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Bursting my bubble
As regular visitors to this page may well be aware, perhaps the only thing I ever had in common with Michael Jackson was an interest in the behaviour of bubbles. Indeed, having again touched on the subject only a few weeks back, I had resolved to steer clear of it for the foreseeable future - until, that is, I discovered a whole chapter of Barclays Capital’s recently published Equity Gilt Study 2010 is entitled, Bubble identification and some implications.
Obviously, this is dangerously subversive stuff because this column’s take on asset price bubbles, as you may again be only too aware, is that they are a mischievous breed and, while one person or possibly a handful may truly be able to spot one, when they gain any sort of widespread coverage, they tend to deflate just enough to drop off the radar - until, of course, we have all forgotten about them.
Perhaps a little unkindly, this column also maintains bubbles only interest the majority of investment commentators to the extent that flagging one up in advance - on whatever basis (or lack thereof) - enables them to look back when it pops and say: “I told you so.”
With that in mind, I then recently wrote the line: “That bubbles only work in hindsight is a minor inconvenience”. As such, the appearance of a theory - and from no less an authority than the Equity Gilt Study - that bubbles might not only be identified in advance but also used as “a decent source of alpha” has come as something of a shock.
Nor am I even able to take any comfort from this being the brainchild of an economist - there being good reasons why you can’t spell that word without a “con” and a “mist” - for the chapter that has painted my sky green and my grass blue was penned by Barclays Wealth’s Michael Dicks. He is, if I read my notes correctly, an econometrician and that sounds a whole lot more scientific to me.
According to Dicks, policymakers are now taking a much greater interest in stopping asset price bubbles materialising in the first place. Even so, he reasons, unless they suddenly become hugely successful in doing so, investors who help eradicate bubbles once they have appeared, by tilting their portfolios along the lines he suggests, should manage to tap the aforementioned decent source of alpha.
Dicks looks to illustrate two simple - it may not surprise you that is his word not mine - ways in which asset price bubbles can be identified in practice. If you are interested in finding out more about these methods, then for reasons of space - both the amount available here and that between my ears - I trust you won’t mind if I direct you to www.equitygiltstudy.com rather than attempt a more indepth explanation.
Now, good sport that he is, rather than attempt to come up with “rules of engagement” for policymakers who want to stop asset price bubblesfrom growing too big and hurting the economy when they pop, Dicks instead considers how investors might take advantage of the fact bubbles cannot grow indefinitely.
He says: “It turns out there have been quite large gains to be had, in terms of riskadjusted returns, from adopting such a strategy in the past. We suspect that if policymakers start to identify and squeeze bubbles before they pop, then it should help investors who are acting with a similar mindset when making their investments.”
Fortunately - at least for me and probably a few others who might otherwise have one less subject on which to hold forth - Dicks reckons it will be very surprising if policymakers manage to prevent bubbles from arising.
However, he goes on to say: “Their policy actions may well mean that, on average, bubbles stay smaller and last for shorter periods of time than in the past.
“With history therefore an imperfect guide to the future, the rules we suggest may need amending to allow the investor to become more nimble - but we doubt very much that the world has changed so much they will be totally defunct.”
As I say, this has all turned this column’s world upside down. I’m off to have a little lie down on the ceiling.
Julian Marr is editorial director of marketinghub.co.uk
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