Bubbles All Have a Familiar Pattern… They All Pop

Dear Reader,

The history of smart people doing dumb things is long and storied.

In 1720 — exactly 300 years ago — Sir Isaac Newton penned his complete and utter incomprehension of mankind’s capacity for speculation with these words…

 I can calculate the movement of the stars, but not the madness of men.

The rise, rise, rise and fall of the South Sea Company share price was the source of Newton’s bewilderment, frustration and more importantly, his lost fortune.

After a successful foray into the stock — ‘buying low and selling higher’ — Sir Isaac defied his inner voice of reason and surrendered to the market’s seductive lure.

Newton’s second (and even larger) investment sowed the seeds of his undoing — buying high and selling lower…much lower.

Port Phillip Publishing

Source: UK Telegraph

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Sir Isaac could not resist the temptation of an exponentially rising market.

Newton is recognised as one of Britain’s greatest physicist.

He was no stranger to logic.

But, as we know, emotions are not logical…they’re irrational.

Which is why smart people continue to do dumb things.

In the late 1990s another bunch of really clever people made the same mistake…allowing greed to short circuit rational thinking.

Long-term capital management (LTCM) was a large hedge fund led by Nobel Prize-winning economists and renowned Wall Street traders that nearly collapsed the global financial system in 1998 as a result of high-risk arbitrage trading strategies.


They were ‘too clever by half’ as defined by Wiktionary as…

shrewd but flawed by overthinking or excessive complexity, with a resulting tendency to be unreliable or unsuccessful.

Human nature is our most predictable and reliable indicator

Even though our forefathers’ errors of judgement are well known and documented, we’re compelled to perpetually repeat them.

Central banks are brimming with intellectual firepower. Yet, these bastions for the academically gifted continue in their dogged pursuit of the dumbest of dumb policies.

Learn about the critical factors that affect the rise and fall of the Aussie Dollar. Download your free copy of this special report: ‘Will the Aussie Dollar Enjoy a Post-Pandemic Resurgence?’

How you expect to cure a debt crisis with more debt defies all logic. It’s so recognisably dumb that only really smart people could have come up with this ‘solution’…and then sold it to the mob.

And it’s not like we don’t know how the story of too much debt ends.

Professors Carmen M Reinhart and Kenneth S Rogoff have written several scholarly articles and books on debt crises.

Here’s an extract from their paper titled ‘From Financial Crash to Debt Crisis’:

…employing a comprehensive new long-term historical database for studying debt and banking crises, inflation, and currency crashes…

The data covers 70 countries in Africa, Asia, Europe, Latin America, North America, and Oceania.

The range of variables encompasses external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodity prices.

Our analysis spans over two centuries, going back to the date of independence or well into the colonial period for some countries.

Exploiting the multi-century span of the data, we study the role of repeated extended debt cycles in explaining the observed patterns of serial default and banking crises that characterize the economic history of so many countries—advanced and emerging alike.

200 years of data. 70 countries.  A range of variables.

Seems like that should be enough information from which to draw a reasonable conclusion.

And what might that conclusion be?

Extended debt cycles DO NOT end well

Repeated extended debt cycles with observed patterns of serial default.

How much more evidence is required to conclusively prove that extended debt cycles DO NOT end well?

You have to seriously ask what do they teach these economic theorists at uni?

Since the beginning of 2008, the world’s major central banks have created over US$17 trillion…out of thin air.

Port Phillip Publishing

Source: Yardeni Research

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The rationale for this irrationality was explained away by former Fed Chair, Ben Bernanke, on 4 November 2010:

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

The god old ‘wealth effect’ theory.

Before embarking on this grand experiment, Bernanke should have listened to Yogi Berra…

In theory there is no difference between theory and practice; in practice there is.

Lower corporate bond rates will encourage investment…well, that’s true. But that all depends on your definition of investment.

As reported on 13 April 2020:

Port Phillip Publishing

Source: World Finance

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Most experts agree that the monetary policies seen over the past decade have exacerbated the [zombie] problem. Historically low interest rates coupled with quantitative easing (QE) may have helped developed economies avoid collapse during the 2008 financial crisis, but they have also created a credit bubble that is difficult to sustain.

A lot of that corporate bond money has gone into some not so creative accounting.

Share buy-backs. Goosing up earnings per share (EPS). Padding out dividends. And, the real end game, enriching executives.

Lending money to companies that do not have the revenues to fund debt obligations — zombies — is really, really dumb investing.

But that’s what Bernanke put in train when he starved investors of a decent risk-free return on capital.

Bernanke is a seriously smart guy…just ask him.

But he has proven beyond any reasonable doubt that when it comes to economics and market he is beyond clueless.

How simple people can be street smart

All you have to do is follow the parabolic curve.

Bubbles — like Tulip Mania, South Sea shares et al — all have a familiar pattern…gradual then parabolic and then…POP.

In the December 2017 issue of The Gowdie Letter (before the crypto bubble burst) I wrote:

I do not profess to know much, if anything at all, about technology.

From what I’ve read and I think I understand, there appears to be some real commercial value in Bitcoin’s underlying blockchain technology.

But on the current price, is there really US$200 billion worth of value?

I think not.

For a little context, this chart compares bitcoin’s meteoric rise (as a multiple of starting price) to some famous asset bubbles since 1900.

Port Phillip Publishing

Source: Value Walk

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The exponential rise in bitcoin’s ‘value’ should have acted like a FLASHING RED sign…

either get out if you’re in OR stay out if you are thinking of getting in.

But it didn’t. People rode that wave of manic crypto stupidity to the very top.

On a more up to date ‘bubble’ pattern, here’s what’s happening in the US with the mania over the current cycle’s market darlings.

Port Phillip Publishing

Source: Bloomberg

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I know, I know…it’s different this time.

The response to defend the pricing lunacy is as predictable as the human nature that created the bubble.

And, here’s one final chart that tracks the ratio between the S&P 500 Index and the NASDAQ 100 Index.

Port Phillip Publishing

Source: Real Investment Advice

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The comment within the chart says it all…

Over 25-years The NASDAQ 100/S&P 500 Ratio has hit 4-standard deviations of the 4-year moving average only twice.

We know when that previous time was don’t we?

The dotcom boom was followed by the NASDAQ falling over 80% in value.

Yeah, I know, it won’t be the same this time.

Ah…the madness of men.


Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion