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THE NEXT BUBBLE?

In an April 2007 piece entitled Rolling Bubbles, I suggested that we were in a world of recurring bubbles, commencing with the technology bubble in 2000, followed by the real-estate housing bubble, and in turn, the current collapse of credit and the demise of many financial institutions. This latest crisis is now well publicized and acknowledged by all investors. While most investors are still running from bank stocks, insurance stocks and speculative home purchases which have proven to be disasters, we are already looking for the next bubble to identify itself.

There are two asset classes which show bubble-like symptoms, but the diagnosis is not yet conclusive.

Commodity prices have boomed in bubble-like fashion. Dollar denominated commodities such as oil, construction commodities and agricultural crops have attracted investors and speculators chasing the scarcity thesis, believing that China and India, as maturing viable economic entities, will devour all remaining critical commodities on the planet. This same train of thought has fueled speculation in many foreign stock markets, especially the emerging and less mature ones.

American investors have been told for many years to invest a significant portion of their savings overseas. This theme has been repeated over and over to investment professionals, retail sales forces and the financial media to the point where virtually everyone has followed the same advice. Our weakened currency has helped deliver decent returns to Americans in foreign markets over the last few years. The sheer magnitude of American investment in these markets suggests that foreign stock markets could well represent the next bubble to be concerned about.

The logic leading to the conclusion goes something like this:

If we accept the fact that the financial crisis is indeed a global phenomenon, and that the American version of this problem is being aggressively addressed by government and may well be in a curing phase, it is logical to conclude that America will be first to survive and remain the world’s largest and most liquid market. This conclusion is likely to be manifested through a surprisingly strong dollar. A strong currency will effectively cut the commodity costs of production in the U.S. while increasing these same costs to foreign economies. If American investors realize this and decide to bring their foreign wealth home, they must begin by selling their shares in foreign markets before converting back to dollars. Herein lies the problem. Are there buyers large enough and anxious enough to buy the American-owned shares at current prices, or will it take a significant decline in price before buyers can be found? Obviously, we’re dealing with aggregate numbers, but human beings show herd-like responses when fear strikes, resulting in an aggregate effect. Many foreign markets simply do not have the mechanisms or size to absorb much selling.

Wise investors understand the emotions of greed and fear. After all, it is these emotions that cause and burst bubbles. One can be sure that wise investors are currently watching the value of the dollar very closely.

About the Author


Harlan J. Cadinha
Founder, Chairman and Chief Strategist
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