Unfortunately, overreactions and journalistic sensationalism have led to the term “bubble” becoming a buzzword. Every day, it seems there’s a new story about how another housing bubble has formed - even though there’s no evidence that we’re in a bubble
. But it makes it difficult to tell what’s real and what’s fictional about market bubbles.
If you’re building a business, one of your main concerns should be whether or not your specific industry is especially vulnerable to bubbles - and how to spot one before it compromises your chances of success. How real estate (and other) bubbles form
First, let’s take a look at how bubbles form in the first place
- and why they’re so destructive in a high-level economy.
The best way to do this is to examine how a bubble might form in the real estate market, but these steps could hypothetically apply to any industry. Bubbles unfold over a series of steps:
- New interest. First, something disruptive enters the stage, defying consumer expectations and generating initial excitement. In the real estate market, this usually presents itself as attract interest rates and higher loan availability. Rarely do stagnant, unchanging industries form bubbles, because there’s never any inciting action.
- The boom. At this point, word begins to spread about the opportunities, and investors start to flood the marketplace, buying up whatever real estate they can find. Prices rise steadily, but as more investors get involved, home prices are pushed artificially higher.
- The high. The high is the peak of the bubble, and it can last for months or even years. Home prices rise far above realistic value points, and investors continue buying houses to keep feeding the bubble.
- The slip. At some point, there’s a catalysing action, and people start realising their houses aren’t worth as much as they thought (or find themselves underwater on their mortgages). Prices start to slip, in turn, and panic begins to set in.
- The downward turn. Temporarily, housing prices start to fall significantly as homeowners wait out the downward turn of the cycle. Inevitably, sometimes within a few weeks or months, prices start to pick back up. In some extreme, rare cases, there is a “crash”, where prices fall significantly, but even crashes in the housing market are temporary.
Unfortunately, the free market system implicitly supports the formation of bubbles - making it one of the unfortunate downsides of a capitalistic environment like ours
. Common industries prone to bubbles
The tech bubble of 2000 and housing bubble of 2008 are two prominent examples of bubbles in action, so let’s start there. Dotcom enterprises were new and exciting in the late 1990s, and everyone seemed to think they were sources of unlimited potential wealth. They developed quickly, but once investors started to realise the limited profitability of these models (and the consequences of unduly high prices), panic set in, and it resulted in a crash.
Other industries prone to bubbles include the commodities market, technology (still), pharmaceuticals, and even some kinds of collectibles. Is your industry vulnerable?
Bubbles can be destructive both for investors and the companies they invest in
. Your niche may be vulnerable to a bubble if it can be characterised with the following:
- Rapid price fluctuations. Price fluctuations can be a catalysing factor both for attracting disruptive interest (and causing the bubble to form), and creating the inciting factor that causes a slip (and inevitable crash). The best industries for avoiding bubbles are ones with slow, steady rises in prices over time.
- Market manipulation. Industries that can be manipulated are also prone to bubbles. The housing market, for example, can be manipulated by lenders who misreport data or artificially increase or decrease loan availability. The fewer hands in the pot, so to speak, the better.
- Customer excitement. The inciting action is usually excessive customer excitement, like you would find in a newly available mortgage or a stunning new technology. Customer excitement is usually good, but the catch is that it can sometimes cause bubbles to form.
Potential bubbles can’t ruin an industry - nor can real ones - but they can set you back significantly if you aren’t prepared for them, or if consumer expectations are significantly altered in the process. Pay attention to your unique market conditions, and be prepared for any sudden changes.