In a world of bubble: What Toronto condos, Apple, tulips and Beanie Babies have in common

Bubbles have been around for hundreds of years. So why is it so hard to know if you're in one before it bursts? Four signs to recognize bubble trouble before it&rsquo;s too late.

Bubble trouble: These tulips may look innocent but you probably don't remember the great tulip bubble of the 1600s. It crashed when the Dutch government declared tulips are not investments.
Bubble trouble: These tulips may look innocent but you probably don't remember the great tulip bubble of the 1600s. It crashed when the Dutch government declared tulips are not investments.  (SVEN HOPPE / AFP)  

What do Canada’s real estate market, Apple shares, gold prices, and the entire country of Australia have in common?

The answer starts with a “b” and rhymes with “rubble,” – which is all that investors may have left when prices suddenly come tumbling down, as pundits insist they will.

All the above are being called bubbles.

From tulips and shipping to high-tech and, economic bubbles keep popping up.

When investor euphoria takes hold, it pushes up prices and demand to unsustainable levels. People say the sky-high prices are justified – until it all comes crashing down.

The word bubble is thrown around a lot these days, said Steve Foerster, professor of finance at Richard Ivey School of Business at the University of Western Ontario.

“It’s not a new term and there’s a long and colourful history of speculative bubbles that goes back to the 1600s. Bubbles have been applied to commodities land, railroads, canals, ships, stocks, real estate, all kinds of things.”

A prominent economist recently warned that Australia is a “gigantic bubble.”

Australia’s mining industry, rich with reserves of gold, iron ore, and nickel, and natural gas, has benefited from huge demand from China. The boom has pushed up the value of its dollar and its real estate, and experts wonder if it is sustainable, given worries about a slowdown in the Chinese economy.

“Australia is actually already in trouble,” independent economist Andy Xie, a former Morgan Stanley chief economist said at a seminar in Hong Kong. “The Aussie dollar is so strong because everybody believes in commodities,” even as demand wanes.

Dylan Grice, global strategist for Societe Generale, has a new report called Popular Delusions, arguing that the bull run in commodities that has enriched Australia is inflating a credit bubble, which itself is being inflated by a Chinese credit bubble.

The trouble with bubbles is that there is no precise definition, and they can be hard to spot – until they’re over. “Often times we don’t know that a bubble existed until upon reflection we say a bubble must have just burst,” Foerster said.

In the last five years, gold prices have risen from the $600 (U.S.) per ounce range to a peak of over $1,900 last September. It has recently settled in the $1,600 (U.S.) range, where some say it is still cheap and others argue it has farther to fall.

A rash of media commentary this week suggested shares of technology juggernaut Apple were in a soon-to-burst bubble.

The company’s shares, which traded in the $300 (U.S.) range through late 2011, are now trading above $600. That’s an increase of nearly three-quarters over the last year.

“As far as I can see Apple is valued by a logic all of its own, where the upsides are valued to the max and the downsides are written off – this is classic bubble thinking,” Clem Chambers wrote on this week.

The stock fell back, but then soared again as the company delivered second quarter earnings of $39.2 billion (U.S.), easily beating Wall Street expectations.

Though often difficult to define, economic bubbles tend to have four distinct parts:

  The price run-up: Consider the bubble in the late 1990s. Soaring technology stocks helped drive the Nasdaq to a peak of over 5,000 points in March 2000. Stocks of companies that had little in the way of actual sales or profits went through the roof as investors clamoured for equities that seemed plugged into the fledging Internet era. Shares of InfoSpace reached $1,305 (U.S.) per share in March, 2000, but traded at $22 a year later. Canadian stock market darling Nortel Networks traded at $124.5 a share.

  The euphoria: from tulips to the dotcom bubble, the sentiment is the same. Investors are desperate to get in before it’s too late. During Amsterdam’s tulip mania in the 1630s “homes were mortgaged to buy tulips while the bulbs were still in the ground, and they were subsequently sold and resold many times before flowering,” Laurence Booth, finance professor at the Rotman School of Management at the University of Toronto wrote in a chapter on the history of bubbles in the Introduction to Corporate Finance.

Naysayers are roundly shouted down as “not getting it,” and observers and experts are happy to explain why “this time it’s different,” when rationalizing why an asset class has taken off. There’s also a feeling that values will continue to rise. Dow 36,000, anyone?

  The event: this is the euphemistic term that refers to something that pricks the bubble, sending prices plummeting. The tulip craze ended abruptly when the Dutch government declared that tulips were not investments. Sometimes it’s a sudden change in government policy or an increase in interest rates, or it can be as nuanced as a change in market sentiment.

“It can vary from bubble to bubble. It can be a change in government policy or a pause in reflection, ‘What’s this thing really worth?’” Foerster said.

“That can lead to a crash or panic as everyone wants to rush for the exits and not be the last one holding the bag.”

  The sober second thought: Soaring stock prices drove a blockbuster merger deal worth $160 billion (U.S.) between American Online and Time Warner. The deal was called disastrous and unwound eight years later for a fraction of its original price tag.

In 1720s England, the frenzy to acquire shares of the South Sea Company ensnared thousands of small investors, even Sir Isaac Newton. The famed physicist and astronomer lost a tidy sum on his shares, Booth wrote, an experience that prompted him to declare, “I can calculate the motions of the heavenly bodies, but not the madness of people.”

Housing experts and economists have been warning of a bubble in Canadian real estate for more than five years.

Even Bank of Canada Mark Carney, who used to wave off suggestions of a housing bubble, has been speaking up sternly. He said in a recent broadcast interview that “there are issues, particularly in some parts of the country in the condo market, without question, where activity has been particularly strong, as reached back to the levels of the late 1980s.”

Average house prices are now 12 times personal disposable income, way above historical averages.

Predictions for the housing market range from a soft landing, where prices decline by 5 or 10 per cent over several years, to prices plummeting by as much as 25 per cent in a matter of weeks.

The trouble, of course, is seeing when the end will come. “Is it going to be next week, is it going to be next month? That’s what’s going to be extremely hard to predict,” Foerster said.

No matter the bubble, how big it gets or how it bursts, the common denominator is greed, Foerster said. “You watch your neighour who has perhaps naively invested in a stock and regardless of the fundamentals they are doing extremely well and you don’t want to miss out on that.”

The point is that everyone who bought “Beanie Babies” or “baseball cards” or gold and silver exhibited the same sort of herd mentality that is exhibited in financial markets, Booth said in an interview. “It is a human trait.”