"The Last Great Myth of Every Financial Euphoria"

See how financial markets are governed by waves of optimism and pessimism -- not cold reason

by Bob Stokes
Updated: March 06, 2018

Beware of the "New Normal" in the Stock Market!

The January 2018 Elliott Wave Financial Forecast put it this way:

After two decades of Mania Era asset bubbles and sentiment extremes, what now seems normal to many investors is actually highly abnormal.

That's right -- many investors no longer fear asset bubbles. That is why too many will be caught off-guard when the Mania Era inevitably ends.

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Many investors are not frightened by the phrases "stock market bubble," "housing bubble" or any other type of financial bubble.

Because, by the time the talk of a bubble makes it into the news cycle, investors perceive the long rise in asset prices as the norm and "today" as "different."

A classic Elliott Wave Theorist made the point this way:

It's never irrational exuberance in the present, only in retrospect or in the future. To quote the White Queen, "The rule is: jam tomorrow and jam yesterday--but never jam today."

For example, even as the bull market in stocks celebrates its 9th birthday, read these headlines:

• There Is No Bubble: Why Stock Bears Continue To Cry Danger -- Seeking Alpha, Feb. 7, 2018
• There's no reason to run from the stock market -- CBS Moneywatch, Feb. 7, 2018
• Stock market fall looks like a correction, not a crash -- The Guardian, Feb. 6, 2018

Also think back to 2005, when housing prices were soaring and house flipping was the rage. In November of that year, the Elliott Wave Financial Forecast mentioned another fatal assumption about bubbles:

After Manhattan real estate prices collapsed 12% in the third quarter [of 2007], the NY Post asked "Could it be the bursting of the real estate bubble? Not exactly. There are no indicators that this is the beginning of a crash. Think of the current kinder, gentler bubble, not a catastrophic burst, but a reality check, a skimming of the froth, a round of requisite price corrections that is seen as a welcome necessity." This is the last great myth of every financial euphoria; that the excess can be slowly "unwound." It is exactly what was said about technology stocks in May and June of 2000.

Around the same time, this headline reflected the sentiment of then Fed chairman Ben Bernanke (Washington Post, October 2005):

There's No Housing Bubble to Go Bust

Less than a year later, housing prices peaked in June 2006. But there was no "slow unwinding."

Instead, home foreclosures skyrocketed through 2010. Some markets, like Las Vegas, saw housing prices plummet more than 60%.

Or, think back to technology stocks in 2000 -- no slow unwinding there, either. This chart is a reminder:

Instead of a methodical and rational unwinding, the technology-heavy NASDAQ crashed 78%.

Here's a more recent example of a bubble bursting: the October 2007 DJIA top followed by a 54% crash:

Financial markets are driven by emotion --optimism and fear -- not by cold reason.

So, it's a myth that financial bubbles are "rationally" unwound or deflate slowly.