We're in an asset bubble currently, what can I do about it?

Question

My opinion is that we are in an asset bubble: house and property prices are sky-rocketing, interest rates are low, and inflation rates are high.

I'm aware of the futility of trying to time the top of the boom/bust cycle. Other than blind luck, I will never be able to buy and sell at the magic moment to get it just right.

Assuming my opinion about the asset bubble is correct, what should I keep in mind when I go through day-to-day life?

I'm just an ordinary John Doe with a bit of spare money. What should I keep in mind in an upwards market (with the knowledge that a downwards market will be coming), when looking at:

• Buying property
• Investing in small businesses
• Purchasing commodities
• Making decisions to take out loans

Note I'm not looking for specific advice on investments. What lessons can we learn from hindsight and from historical asset bubbles, that we can apply today?

Answer 1

Just be aware that your three items you mention are incredibly different

1. Buying property
2. Purchasing commodities
3. Investing in small businesses

Here's a graph which shows 20 or 30 years:

Don't forget these are many-decade graphs:

Things that you "invest" in, look like this^†:

Things that you "trade" in, look like this:

"Starting a business or product" looks like this:

"Investing" is either the major stock market indices, or, real estate. You buy and hold forever. {In some cases, you even as a bonus get income of some form along the way.}

"Purchasing commodities" (oil, gold etc) is inherently timing the market. Looking at my graph #2 you believe that over the next (let's say) five years, you know it's gonna go up or down and you act on that. You can't "invest" (ie, over long periods of time) in oil or gold or FCOJ prices, they simply go up and down over long time periods.

The three things you mention are not even the "same category of thing".

You can't "invest in" oil; conversely you don't really try to "time" a real estate purchase or the S&P index in your retirement fund (you just "buy and hold forever"). And businesses are completely unrelated to either investing or timing; you either get unimaginably high gains (thought of on a percentage basis versus what you put in) or you simply lose every cent. And there's very little connection to macroeconomic factors.

(Of course, you can trade anything - stocks, oil, houses, etc on very short time scales, but that's completely irrelevant here.)

"What lessons can we learn from hindsight and from historical asset bubbles, that we can apply today"

Be aware that you have in mind three wildly, wildly different "paradigm" of things.

What lessons can we learn from historical asset bubbles

The answer is simple and has two parts

1. Nobody, ever, has made money from a bubble, other than by sheer luck. It's the ultimate example of after-the-fact confirmation bias. The handful of examples (which were just after-the-fact confirmation bias) of someone or some thing "doing great!" in a bubble, have no correlation and are the perfect proof of the total randomness at hand and the utter inability of anyone to understand or make order out of bubbles, in spite of the endless (wholly divergent and diverse) theories on same.

2. Fantastic sums of money can be made selling books, newsletters, tv shows, etc. about how to make money in bubbles.

---

^† {Regarding the "investing" one, note that of course, it may go down slightly over time rather than up slightly, if you choose the wrong thing.}

Answer 2

We're in an asset bubble currently, what can I do about it?

The first step is to let go of the assumption that you know where in the cycle the market is. Point-blank assertions like this are something I ignore out of habit. I assume you posted it this way because you read it somewhere in this way. The kind of publications where things are printed like this are not the ones you want to get your information from.

What lessons can we learn from hindsight and from historical asset bubbles, that we can apply today?

• The market is efficient (*). This means that it is impossible (except maybe in very weird edge cases and when putting huge effort in) to "beat the market" with some strategy.
• Even if there existed some way, the people who live and breathe stock markets 24/7 will capitalize on it long before you as a private lay person ever know about it. If you figure something out, you can be 100% sure that someone else has tried it before.
• It is completely impossible for your to bank your success on reaction time. The big players work in terms of milliseconds or lower these days. As a lay person, you have hours or days from an event up to your decision, and then execution. (The same for other markets like houses etc., scaled appropriately.)
• Crashes happen, but the markets so far always recovered over a long period (sometimes months like during COVID-19, sometimes years or decades). We do not know when the next crash comes, but it helps to assume that a crash will be coming at some point in the future - be it through systemic problems, natural catastrophes or other unforeseen events. But do keep in mind that it could take months, years or decades until the next crash, we don't know.
• From these, it follows that the best (and in my opinion, only) strategy for a private person who just wants to put their savings somewhere is to follow the market as closely as possible. For example, when you're young, simply get some ETF which is as cheap as possible (i.e., little recurring/overhead costs) and which consists of a market coverage as large as possible (i.e., worldwide, or at least continent-wide). Humans will, over decades, always grow, and these ETFs reflect that growth.
• When you are old and start to use up the wealth stored in your investments, the focus shifts on deciding when to shift to ever less risky investments.

I can heartily suggest a decently old book for you, "The Intelligent Asset Allocator". Not necessarily for its concrete content - the example stocks/funds it uses are clearly focused on North American citizens, so if you're not American, it might not be applicable. But the general principles are still sound for everybody.

The most important takeaway for you is: nobody knows in which part of the inevitable cycle of crash-grow-crash-grow we are. Or rather, nobody who knows that would tell anybody else about it, at the very least the public. No, they would take the knowledge (if it were possible to have the knowledge, which it is not - for nobody) and get unfathomably rich.

This is the same as people posting in newspapers about the next greatest stock everybody should buy. They do not know how the stock develops. They are doing that to influence the market - they (or their partner) got some of the stock beforehand, and trust that enough people buy it so they make a tidy sum (or, alternatively, they simply want to sell magazines). For if their pretend knowledge were real, they would not bother writing an article. They would simply use the knowledge to make ungodly sums of money in private.

Finally, a good strategy is the same in every (unknowable) phase of the cycle: invest in a way that if a crash happens, you have enough time to just sit on your almost worthless instruments until they recover. As a regular "Joe Doe", you have zero chance of reacting fast enough (and correctly enough) to do much else. There are some addenda of course, all depending on your risk adversity and many other factors (like how to optimize taxes and such, how much cash reserves to keep to be able to quickly buy cheap instruments after the crash and so on).

(*) Side note: the comments mentioned the Efficient Market Hypothesis and the associated criticism and alternatives/extensions to it. I don't take sides here. This answer is targetted at somebody who is clearly a layperson, has no interest in digging very deep, and just wants to put a little saved money aside. In that context, assuming the market is efficient is useful for me to argue them out of psychologically motivated hasty decisions. I will not start arguing with Warren Buffet et al ;).

Answer 3

What lessons can we learn from hindsight and from historical asset bubbles, that we can apply today?

Other than to avoid bubbly asset classes, the past does not offer an easy path through a bubble burst. Sometimes cash and bonds are a great alternative to stocks (e.g. the 2000-2002 stock crash). Other times, because of inflation or insolvency cash or bonds are not a refuge (e.g. the 1973-1974 stock crash).

Answer 4

First the mandatory disclaimer: It is very hard to actually know whether you're in a bubble. I know you said to assume you do, so I won't argue with the premise, but it's worth noting that this is actually a very unrealistic hypothetical.

The problem as stated is not tractable. Knowing that you're in a bubble is like knowing you're going to die. It's useless "knowledge" because you are missing two critical pieces of the puzzle:

• When (the bubble will pop)
• How (high will the top be and how far it will drop)

Without this, there's not much action you can take. I had a lot of bitcoin when it was less than $10. When it hit $1k I thought, surely this is a bubble and cashed out on 1,000% upside. I have missed out on 5,000% of upside. Recently Bitcoin did "crash" - from 60k to 30k, a giant 50% drop. It would still have been 3,000% upside. Hindsight is of course 20/20, but the point is that being in a bubble does not imply that:

• The bubble will pop soon
• The bubble will not go much higher yet
• When the bubble pops, it will go lower than now

By definition a bubble is an overvaluation, which seems to imply that when it pops, people will no longer overvalue, hence their final price must be lower and the third point must be true. Unfortunately, that is not so. Valuation is subjective and people are under no obligation to return to rationality -- arguably the markets have not had rational valuations for most of their existence. Moreover, as the saying goes, the market can remain irrational longer than you can remain solvent.

The constructive thing to do is to reframe the thesis as a bearish outlook. Hopefully, the same sort of evidence used to detect the bubble, can also support the bear thesis. Not to belabor the point, but note that saying we're in a bubble is not really bearish - it is also bullish since the bubble could keep going, so there's really not much directional information in it. Anyways, if your outlook is bearish, then you should sell assets. You can short them, literally sell them, buy inverse funds, buy puts, sell calls, and use any number of similar strategies. You could also just hold cash in anticipation of the bottom, or buy supposedly uncorrelated assets like precious metals. You could look at things like reverse mortgaging your house. Each of these strategies has variables that go into pricing, and depending on your knowledge of when the assets will come down, which ones and how much, and the respective certainties you have, you can figure out the best strategy and the best price. The details of this would be out of scope for this question.

If you are not able to support a bearish outlook, then it gets tricky. You could frame it as a volatility play - you don't know where exactly it will move, but you do expect it to move a lot. Then you can buy volatility indices or trade various option spreads like short butterfly.

In every case, you will likely need to do a bit more than merely buying and holding a security. You'd have to set up some limits, stop losses, trailing stop losses etc. to account for the uncertainty you are expecting in the price.

The above is what you can do on the rent-seeking front, without doing much work. Serious bubbles often bring economic depression when they pop, jobs become scarce, purchasing power goes down, things become expensive. So you might try to prioritize gaining skills, work experience and increasing your employability so that you can bounce back post-crash. However, the trouble is that crashes can change the job market a lot, so it's hard to say which jobs will be lucrative after the crash. But nevertheless, the general idea is simple: Prepay for things you need that are currently cheap, defer expenses that are inflated. Hope you can last long enough.

Answer 5

Risk and reward go hand in hand. If you want to participate fully in the upside gains, for the most part you have to accept the risk of the downside. If you are willing to forego some of the upside gains (direct hedging cost or opportunity loss), you can hedge some of the downside. Such active hedging can involve buying puts, shorting equities or commodities, or buying inverse ETFs. The problem with these it that it takes conviction as well as market experience and most buy and hold investors lack both.

I have lived through three major bear markets, four if you count the 2020 pandemic which I consider more of an aberrancy than a traditional bear.

1987 showed me that the market can quickly take a lot of money away from you. That lesson showed me the importance of risk management and I avoided the bulk of the 50% drop in the 2000. By 2008 I was able to get out of the way of that bear and make a wad of money when the market craters.

Here are a few of my posts about hedging:

ONE

TWO

THREE

Answer 6

You could consider the Permanent Portfolio, an equal mix of stocks, bonds, gold, and cash that "reduces losses in market downturns".

Answer 7

First, before investing make sure you have a safety net should a recession come. This will limit your exposure to risk of any kind.

Second, whatever you buy, be it stocks, real estate or something else, do not overpay. Do not pay crazy prices just because everyone else does.

Third, diversify. Not all stocks are overvalued the same way. Some sectors and regions are more reasonably priced than others.

Fourth, keep in mind that asset price inflation can resolve in multiple ways. Prices can crash down, prices can stagnate for extended periods or "common inflation" can simply catch up. Each of those scenarios calls for a different hedge.
Also keep in mind that the severity of each scenario can be vastly different, both in absolute terms and relative to your personal situation. You already live in your pay off home? Stop worrying about home price inflation. You are 25 and just start investing in the stock market? Whatever bear market might come in the medium future, it will not decide your retirement. If you are in the mid 60s, things look vastly different

Answer 8

There is actually one form of investment which won't lose value in any crisis and might actually even increase in value when times are bad: Invest in yourself!

Spend money on the improvement of:

• Your physical health
• Your mental health
• Your practical skills and education
• Your relationships with people who are going to reciprocate

As with any investment: It is wise to prioritize long-term over short-term gains, to not invest money you don't have on uncertain gains and to start investing early in life.