Bubbles don’t exist. But that doesn’t stop people from seeing them. In 2015, I predicted that the 21st century would see an unprecedented number of bubble claims, due to the fact that people have trouble accepting the fact that low real interest rates imply high P/E ratios.
A few years ago, many people claimed the Canadian housing “bubble” was bursting. This Business Insider headline discussing Canadian housing is from June 2016:
‘This is a bubble. A very big bubble. And it is going to end in tears’
And Bloomberg in June 2017:
Canada’s Housing Bubble Will Burst
And the Financial Post in September 2015:
Canada’s ever growing housing bubble: As Alberta’s market tumbles, the rest of the country wonders who’s next
Here’s TheMotleyFool in January 2016:
Why 2016 Could Be the Year Canada’s Housing Bubble Bursts
It’s a major embarrassment that the media prints these sorts of stories. It’s no different that claiming stocks will go down because Saturn is aligning with Mars in the constellation Aquarius.
In fact, the Canadian housing “bubble” never did burst:
Instead, local markets occasionally dropped slightly, reflecting local conditions. Might the national market plunge at some point? Yes, that happened in America after 2006. But that has nothing to do with mythical “bubbles”. It simply reflects the fact that efficient markets go up and down. For a bubble theory to be useful it would have to be able to predict asset price movements. Since they cannot do so, the theories are not useful.
PS. The Financial Times article that I took this graph from points out that Canada’s real estate market is booming:
Signs of exuberance in Toronto’s housing market abound. The city’s skyline is a forest of cranes. There were 120 at the last count in July, according to the Rider Levett Bucknall crane index, more than America’s three-largest cities — New York, Los Angeles and Chicago — combined.
They suggest that rapid population growth (driven by increasing rates of immigration) plays a role:
Canada is also experiencing its fastest population growth since 1990, while jobs and wages are on the rise. In September the employment rate for those aged 25 to 54 — prime working age — hit 83.6 per cent, the highest level since Statistics Canada began tracking the measure in 1976.
PPS. Ever since the early 2000s, people have been predicting that the Australian housing bubble would burst. I’m still waiting:
Australian house prices rise more than at any time in past four years
PPPS. Some commenters tell me that just because they think something’s a bubble doesn’t mean they predict it will burst. Oh really? Then why choose this metaphor:
READER COMMENTS
P Burgos
Nov 10 2019 at 9:29pm
At some point an investment just has a bad risk/return profile relative to other investments. Why not call that a bubble?
Scott Sumner
Nov 11 2019 at 1:19am
Bad in whose opinion? Yours? Mine? The market’s?
P Burgos
Nov 11 2019 at 7:04am
I would think that if professional investors don’t want to invest in it and yet retail investors do, and the retail investors drive up the price, that might be a bubble. The underlying dynamic being that the professionals don’t believe that the price the asset is being bought for is worth the future cash flows. Of course, that raises the question of why the retail investors are buying it up, the reason being that someone is doing a really good (perhaps fraudulent) sales job.
I think a good example is Florida property in the aughts, especially outside of metro Miami. I don’t believe that right now the prices have reached the same prices as before the financial crisis/great recession. So why were people paying so much money for those houses? Sure, the prices had risen, and interest rates had fallen. But were there any credible reasons to believe that some combination of employment, wage and population growth would combine with a restrictive regulatory environment and/or lack of land to make housing more scarce in Florida metros? Were rents rising rapidly? That’s what I think of as a bubble.
Michael Sandifer
Nov 12 2019 at 11:47pm
The vast majority of professionals don’t beat the market consistently.
JdL
Nov 11 2019 at 6:54am
You assert “Bubbles don’t exist.” So … the tulip mania in Holland around 1637, that wasn’t a bubble? Certainly prices peaked and then dramatically crashed. By saying that never never is there a bubble in prices, you are engaging in a semantic quibble, which seems (to me) to be rather pointless.
Your points about housing prices in Canada are solid, and you can clearly argue that in this case there was no bubble, assertions to the contrary notwithstanding. But to claim that bubbles never happen seems silly to me.
Philo
Nov 11 2019 at 10:24am
Of course, Sumner didn’t say that the price of something never goes up and then back down. Though he didn’t define ‘bubble’, I think he meant that there is no reliable theory that would allow one to recognize a risen price as about to return to its earlier, lower level *before the price had actually gone back down*.
Scott Sumner
Nov 11 2019 at 1:10pm
I recommend Peter Garber’s book on the Tulip Mania.
sty.silver
Nov 11 2019 at 1:28pm
The point is that stock prices are always hard to predict. You don’t know how they will change if they’ve gone down so far, and you don’t know how they’ll change if they’ve gone up so far.
You can define bubbles as times when prices suddenly fell by a lot, and that gives you a consistent definition. But it has zero predictive power. And as a matter of fact, people are talking about bubbles as if they had predictive power. So the thing that doesn’t exist but people keep seeing is bubbles with predictive power.
Michael Sandifer
Nov 12 2019 at 6:22pm
Though Scott doesn’t come out and say it, there’s no reason to believe there was a tulip bubble. It’s likely a myth.
robc
Nov 11 2019 at 8:06am
I dont think there is a bubble in bubble calls. If there was, there would be an expected collapse in bubble calls and the Paulson of bubbles would be shorting the market in bubble calls.
Matthias Görgens
Nov 11 2019 at 10:35pm
If bubbles do exists, you’d expect to see more of them in areas that are harder to short. There’s no way to short bubble calls that I am aware of.
(I specifically write ‘areas’ instead of markets, because I assume that areas of the economy that are so restricted that you can’t even call them markets would be the most bubble prone.)
Colin Michael Steitz
Nov 11 2019 at 11:01am
I am wondering whether there is a misunderstanding in economic as to the translatability of a “bubble” into a full-blown financial crisis or anything that needs to be fretted over. Whether or not bubbles exist, the damage that asset price collapses result in is varying with respect to the risk it posses to capital requirements and liquidity.
Nick
Nov 11 2019 at 1:19pm
Scott, I dont quite understand your call here. is your view that the media will just generally predict more bubbles, and that that will have no predictive power? in which case I have no strong reason to disagree, the financial media already generates nonsense headlines almost constantly. Their objective isn’t to create correct valuations though, its to sell adverts, talking about bubbles seems to do that.
If your call is instead, no one can reliably say when things are overvalued then I think you are wrong. Some (but not many) people consistently make money in financial markets predicting rebounds or falls in valuation. I don’t believe anyone will reliably predict all bubbles, but that would seem a rather strict criteria for success.
robc
Nov 11 2019 at 9:26pm
That was my argument in a previous bubble thread. That Paulson made billions shorting the housing market proves that predictable bubbles exist. Even if rarely.
Matthias Görgens
Nov 11 2019 at 10:37pm
I’m not sure, that’s the case.
What’s your assessment of George Soros’ bet against the Pound? Was there a Pound bubble?
There was no bubble in the housing market, but there was definitely a bust. (See Kevin Erdmann’s ‘idiosyncratic whisk’ blog for details.)
robc
Nov 12 2019 at 1:17pm
https://fred.stlouisfed.org/graph/fredgraph.png?width=880&height=440&id=CSUSHPISA
Looks like steady growth with a bubble/bust in the middle to me. The bust exists, but the bubble does too.
I have only wanted to short things 2 times in my life:
SCOX during their profit-via-lawsuit phase.
The housing market in 2004.
I didn’t have the capital available to do the first at the time, and the second I would have been too early and didn’t know how to do it anyway.
I think bubbles are rare, but they do exist. And some people can see them and profit off of them.
Nick
Nov 12 2019 at 3:16am
That one person (paulson) did it once is not evidence. But there definitely are investors who are clearly better than chance at predicting asset price moves. Probably the best known modern case of a bubble (that was clear at the time) was VW stock when porsche were trying to take over them. Various aspects of the situation caused people to have to irrationally buy VW stock, VW temporarily becoming the most valuable company in the world, then a very quick fall back.
In general it is clearly not easy to see bubbles.
robc
Nov 12 2019 at 1:20pm
It is evidence. It may not be convincing, but it is a point in the favor of the “bubbles exist” argument.
Not every time an asset is priced too high is a bubble, so maybe an argument can be made that the housing market was just a misallocation and not a bubble, but people doing crazy stuff like 50 year mortgages and 120% mortgages screams bubble to me.
Nick
Nov 13 2019 at 3:24am
that people were offering 50y mortgages and 120% loan to value is evidence that either those people did not think it was a bubble, or potentially they had perverse incentives. In hindsight we know they many did have perverse incentives.
Scott Sumner
Nov 12 2019 at 9:52pm
I think Paulson got lucky. After that big win his fund did poorly (if I recall correctly.)
Nick
Nov 13 2019 at 3:21am
I think it’s worse than that. I think he initially did fantastically well on a small(er) capital, everyone allocated funds to him, then he did poorly. I’m not sure if the absolute gains were bigger than the absolute losses, certainly the percentage gains were higher.
robc
Nov 13 2019 at 8:06am
Did he get lucky or just predict one of the tiny handful of true bubbles?
If bubbles are rare, but not non-existent, what would it look like? I think that was it.
Oh, and one nitpickity thing that bothers me, it wasnt a housing bubble, it was a land bubble. Structural values dropped, but not much. The underlying land value cratered.
Thaomas
Nov 12 2019 at 1:05pm
Intellectually it may be annoying, but since investors are not being misled by “bubble” talk, what’s the harm.
Lorenzo from Oz
Nov 12 2019 at 6:46pm
Because it may influence policy. Indeed, it has and not in a good way.
robc
Nov 12 2019 at 9:10pm
That is where having the libertarian view that policy shouldnt exist comes in handy.
If there is no policy, it cant be influenced.
Nick
Nov 21 2019 at 9:26am
https://www.ft.com/content/8ca3219c-0c1f-11ea-bb52-34c8d9dc6d84
not a story about investors making billions , but from the quick read this looks about as obvious a bubble as youll ever get.
strange choice of words on the other company they mention saying it was “attacked” by short sellers, then it seems to offer genuine reasons one might doubt that the company was as valuable as suggested.
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