Business, Legal & Accounting Glossary
An economic bubble is a situation where a large amount of liquid cash is channelized to specific markets like stocks, dot-com or housing. Increased demand for stocks of a particular sector leads to inflated prices. However, this is normally a limited period of prosperity and late investors in search of astronomical profits actually go bankrupt. Equity market bubbles lead to resource allocation to such sectors, which are not sustainable in the long run. A bubble burst is accompanied by deflating prices. Negative effects of a bubble burst often transcend geographical barriers of the country of its origin (due to the interlinked nature of modern economies).
In markets, a bubble is an extended period of extreme overvaluation. Bubbles occur in stock markets, real estate, commodities and precious metals. There have even been bubbles in the flower market, the most famous example being the Dutch Tulip Mania of the seventeenth century. Bubbles are formed when excessive speculation enters a market. Instead of viewing the intrinsic value of an asset, speculators in a bubble market instead focus on the resale value of the asset. This is sometimes referred to as the greater fool theory of investing. In a bubble, it doesn’t seem to matter that a price is irrationally high – it only matters that it can be sold for an even more irrational price at a later date. Bubbles often end with steep declines, where most of the speculative gains are quickly wiped out.
All bubbles eventually burst – whether it be those found in soap powder, the U.K. housing market or those associated with the stock market. Unreasoned and excessive buying of shares in a company that is financially weak, and/or becomes overvalued, will increase the market price of its shares to unsustainable levels.
The ‘rising’ phase of the upturn tends to become an increasing ‘buying frenzy’. Investors tend to increasingly believe if they don’t ‘buy now’ they’ll miss out and be forced to pay even higher prices later.
Older brokers ought to know better if they’ve been around for previous crashes, but even they invariably get caught up in wild exuberance. You know something is becoming ‘a bubble’ when
A bubble in the U.K. housing market burst in the late 1980s, taking prices down by 30% or more in some areas over the next six or so years.
The most famous stock market bubble was the South Sea Bubble of 1720. Stocks in the South Sea Company soared spectacularly, only to crash equally spectacularly.
Dot-com bubble burst in 2001. It was essentially a stock market bubble. Dot-com bubble was powered by the proliferation of Internet sites and the global tech industry. Investors worldwide suffered huge financial losses in the dot-com bubble burst. This ushered in an economic recessionary phase in the first half of 2000. Internet companies engaged in aggressive growth strategies (putting profit issues in backburner) during the dot com bubble era. Investors put in huge amounts of money in these companies attracted by their daring business practices and associated glitz and glamour. Unfortunately many companies failed to attain targeted growth in business and profits. Unscrupulous business practices like borderline monopolies were formed. Outsourcing also led to substantial unemployment in IT sector. Again post 2001 terrorist attacks in the USA, IT companies engaging in questionable bookkeeping were pulled up by the US government. All these negative market sentiments piled up for the tech industry and ultimately people were in for a major stock market crash.
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This glossary post was last updated: 26th March, 2020 | 0 Views.