Identifying bubbles seems to be a preoccupation of more and more market participants these days. Talk about bubbles in treasuries and gold seem to be everywhere currently. They will likely be right at some point. However, it does seem that many people were shunning real estate because of the threat of a bubble years before it actually peaked. It is easy to see why there is so much fascination with trying to time bubbles. After all, think of all the money you would have if you could get in at the low and get out at the top ! Never having to worry about the aftermath of bubbles would make investing so…idyllic.
There are certain aspects of bubbles that are predictable. Namely, one can predict with a very high degree of confidence that we are going to see numerous bubbles in the future, just like there have been in the past. A bubble timer may correctly identify different phases of every bubble (Stealth Phase, Awareness Phase, Mania Phase, and finally Blow Off Phase.) However, the challenge is that every bubble is just different enough to make timing them practically impossible.
For example, you may remember the story of hedge fund manager Julian Robertson who in the 1990s very correctly and loudly pointed out the Dot.com bubble. As a result of his conviction that the technology bubble was going to burst, he refused to participate in technology in the late ’90s and his hedge fund, Tiger Management, lost 4% in 1998, and lost 19% in 1999. Tiger Management closed down in February of 2000, just before the bubble burst. He was absolutely right on the fundamental story, but the timing was off.
Capitalizing on bubbles is a major reason that relative strength strategies have the potential to deliver superior results over time. However, instead of trying to identify tops in bubbles we simply allow the market forces to dictate when we exit a trade. Invariably, we will exit the trade after the trend has declined from its peak and we will have given back some of what was gained in the often multi-year run-up to the peak. However, it is better to make money than getting caught up focusing on how the market should perform based on your fundamental position, no matter how correct that fundamental position is.
