I have been trying to get to grips with the meaning of investment “bubbles” for a couple of years now (for instance in this blog post about tulip mania). I first started to look into this during the local property boom when I was also studying finance. However, there’s increasing talk online of whether we are now in some sort of tech bubble, akin to what happened around the years 1999-2000 and resulted in the dot-com crash.
I wouldn’t say that I have a mature position yet on bubbles, but I think I know enough to say that we’re not in a tech bubble. At least, not yet.
One problem with a test for a bubble is that it is difficult to know for sure that you’re in one until after they’re over. For one sure sign of a bubble is that it ends in a crash – the bubble pops. At this point, prices of the investments in question drop quickly, and many people lose a fortune.
Other signs of a bubble, such as speculative investors (people investing because they expect prices to go up due to investor behavior not necessarily due to increase in underlying worth) or dodgy investments are present in most markets most of the time, and shouldn’t be a concern of themselves. You would hope that in a market there are a variety of positions being taken on investments for a variety of reasons, and that new investments can be introduced into a market if there is a demand for them.
Also, many markets are naturally cyclical, with regular booms following busts over time. Just because a market is hot doesn’t mean it’s in a bubble, although it probably means prices are higher than otherwise warranted, in which case you’re unlikely to pick up a bargain. But people investing for the long-term with diversification across different markets can typically ride-out a cyclical decline.
That said, the first reason I don’t believe we are in a tech bubble is that currently a decline in the value of tech start-ups wouldn’t result in the average punter losing a fortune, because the average punter is not able to invest in tech start-ups. We’re not in a situation, like back in 2000, where an ordinary investor can invest in the latest crazy tech stock on the NASDAQ. It is really VCs and Angels who are taking the risks right now. So, we can’t yet experience the sort of widespread disaster that characterizes a crash.
The other reason I don’t think even the keen anticipation for the Facebook IPO could make this a bubble is that a bubble is a description of a market and not a single investment. You can’t really talk of a 13 Pearl St Essendon bubble or an Enron bubble (even while their stock did crash and wipe many people out). We would need to see average people investing in a variety of new tech companies for there to be a bubble in the tech market.
But there may be signs that this could yet occur. Services like Kickstarter and IndieGoGo have sprung up that allow everyday people to pledge or commit money to a cause, which might be to bring a product or service to market. If causes start to take on more investment characteristics, this begins to look like a means for early stage investment in tech companies.
If I start to hear about people extending the mortgages on their homes to put funds into Kickstarter projects, I will be worried that we’re in a bubble, but I’m not worried yet.