Secular bear markets have a way of fooling investors at every twist and turn.  Just when you think recovery is around the corner everything seems to change on a dime and the bear sinks its claws back in.  But what rarely changes throughout time is psychology in regards to bubbles.  We’ve discussed the dynamics of bubbles in past articles and this instance is unlikely to be all that different.

Time after time we see the same sentiment and the same fundamental mechanics at work.  In each case, we see massive supply/demand imbalances.  The supply build leading up to the bubble persists for years and sometimes decades as irrationality grips markets.  Demand rips higher until it outpaces supply.  The market begins to falter.  As demand subsides the bubble shrinks.  At first, investors aren’t convinced prices will fall substantially and buyers come in. Ultimately, the laws of supply and demand impose their will on the market and the shrinking demand can’t meet supply.  Prices continue to fall until capitulation sets in.  Its not until that point that investors finally fold and prices tank.  Only then can the markets normalize and the healing process begin.  Unfortunately, due to the continuing supply imbalances this process generally takes years if not decades.  What we’re experiencing now in many markets is unlikely to end differently.

After watching one of the greatest credit bubbles of all time investors are wondering where we are in the cycle.  Is this a head fake or is this really the bottom?  The following chart shows the stages of a bubble and the sentiment changes that accompany the various stages.  What investors need to ask themselves now is whether we are at the “return to normal” stage (before another massive collapse) or at the “return to the median” stage (before some form of recovery can begin).

In my opinion, I think the panic phase of the credit bubble is past us.  Unfortunately, what is consistent in each of the major bubbles in the history of the world is that they always suffer extended periods of sideways to down action (though generally not dramatically down).  The playbook is disturbingly consistent in prior bubbles.  While government officials believe they can fend off the laws of supply and demand with stimulus history proves otherwise.  In all likelihood, continued government spending and intervention will only prolong the inevitable.

We have previously discussed the dynamics of the housing market bubble among others.  Using the Nikkei, gold bubble, Great Depression and Nasdaq Bubble as reference its likely that the bubble markets of the last few years are in for a sustained and difficult road ahead:


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. ask the greeks if debt matters(having the worlds reserve printing press just pushes it down the road for US )……we are at bull trap high… tho i believe a slide down not a fall.

  2. TPC,

    You say that we have passed the panic phase of the credit bubble has passed. But where does that put us on the chart???? The chart does not show a panic phase.

  3. there seem to be two chrises commenting on this blog…perhaps one of us should add an initial…in any event, the interesting question for the second graph is where is the return to the mean for the s&p…the second graph only shows the falls from the top, all of which seem to me to imply capitulation; since there is no graphing pre-top for the second graph, you can’t tell where the mean is per the first graph; one might think that it might be at year seven and a half, where various lines converge at 50% below; yet the bottom of the s&p was only about 60% below, so if you were a rigorous chartist (i am not) you might take from this second graph that the s&p has further to drop…but the second graph should probably be extended pre-bubble in light of the point made by the first graph

  4. The panic phase looks like it would be the capitulation phase. TPC is saying that the panic is over, but the heavy lifting has yet to be done. In other words, recovery will be long and arduous.

  5. another point…interesting to compare the recent bank stock decline to the nasdaq 2000-1 decline

  6. What is the definition of capitulation. This was a buyers strike made worse by short sellers. Is capitulation defined by mere emotion awe or by financially pain.

    Market analysts are either baby boomers or post baby boomers who have become very adept at believing you can have something for nothing. You can learn the virtues that participating in life has to offer an individual or society vs learning virtues by watching it on a screen without having to lift a finger.

    Examples: adopting as the central tenant of a capitalistic system the need to cut taxes to deregulate the financial system, creating trillions in useless paper trading while not lifting a finger to build anything, making millionaires of everyone who will on the aggregate pay more while individuals are taxed at a lower rate


    market bottoms are made by merely watching a video game of price action on a screen vs actually having to dispense with your stock holdings.

  7. I would hate to think that a 40% decline was simply a “bull trap”!

    It seems to me that we experienced fear and capitulation in 2008, while the March lows of 2009 represented true despair. So, from my inexperienced viewpoint, we’re at “return to the mean”.

  8. I believe we are in a bull trap high and are no where close to capitulation and despair, at least in the stock market. People are still hoping for a return to normal. That’s surely not despair. Even in the real estate market, you can still get risky loans for no money down. You would think this would have all ended by now but greed is still very much alive in both these markets. Because of this, we can in no way be near capitulation and despair because when we are, this greed will turn to fear, and then an outright hatred of the markets. That’s when it will be time to buy. Keep your gold and silver dollar coins for the time being.

  9. Great post TPC — I think you’re spot on with your markings on the graph, which is why there seems to be such a debate between the bulls and bears. There’s just enough encouragement for both sides to believe they’re right, but only time will tell…

    Obviously, the mischevious bear in me would like to point out just how well that 1st graph fits the other bubble (stock market valuations). You could overlay a Shiller’s PE-10 graph (especially of the last 30yrs) onto it…

  10. IMHO we are in the Return to Normal Phase just like the US was in 1931. We have absorbed less than half of the retail housing bust, have not really even begun the CRE bust ( it starts up in the next 3 months), China has a major real estate bubble getting ready to burst, the PIIGS, the Euro and so on and on. There are too many hits still coming, and this economy is not strong enough to withstand just what I have mentioned. Rosenberg and Roubini have said since January of 09 that the problems would be hitting us in H2 2010. We have 4 more months before the start, but I somehow do not believe that we will make it that far.