The phenomenon of a market boom, bubble rise, or the utmost incremental margin all refer to the condition in which the prices of financial assets, stocks, or the overall market experience a significant increase. When the value of these financial assets surpasses their fundamental underlying value, bubbles are formed.

This topic has captured the interest of individuals involved in economics, academia, policy-making, and securities trading. Understanding the ripple effects, causes, and repercussions associated with such market movements has become a subject of study.

Market analysts have continuously sought to determine whether substantial, dramatic price rises inevitably lead to crashes. The analysis of market bubbles is often linked to the historical trend of market booms resulting in busts. The speculative nature of booms makes them a captivating subject for study, as they involve a combination of intuition and timing.

The allure of market bubbles lies in the fact that they eventually reach their peak, burst suddenly, and fall rapidly like a shooting star. This cycle of boom and bust creates a sense of anticipation for when the next boom will occur.

The price increase can be observed in stocks, assets, or the overall market, causing the fundamental value to exceed its margin. This trend has been particularly evident in the world of cryptocurrencies in recent times.

Historic Market Bubbles And Bursts

The Dutch Tulipmania (16th -17th Century)

In the 16th century, a phenomenon known as Tulipmania swept through the Netherlands, causing a frenzy of passion and speculation surrounding the beautiful tulip flower. This craze, fueled by a deep love for tulips, led to a dramatic increase in the market price of these flowers, reaching its peak in Western European countries.

The Dutch people became enamored with tulips, creating a hierarchy of prized varieties and breeds. The wealthy elite were the first to invest in these expensive flowers, with the middle and lower classes following suit as the craze spread. By the late 16th century, the market for tulips had reached its maximum height.

This trend was driven by speculative behavior and a romanticized view of tulips, leading people to mortgage their assets, homes, and lands to purchase bulbs in anticipation of profits. The allure of tulips was so strong that individuals were willing to trade essential items such as food, animals, and valuable possessions for a chance to partake in the tulip market.

The people were ready to barter elements like:

Food– wheat, butter, wine, beer, cheese

Animals – oxen, sheep, swine

Things– drinking cup (silver), attire, daily bed

Tulipmania serves as a cautionary tale of the dangers of speculative bubbles and the power of human emotion in driving financial markets. The allure of tulips, with their vibrant colors and delicate petals, captivated the hearts and minds of the Dutch people, leading to a period of irrational exuberance and eventual financial collapse.

In 1637, as spring approached, the demand for Tulips among consumers began to decline rapidly. This lack of interest led to a sudden crash in the market, causing the collapse of the Tulip industry. By May of 1638, the Tulip contracts were declared void, resulting in a settlement of 3.5% interest. The once-thriving Tulip market had come to a dramatic and abrupt end, with no buyers left for the once highly sought-after bulbs.

London- South Sea Bubble (17th Century)

In London during the 17th Century, around the year 1720, a significant number of individuals became ensnared in the South Sea Bubble. The House of Lords had passed the South Sea Bill, granting the South Sea Company a monopoly on trade with South America. The value of shares skyrocketed, increasing more than tenfold. The South Sea Company began shipping slaves to South America, leading to inflated stock prices that ultimately resulted in the bubble bursting.

The Royal Museum Greenwich has documented that the exorbitant prices paid by investors for stocks played a key role in the bubble's collapse. As the South Sea Company struggled to fulfill its obligation to supply 4800 slaves to South America, numerous illegal companies emerged, exacerbating the situation. The subsequent investigation revealed these illicit activities as a primary factor in the bubble's demise.

This historical event serves as a cautionary tale, illustrating how market bubbles fueled by unethical practices can lead to the sudden collapse of businesses and the devaluation of stocks. It underscores the importance of ethical conduct and transparency in financial markets to prevent such catastrophic outcomes.

The Dot Com Bubble (19th Century- Early 20th Century)

The period from 1995 to 2000 witnessed an extreme increase in the stock of technology equity valuation, commonly referred to as the Internet bubble. This era was characterized by a significant influx of investments in internet-based startups, driven by the anticipation of high returns and profits. Investors were captivated by the booming internet industry and the allure of .com domains, leading to a speculative frenzy.

The hype surrounding dot com companies fueled a rush among investors, who often disregarded fundamental analytical measures such as the P/E ratio. Instead, the focus was on building brand image and market awareness, rather than traditional investment strategies. Despite the speculative nature of the market, many investors experienced substantial gains during the dot com bubble.

However, the bubble eventually burst, resulting in a stock market crash and a shift towards a more information-centric investment approach. It was during this tumultuous period that companies like Google and eBay solidified their presence in the market.

Other Market Bubbles Such As the Japanese Real Estate And Stock Market Bubble And the US Housing Bubble

The Japanese real estate and stock market bubble and crash of 1986-1991 occurred as a result of significant inflation in Japan's real estate and stock markets, driven by unchecked money supply and credit expansion. This phenomenon is detailed in "The Asset Price Bubble and Monetary Policy: Japan's Experience in the Late 1980s and the Lessons".

Even amidst the ongoing pandemic, the real estate market continues to experience a surge. The investment of banks in real estate has served as an encouragement for individuals engaging in buying and selling properties. However, a persistent bubble exists within the real estate landscape, and unforeseen events such as natural disasters like floods can swiftly erase the real estate market in a particular area. Therefore, thorough analysis is essential before making any investments.

Pamela Liebman has expressed her belief that real estate does not behave in a manner that aligns with the characteristics of a bubble, as real estate values do not plummet overnight.
The US Housing bubble serves as a pertinent example, impacting a significant portion of the United States and leading to the Great Recession. The International Monetary Fund notes that such bubbles can endure for several years, often due to a demand for housing surpassing the available supply of land or properties.

Various factors, including population growth, living standards, and the influence of brokers who may manipulate prices, can contribute to the formation of a housing bubble. It is imperative to thoroughly scrutinize any suspicious activities before making substantial investments in the housing market.

Lessons To Be Learned From Market Bubbles And Crashes

Here are some valuable lessons to be gleaned from market bubbles and crashes:

1. Market bubbles can be driven by various factors such as time, pleasure, passion, attraction, and allurement.
2. Governments must formulate proper investment strategies to protect citizens from engaging in unguided and reckless buying and selling of aesthetically pleasing products.
3. Regardless of the type of market, the shopaholic instincts of humans can lead to irrational behavior and extreme fluctuations in the prices of goods and services.
4. The feeling of ownership and security in assets can sometimes cloud judgment and lead to risky decision-making.
5. Markets evolve based on the prevailing time and circumstances, emphasizing the importance of prioritizing financial safety when engaging in transactions with volatile price fluctuations.
6. Making money during a market bubble period carries inherent risks, as gains and losses are equally likely.
7. Following the herd mentality in buying and selling is not a sustainable long-term strategy, as once the buying cycle halts, the selling frenzy loses momentum and investments lose value.
8. Thoroughly studying economic indicators and possessing financial literacy are crucial for making informed investment decisions.
9. Comparing local and international markets is essential for gaining insights into potential market bubbles and crashes.
10. A prudent investor considers all aspects of an investment opportunity and does not solely focus on short-term gains.