Dynamics of a Market Bubble

Bespoke Investment Group LLC has an insightful look at how market bubbles form and then burst on its blog.  The lesson is that when the bubble bursts, there is often little time to get out before all of the gains are lost.

Bubbles: The More They Go Up, The More They Go Down

The carnage continues for oil this morning as the commodity is currently trading in the low $30s.  As shown in the first chart below, after rallying 732.6% from its low of $17.45 in 2001 to its high of $145.29 this July, oil is now down an astounding 76.1% from its peak.  In the past, we’ve compared the oil bubble with the Nasdaq and homebuilder bubbles.  At its current price of $34 and change, oil only needs to fall another $2 to see the same declines that the Nasdaq saw during the bursting of its bubble.  The only difference is that it took years for the Nasdaq to reach its lows, while oil has declined by almost as much in just a few months.  Back in September, we highlighted our bubble comparison and suggested that oil in the $30s wouldn’t happen until 2011 if it took the same track as prior bubbles.  At -76.1% in 5 months, oil’s fall, like the drop in the Baltic Dry Index, is one of the most extreme bubble bursts in history.

 

Below we compare the inverse of oil during its runup from 9/01 to 7/08 with the regular price of oil from 7/08 to present.  Our goal here is to show how much quicker assets usually decline than they go up.  It took more than 1600 trading days for oil to reach its highs and just a little more than 100 to move back down close to its lows.

 

[SOURCE: Bubbles, The More They Go Up,  The More They Go Down, Bespoke Investment Group LLC, December 19, 2008.]