There is a natural desire to want more in every human being. Human nature also dictates that we don’t want to miss out on anything.
History students of financial markets know that market manias and bubbles have occurred hundreds of times throughout history. Exactly what is a bubble? When asset prices rise based more on emotion than fundamentals, it is considered a bubble. Psychology plays a role in the formation of bubbles. However, we must keep in mind that bubbles are also created by the monetary policies implemented by the Federal Reserve.
What makes bubbles pop?
We have seen bubbles pop in recent market history due to tightening monetary policy by the Federal Reserve, such as we are seeing in 2022. Some examples follow.
During the mid-1960s, a U.S. stock market bubble developed led by the so-called “nifty 50,” 50 large-cap stocks on the New York Stock Exchange that investors flocked to because of their high returns. For five years, up until 1972, nifty fifty stocks returned nearly 28% per year; in 1972, they returned over 43%. Comparatively, the S&P 500 returned about 6.7% for those five years, and just under 19% in 1972. What caused this bubble to pop? To combat inflation, the Fed raised interest rates aggressively.
Federal Reserve interest rates were cut 11 times in 2001, bringing the benchmark rate down from 6.00% to 1.75%. As a result, one of the largest housing booms in American history took place. The ultra-low rates homeowners and builders took advantage of from 2002 through 2005 skyrocketed housing prices across our nation. As institutional players began investing in risky and complex mortgage-backed securities, the housing bubble became more complex. In 2005-2007, the Fed increased interest rates, which deflated the housing market, which only worsened with the 2008 financial crisis.
Cryptocurrency investors suffered devastating losses in 2022, depending on when they invested. Currently, Bitcoin prices are hovering around $16,500, down from over $64,000 in November 2021. In 2022, the Fed raising rates had a negative impact on crypto market gains, as well.
Stock market bubbles have been widely argued during the multi-year run-up to the January 2022 high – fueled by years of near zero percent interest rate policies from the Fed. In 2022, the S&P 500 is down 16% and the NASDAQ composition index is down 29% after six interest rate hikes.
What you need to know about surviving booms and busts in the bubble economy
An investor’s emotions play a role in the investment process. In the case of bubbles, investors learn a hard lesson about speculation.. It’s okay to speculate. There are a few lucky people who can make money this way. Speculating, however, can cause you to lose 100% of your money.
The path to long-term wealth building may not be glamorous, but it is a proven method, and it involves diversifying into non-correlated assets like physical gold and silver. A safe-haven investment and value store throughout history, gold has served investors well. Gold-allocated portfolios perform better than those without. Speculation is what you should recognize it for if you want to do it with a small portion of your portfolio.
Physical gold, on the other hand, has been a store of value for thousands of years and is a proven asset.
Despite declining 5%, gold remains one of the best-performing asset classes in 2022. This is compared to a 16% decline in the S&P 500, a 29% decline in the NASDAQ composite index, and a 13% decline in the iShares Core U.S. Aggregate Bond ETF (AGG), which tracks U.S. investment grade bonds.
Rate hikes aren’t over for the Fed. As a result, the stock market bubble of the past few years hasn’t yet deflated. The stock market has continued to fall over the past month, while gold has been rising. This time may be an opportunity to increase your gold allocation before the stock bubble bursts any further.
