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Bubbles mean trouble

The first sign of a bubble is that share prices have risen dramatically relative to earnings and dividends, or property prices have risen dramatically compared to people’s incomes and rents.


What is a bubble? AMP Capital Head of Investment Strategy and Chief Economist Shane Oliver puts it down to two main factors.

“The first thing is a degree of over valuation. That is a situation where the price of an asset has diverged dramatically from the underlying fundamentals of the asset. Share prices have risen dramatically relative to earnings and dividends, or property prices have risen dramatically compared to people’s incomes and rents,” he says.

The second factor Oliver describes as being evident in bubbles is euphoria. “Prices are inflating dramatically as investors say, ‘I have to be invested in this asset because the only way is up. How do I know that? Because it rose last year and the year before’. Therefore you get over valuation and a degree of bubbliness as investors extrapolate past rapid capital gains indefinitely. It then takes on a life of its own.” 
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