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Succesful Investing - Valuation - mania's and bubbles


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"Stock market bubbles don't grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception."
Our latest presentation on investing looks at bubbles, why they happen and what to look out for.

Published in: Economy & Finance
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Succesful Investing - Valuation - mania's and bubbles

  1. 1. Valuation – Mania’s & Bubbles “How not to be your own worst enemy”
  2. 2. Valuation – Mania’s and Bubbles
  3. 3. Introduction The first stock exchange was found in 1602, the first equity bubble was 118 years later – why do bubbles occur?  Usually a great story:  Internet will change the world  House prices don’t go down (in the US)  This times its different If efficient market theory is true how can it be that bubbles exist?
  4. 4. “At the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman. It is generally considered the first recorded speculative bubble” So how can we watch out for bubbles……
  5. 5. Valuation – Mania’s and Bubbles If we define a bubble as a (real) price movement that is at least two standard deviations from the the trend then:  Assuming efficient market theories, a bubble should should occur every 44 years  However, there have been 30 bubbles since 1925 (roughly one every three years)  Each of those bubbles burst returning it to two standard deviations  Statistically that should happen according to efficient market theories every 2000 years not 30 times in 87 years!
  6. 6. Valuation – Mania’s and Bubbles Why bubbles?  Over optimism – people believe they are better than they really are  Illusion of control – people believe they will know when to get out  Self serving bias – people believe what they want to believe  Inattentional blindness – people don’t pay attention to what they are not looking for
  7. 7. Valuation – Mania’s and bubbles Take a sport like basket ball:  Team in white and black  People asked to count number of passes made by white team  Half way through guy in a gorilla suit walks to the middle court beats his chest and walks of  60% of people failed to see it, caught up in counting the passes
  8. 8. Valuation – Mania’s and bubbles Bubbles are a by product of human behaviour, they have the same pattern  Change in circumstance – internet creation  Credit creation – finance available  Euphoric – mania  Financial distress  Revulsion They will continue to happen because its who we are…