Track 3 · Lesson 2 · 6 min
Bubbles, crashes and the warning signs
How manias run, which warning signs have a record, and why timing a top is so hard.
A bubble is when prices rise far beyond what the underlying businesses can justify, driven by the expectation that prices will keep rising. A crash is a sudden, deep fall, often 30% or more. Not every crash follows a bubble (COVID didn't), and not every boom is a bubble.
The economist Charles Kindleberger, building on Hyman Minsky, found the same five stages in centuries of manias: displacement (a new technology or policy), boom (prices rise, credit grows), euphoria (rising prices become the reason to buy), distress (insiders sell, money tightens) and revulsion (the panic).
Checkpoint
Prices keep rising, new investors pile in because prices are rising, and borrowing to buy hits records. Which stage is that?
When rising prices themselves become the reason to buy, and borrowing grows, that's euphoria.
Warning signs with a record. High valuations (CAPE) came before poor decades, but not on a schedule. An inverted yield curve came before every U.S. recession since 1969. Widening credit spreads led downturns. Big run-ups raised crash odds: in Greenwood, Shleifer and You's study, industries up 100% in two years crashed about half the time. The Nasdaq-100's two-year gain is 51% tonight.
Why timing is still hard: those same run-ups kept rising for about six months on average before they peaked. Robert Shiller warned in 1996; prices doubled first.
The full history, from 1929 to 2022, is in A century of bubbles and crashes. How today's market reads is in Is this a bubble? and live on the Markets page.
Check yourself