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The Hot Potato Market


Fed hides problem assets on own balance sheet.

Everybody stands in a circle
Pass a beanbag around circle to music
When music stops person holding beanbag is out
Pretend the beanbag is a very, very, very, HOT POTATO

For years I've been writing about the burgeoning debt bubble which I named 'The Great American Debt Experiment.' Bubbles or manias are generally followed by a bursting of the bubble. Bubbles are nothing more than the crowd heading to an extreme position of greed, or investors and traders buying something because it's rising.

The need to get in usually leads to the pain I like to call '1-800'GET-ME-OUT.' Such is the cycle of markets including stocks, bonds, commodities and real estate.

I've always been amazed at how investors behave when trading intangible assets like stocks, rather than tangible ones like an automobile. When investors hear all their buddies are making a fortune in real estate or tech stocks, it's hard to resist buying because everyone hates missing out on the party.

Contrast that behavior to the typical local Sunday newspaper that's littered with huge sales on automobiles. Why will folks clamor for a car on sale, yet scorn stocks and bonds that are on sale? This dichotomy has always struck a chord with me.

In investing, I've always lived by the age-old adage of 'buy from the fearful and sell to the greedy.' Another way of stating this position is 'avoid the crowd at extremes.' Extremes in prices are usually accompanied by a parabolic move in prices, the peak of which is usually accompanied by the refrain that 'it's different this time.'

To me, the only actual difference is the asset or asset class, but the emotion is the same: greed. These sort of emotional tops are few and far between, but important when they occur.
These parabolic moves typically begin with a basing pattern that takes flight and can last two to three years, averaging 400-500% spikes upwards. This big move up is usually followed by a sharp break in prices of 20% to 30%, then an unsuccessful retest up of the previous high. The failure is followed by years of pain as greed slowly turns to denial, then acceptance, fear, capitulation, and finally despondency.

Previously I have highlighted the similarities of bubbles in Japan's Nikkei Index, the NASDAQ, homebuilding stocks and finally, Google (GOOG) and The Shanghai Shenzhen Composite. The charts below are truly amazing and define fear and greed at its best.

Broken Bubble Comparison #1-Nikkei, NASDAQ, Homebuilders, Google

Click to enlarge image

Broken Bubble Comparison #2-Nikkei, NASDAQ, Homebuilders, Shanghai Shenzhen Index

Click to enlarge image

I've lived through so many bubbles in my career, I'm sure I could produce dozens of these parabolic charts. It started in the early 1980's with a bubble in casino stocks, then theme restaurant stocks, cigar company stocks (believe it or not), and biotech in the early 1990's. The list goes on and on - the bubble in interest rates and inflation in the early 1980's and the bubble in the dollar in the mid 1980's.

In all these cases, those burned at the top loathe the same assets at the bottom of the cycle (the period of neglect) which is precisely the time to buy: buy from the fearful.

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No positions in stocks mentioned.

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