite for risk.
Consequently, we highlight, some of the most evident signs of asset (price) bubbles.
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