The Psychology Of A Market Bubble
We're in the eight year of an unflagging bull market that has seen the NIFTY quadruple since 2009. One that has withstood stormy politics, global shocks, the throes of demonetization, the semi-chaotic implementation of GST and three years of negligible earnings growth.
At the same time, cryptocurrencies have gone ballistic. Bitcoin, the blockchain based digital currency that not many of us have quite wrapped our heads around, is up a mind-bending elevenfold in the space of a single year. Predictably, "million dollars a Bitcoin" prophecies have begun floating around.
Are Financial Assets on a collision course with reality? That's anybody's guess, really. As Gaurav Rastogi, CEO of Kuvera, a Financial Planning platform points out: "Identifying bubbles in real time is hard. Stretched valuations can continue for long periods before correcting sharply"
That bubbles invariably end badly is a time-tested theory. Right from the Dutch mass hysteria of the 1600's that inflated Tulip prices beyond the bounds of rationality, and the infamous Missisipi Mania that gripped the French in the 1700's, to the more recent examples of the tech boom and bust and the real estate crash and burn, bubbles burst. Always.
The Siren Song of Stories
All bubbles begin with a good story. Stories of how dot com start-ups would magically transmogrify into billion-dollar conglomerates overnight, stories of how a country is all set to become an economic superpower under a new government, stories of how people will eventually ditch the concept of fiat currency and eventually use only digital coins and tokens to exchange goods and services.
Consider the fascinating narrative surrounding Bitcoin. A mysterious, supposedly Japanese founder whom nobody has seen, an underlying technology that has the genuine potential to disrupt the way global businesses function, and the freedom to bypass government controls while transacting across borders - the allurement is indeed irresistible!
Over time, these tales invariably pique the interest of more and more investors, and this up the price of the asset that is now ensconced within the narrative; creating what can be termed as a self-fuelling buying frenzy. As Jiju Vidyadharan, Senior Director, CRISIL, succinctly observes: "Market uptrends result from, and in turn feed, investor interest"
What next? The raging herd of overoptimistic investors proceeds to exhibit what is known as the confirmation bias - the dangerous tendency to view their favoured asset class through rose-coloured glasses. "Investors collectively focus on positive supporting data, while ignoring naysayers or doubters", points out Rastogi. Telling facts such as the nearing of an all-time high price to earnings ratio, or the complete absence of a model to attach an intrinsic value to an innovative new digital asset, are conveniently swept away in a mighty wave of overexuberance.
Eventually, the asset bubble bursts - sometimes triggered by an event, or sometimes for no apparent reason at all. This typically occurs at the point in time when return comparisons and avarice are at all-time highs. "At the peak, like in 2008, markets are driven purely by greed", observes Rastogi.
Banal - but powerful - advice
The best defences against a market crash are simple - disciplined investing, and a diversified portfolio. While this advice may seem deceptively banal, it is powerful nonetheless. Diversification ensures that the capitulation of a particular asset class in your portfolio won't wipe you out, while disciplined investing will allow you to benefit from rupee-cost averaging and protect you from overcommitting moneys at peak prices; while parallelly alleviating your "fear of missing out".
Vidyadharan adds that staying put for the long haul is another defence mechanism against bubbles. Alluding to the recent spike in interest in Equity Mutual Fund SIP's, he says: "While disciplined investing is good, it needs to continue for long - despite volatility in the underlying market, for best results".
