What Happens After Bubbles Pop?

Hot Air Balloon photo via Pixabay on pexels.com

Success is how high you bounce back after you hit bottom.

– General George Patton

As long as people are involved in markets, we’ll get bubbles and crashes.

It’s glorious and horrible and a reflection of the emotional rollercoaster we ride when we put on risk. We’ve seen it over and over again throughout history. Which brings us to the question of the day.

What happens to asset prices after bubbles pop and what might this tell us about future prices?

There are three possible scenarios…

Scenario One: Sometimes, Prices Never Come Back

If you got long tulip bulbs during the second half of 1636 near the peak of Tulip Mania, we’re sorry to report, but you (your descendants really) are still waiting to break even and it’s not looking good.

At the height of this historic bubble, a buyer paid eight fat swine for one tulip bulb. Today, you can buy them online for $2 a bulb.

It’s been 400 years. In this case, the asset was never worth prices paid at the highs. The price behavior and the mania can be chalked up to human irrationality in its purest and most spectacular form.

A more recent instance might be the Nikkei 225. The index peaked in early 1989 near 39,000 and has not yet surpassed that high. It’s been 31 years in the desert, though recently, it has rallied a lot and only has another 23% to go.

We’re patient and so we’ll put the Nikkei in the too soon to tell camp. It could be a Scenario Two.

Scenario Two: Price Comes Back, Eventually

Sometimes, price recovers after a bubble pops but does so only slowly over a long period of time.

Let’s take the Nasdaq 100 Index after the internet bubble.

In March of 2000, the index closed near 4,700 after an epic run. Over the next 2.5 years, it fell to a low just below 800. Quite the crash.

It took 15+ years for the NDX to make a new all-time high above the March 2000 high. It came back, eventually.

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