A Fascinating Observation About Bubbles And The Fools Who Trade Them

Scott Sumner has a great observation about financial bubbles. He notes that the NASDAQ peaked in March 2000 at over 5048.62, and then by October 2002 it troughed at 1114.11. Today it’s at 4336.22, which means stocks were ridiculously cheap in October 2002.

As of today, it looks to me like investors were somewhat more insane in October 2002 than March 2000. In absolute terms they might have been roughly equally wrong. The values of 3000 and 3200 are roughly half way between the 2000 highs and 2002 lows. But it’s percentage differences that matter in investment. If you can’t see that, consider this example. You are looking out the window at a new Mercedes parked at the curb. You comment that the car probably cost $US80,000 new, and your friend says he’d estimate it was about $US1000 new. If the actual value was $US40,000, who would have made the more reasonable guess? And yet who was closer in absolute terms?

I believe humans tend to notice absurdly over-priced assets more readily than absurdly underpriced assets. People are more likely to talk about the fools who bought stocks when the NASDAQ was 5000, than those who foolishly sold when it was 1100 a few years later. Or the fools that bought Vegas property in 2006, not those who sold London property in 1994. Or those who bought Bitcoins at $US1000, not those who sold Bitcoins when they were $US5. You might say that sometimes people might have to sell, but they never have to buy a particular asset. That’s true. But even people who sell and then reinvest in something else seem to get a pass. It’s the buyers who pay too much who are mocked.

Read Sumner’s whole post >

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