The Bubble Really Does Not Burst

"The bubble has bursted." You hear it stated whenever any investment market has been doing so well for so long and then all of a sudden is not a hot thing anymore. It happened during the internet/tech boom of the late 90's. It happened recently with real estate throughout the United States. It happens to just about every market at one time or another.

The internet/tech boom that we all recall, when just about everyone and their friends were throwing a majority of their money into technology stocks is a great example. Companies that we never heard of and had no idea how they even made their profits, suddenly became our favorite investments. Why not? Every other technology and internet stock was sky rocketing. After all the internet and computers were our future. When there is a wave, and your friends are surfing it, you're going to do the same thing. Investing in companies that were internet related was the "cool" thing to do.

When people see their friends and family making a fortune in a certain market, they tend to not want to be left out. I'm sure you know many people who invested in certain internet stocks that they had no clue whatsoever what the company actually did. Unfortunately these companies were relying mostly on their hype which caused their stocks to soar even though their earnings were not up to par. A few experts began looking at these companies P/E ratios (price per share divided by earnings per share), which showed that most of them were extremely overpriced. Companies that are considered to be "high growth companies" are usually allowed to have higher P/E ratios. However there was no proof that these companies were growing at a large enough rate to off set the high P/E's.

After these experts started criticizing certain internet stocks with extremely high P/E ratios, we saw the stocks for these companies fall enormously. In turn some of these companies were forced to go out of business, signaling a not so good future for similar companies. The bubble didn't really burst. The market didn't just collapse all at once, but it was a gradual process which took months. This is the business cycle in a micro economical sense. The sub market (internet technology) began to fall on a steeper then normal slope. People who had made literally millions in the stock market were now in the negative.

The same thing happened in the real estate market just recently (2006/2007/2008). Real Estate everywhere was soaring. Homes that were selling for just $300,000 in 2000 were going for over $600,000 in many markets just a year or two later. People took out mortgages that had arms on them, and invested their money in real estate. What these people were expecting was that the market would continue to go up for years to come, and that they would be able to sell for a significant profit before the mortgage arm would kick in. What these people didn't take into consideration is that real estate, just like any other investment market, has a cycle of it's own. What goes up much come down, and come down it did.

In this case again, the bubble didn't simply burst either. It rather deflated like a basketball with a slow leak in it. Slowly people could not afford to pay their mortgages because their rate increased (due to the arm). As their rate increased so did the rates of other investors. The price of real estate leveled off, so these people could not sell their investments for a profit. This began happening on a massive scale, and these investors had no choice but to sell at a price lower then they paid in order to make their mortgage payments.

This happens in just about every investment market. There is always hype when things are good, and people jump in at this point. There is a saying "Buy low, sell high", yet even the people that say this all the time buy when prices are high because of this hype. Usually when something seems too good to be true it turns out it is. Remember that. The Bubble will eventually deflate no matter what!