Can you spot a bubble before it bursts?

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Needle about to pop a green balloon © Brian Jackson/123RF Stock PhotosWhere are the current financial bubbles and how can investors tell which one is at risk of bursting?

“When it comes to the domain of financial bubbles, I believe each and every lens we look through is bias and incomplete,” says Vikram Mansharamani, author of Boombustology: Spotting Financial Bubbles Before They Burst. “And therefore, looking through multiple lenses increases the chances you’re able to navigate uncertainty and identify dynamics taking place on something as complex as a financial bubble.”

This involves using micro and macro lenses to look at economic indicators, as well as a psychological lens to look for signs of overconfidence and herd behaviour.

“You’ll never be able to say something is definitely a bubble or something is not a bubble,” says Mansharamani. “What we can say is, something looks more or less bubbly. And from the perspective of a pension planner and someone with long-term capital . . . what I think it enables is a different approach to thinking about risk. And so what it changes is, it gives you a nudge into saying, ‘Look, we all make errors in investment decisions, but the choice of what type of error we’re going to make is ours.’”

Investors can make errors of omission, where they understand something is bubbly and know they may miss out on the gain, but they get out early so at least they won’t feel the loss. On the other hand, they can make the error of commission, where something is bubbly but they take the risk and stay invested to try to see some gain.

“I believe at certain times it’s prudent, based upon the framework I have, that you would nudge yourself towards errors of omission . . . Don’t try to time the perfect time to get out of it. It looks bubbly, it looks risky, the reward to risk ratio is not favourable — get out,” Mansharamani says.

Investors can tell if there are bubbly conditions by considering key indicators; for example, the state of art markets or a new skyscraper build as indicators of what’s going on in the underlying economy.

Looking through many lenses and trying to find underlying signals can help investors see through the noise and manage uncertainty, says Mansharamani.

Mansharamani will be the keynote speaker at the Canadian Investment Review’s annual Risk Management conference in Muskoka, Ont., on August 14-16, 2019. The event is free for plan sponsors to attend. If you’re interested in attending, please contact Alison.Webb@tc.tc.

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