MBA, I am beginning to wonder myself if China isn’t another bubble in the making. It would seem that the fundamental landscape is there and if Europe and USA continue to be capital unfriendly locations China is going to become the no-brainer in the coming decade. I don’t think housing will explode to the upside again. I think that was a baby boomer driven event and that this generation of wealthy Americans has learned their lesson. I know my parents will never buy a house again….

When I refer to “average”, I’m not speaking of the exact mean, but of a narrow range on either side of the mean. In effect, I’m dividing the world into three camps (average, below average, average average) and labeling those who are close to the mean as being “average,” even if they are nominally above or below the mean.

Assuming a typical bell curve, most people will naturally fall into the first two camps. But if we wish to be more precise in our language, then yes, you are accurate.

Actually 50% will be above average and 50% below average; perhaps your claim is that over a long duration observation period only the minority will be able to beat average consistently is what you intended.

I like your comment re: “institutional memory”; I also believe that this is fed by the U.S. (and global) speculative culture; it seems everyone moreso enjoys the tale of speculative profits, however due to ego ignore the speculative losses.

While i agree with your cocktail party originations of another bubble; I do not see it w/in 10-years…i do know that it will occur again in our lifetime and the recipe for success is to find the funding enterprise and take a highly levered, calculated out-of-the-money put position for max profit (i.e. subprime origination shops).

Bubbles occur when the effort to achieve above-average returns results in excessive capital being invested in a given segment to the point that market prices exceed intrinsic value. It’s human to like easy money, and every portfolio manager likes to believe that he can outperform the averages even though by definition, only a minority can outperform the average. By definition, the majority will be at or below the average, but that statistical fact doesn’t prevent most of us from trying to be the exception.

Just about every bubble began with some decent fundamentals to support them. That’s important to recognize, because those beginning fundamentals will usually provide the basis for the buy story that will carry the market to inefficient levels. That’s the same story that will be recited by the pundits in the financial media and brokerage business, and repeated by the dumb money at dinner parties. We saw this with housing, the internet, oil and just about everything else — there was generally some fundamentals-based rationalization that makes the whole thing sound reasonable at the time to those who accept the popular view.

Basic economic theory tells us that markets should generally work their way toward equilibrium — high prices due to surging demand should attract new suppliers to a market, which results in prices eventually falling. So barring some extraordinary major macro permanent event, a dramatic price increase over a short period of time is probably not sustainable, because prices in a functioning market generally have no good reason to rise dramatically. When prices skyrocket, as was the case during the oil bubble, that’s the time to be wary, because there is rarely a good reason for something like that to occur.

Basic economic theory does not tell us something that is should, namely that leverage impacts pricing. If anything, it suggest that leverage or deleveraging have no impact on pricing at all, which of course is terribly wrong. If you want to know why economists missed this whole thing, this is probably the reason; they generally ignore the impact of debt.

If we understand these points, bubbles will be seen as they are, not as some sort of weird aberration or indication of a world gone mad, but as a normal occurrence that occurs because of perfectly human inclination to outperform. Combine this with the general lack of institutional memory, and you end up with bubbles being replicated unless they are regulated out of existence, as individuals don’t tend to learn their lessons. Over time, I would expect this phenomenon to accelerate, because technology has sped up the information flow that feeds bubbles and because we have fundamentally higher levels of credit and leverage in our system than we used to.

I personally see another housing bubble occurring within the next decade or so, because housing is the easiest way to transfer a large quantity of appreciating assets into the hands of the average consumer, who has become such an important part of developed economies. When your friends start wisely advising you at parties that “they can’t build more land,” you’ll know that the bubble is well underway again.