these silly bubbles

If you're a young working professional (aka a "yuppie"), you've been blessed with having experienced at least 1 1/2 bubbles. The dotcom bubble has faded into bittersweet memory, and right now, the housing bubble isn't sure whether to keep inflating or to pop in many hot markets around the country. Depending on where you were when you were a kid, maybe you might've remembered the casualties and damage from the Japanese economic bubble tailspin.

We know what a bubble feels like, and when we're likely to be in one. But, how is a bubble defined? What's the quantitative description of a bubble?

I've thought about this over the last few days, and believe, for starters, I've found two ways resulting in the same conclusion.

Here's one way of describing it, based on an advanced copy of a book I've just received for review:

EXUBERANCE - How Bubbles are Formed

Stage 1: FUNDAMENTALS change in ways that increase the EQUILIBRIUM PRICE of the asset.



Stage 2: The dramatic increase in SPECULATION of FORWARD ACTUAL PRICE appreciation (as measured by the PSYCHOLOGICAL PRICE ANNUAL CHANGE PCT), that was created in Stage 1 fuels a continued large increase in ACTUAL PRICE well above any continued increases to the EQUILIBRIUM PRICE.

Click here for more examples and supporting data.

And here's a very abridged summary, but well worth-noting, of how notable investor William Bernstein describes it in his timeless tome from 2002, "The Four Pillars of Investing":

The necessary conditions for a bubble are:
- A major technological revolution or shift in financial practice.
- Liquidity - i.e. easy credit.
- Amnesia for the last bubble. This usually takes a generation (Bernstein defines a generation ~ 30 years)
- Abandonment of time-honored methods of security valuation, usually caused by the takeover of the market by inexperienced investors.

So, keep these salient points in mind when wondering whether the current real estate market is in a bubble state.

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One last interesting bit I wanted to tack on before closing this post out. I know there are a few websites out there who've made mention of this without exactly commenting,

Housing Boom! Kenneth L. Fisher 02.26.07

"You can see right through the housing crash story by looking at the prices of housing stocks. The market knows what the economic worrywarts do not, which is that the housing sector is already making a comeback. In the last six months housing stocks are up 24%, well ahead of the overall market. If housing were destined to fall apart in 2007 these stocks wouldn't be so strong now."

"Did you know that housing sales are up in the last few months, not down, and that inventories are lower than six months ago? We're accelerating, not landing. This is true not just in housing but also pretty much across the board."

Whether the current wobbling real estate market is in a bubble or not, the least the quote above does is insult the average investor's intelligence, especially coming from someone who purports to be a leading figure in the investment financial world.

The first problem is, inferring Mr. Fisher's quote, he feels the real estate market is highly liquid, like stocks are. Any serious home-shopper, flipper, investor, and homeowner knows, *as a fact*, that real estate is very obviously illiquid.

The second farce is Mr. Fisher's correlation between homebuilder company valuation and the real estate market. Unfortunately, it seems Mr. Fisher fails to account for the large majority of real estate out there: existing, pre-owned units. I agree that homebuilders attempting to clear inventory are forced to play competitive fit and fiddle with pre-owned comparable homes, but newly-built unsold homes are not the sole, key market driver in real estate (with the exception of master-planned communities that didn't exist until recent mass home-building populated it).

Also, Fisher never specified exactly which type of housing sales are up, and not down, in the last few months? Is inventory lower now than a few months ago because of increased sales volume, demand once again crossing over its equilibrium point with supply? Or is this due to exhausted, frustrated sellers whose listings failed to garner considerable interest?

To be fair, Fisher's focus really seems to be on housing STOCKS vs. the real estate market. The two couldn't be any more different as, say, pricing oil stocks vs. used automotive stocks, for example. The average Joe may automatically associate oil and cars as related, but just because ExxonMobil, Valero, and Chevron are reporting record profits doesn't mean the sum of Toyota, Honda, GM, Ford, and DaimlerChrysler have a rosy future ahead of them.