Market bubbles are usually started with a revolutionary product that is supposed to change the whole competitive landscape. The internet bubble was a fine example. You can have mini bubbles like the "electric car", "renewable energy of all kinds", 2G, 3G, 4G ... etc. Bubbles are NECESSARY, repeat that again in your minds, they are necessary. That is also why private equity and the stock market are EFFICIENT ALLOCATORS of CAPITAL ... like it or not, these capital will be tapped to search for the "best of the best" whenever there comes a revolutionary product or standard of practice. They are necessary because we need to plough tons of capital to fund tons of interesting ideas, value-add propositions to the "revolution".
Sure, maybe only 1% of all internet companies which started up in late 90s till 2001 are still standing today, maybe many investors have lost plenty of money chasing after these pipe dreams ... BUT THEY ARE NECESSARY, repeat that again. There is no other way about it. You cannot have a controlled environment when faced with a "revolution". Opportunities and fresh ideas will fight each other to make it in the new landscape. That is how INNOVATION is super charged, just look at what the internet revolution has brought for us today, the value has been immense.
Bubbles in another way is like "uncontrolled R&D expense accounts". Many companies spend hundreds of millions in R&D every year to make minute but important improvements to many things we use today. Look at how many circuits we can fit onto a microchip, every year there are improvements, and by that, we get more innovative end products and maybe even cheaper pricing. When we have NEW revolutionary products or standards, because they are usually not within the precinct of listed companies, private equity and the stock market take over the funding of these ventures.
Of course not all bubbles are about revolutionary innovative products, most are usually just exuberance of liquidity being reflected in property, or selected country-plays, we have them all ... these bubbles are easier to fathom but just as difficult to stay away from. The main mantra about bubbles is you can join in the party but once people start puking, you better leave and don't touch it for a couple of years.
Generally, when there are market bubbles, it will be because of some over-hyped technology or revolutionary product that is predicted to change the world we live in. When these hypes or revolutionary ideas fail to rise to expectations, thats when bubbles deflate rapidly. Back about a year before the dot com bust in 2000, the renowned Barton Biggs (investment strategist for Morgan Stanley then) was at a conference thingee where he was supposed to give an address, sharing the stage with an academic (whose name I have forgotten now) who predicted that the Dow is undervalued and that in 1999/2000 was the last time to buy before it rockets to the next level - 36,000! Now, they were all in the midst of a dot com frenzy and internet-taking-over-the-world stuff. Naturally Biggs got slaughtered by the crowd's response as he mentioned that the dot com frenzy has led to stretched valuations and is bubble-like.
The interesting thing is that the Mr. 36,000 academic (who has sold hundreds of thousand of his book on how not to miss the 36,000 Dow... or something like it) emphasised that the internet is revolutionary and that Biggs and other bears do not understand the technology and implications.
The lesson here is, whenever there are revolutionary products, investors will go overboard and latch onto a group of stocks and deemed them as future kings. Each hype we go through will almost certainly involve thousands of companies jumping on the bandwagon, but no matter how revolutionary, less than 1% will be able to make consistent real long term money from it.
The internet is an excellent example - its impact is wide ranging and touches almost everyone's life in some way. No one can envisage NOT being in contact with the internet one way or another on a daily basis. Still, how many hundreds or thousands companies do actually make super profits. There is Google, e-Bay, and a few others... again much less than 1% from those getting funds from venture capital firms in the late 90s. What Mr. 36,000 missed out on is every new revolutionary product will produce "madness of the crowds". Mr. 36,000 needed to know that market bubbles are NECESSARY whenver new technology or revolutionary product is available - they are necessary as we need large sums of capital to concentrate on exploiting the "value-addedness" available in this new technology - even though less than 1% will survive, we are all better for it in the longer term. We need to try 1,001 things we could do with it.
Just look at when mobile phones took flight, we also had a carnage. Or when 3G was made available, again many firms lost a lot of money. So, market bubbles are necessary, so too is the inevitability of a market correction. The thing is only a very small number of companies will make money, that's the natural law of business and capitalism. You just cannot have thousands of company making supernormal profits owing to a revolutionary product because competitors and new entrants will come for your market share, go for lower margins, make more innovations, get more value-addedness on the product, etc...
Back to the internet, though it is life changing and very pervasive, internet still lags a few other revolutionary products of the past in terms of importance and impact. Okay, lets say electricity, that's a given, so too is the motor car. Another is air-conditioning and elevators - we so take air-con and elevators for granted as part and parcel of daily life. If we do not have air-con and elevators, do you think there will be high-rise buildings more than 5 storeys, or the lead-on effect of migration of population to cities, etc... As impressive as the internet is, there are still a lot of successful people who do not need to use it to get by. I grew up for the first 25 years of my life not needing a mobile phone - why do we need to be able to be reached at any time, anywhere by anyone? Of course now, you cannot imagine living without it. Still that gives the internet and mobile phone a sense of reality in their degree of importance (or lack of) on the revolutionary curve of things.
So the next time you get a sales pitch on the next big thing, beware, there will be a market bubble, and there will be a market correction ... the next big thing could be: the "no-side effects, eat all you want, guaranteed 10kg a month weight loss pill"; or the pill to cure cancer of all kinds; or the new resuscitation machine that can bring life back to any one who has died not more than 24 hours; or the new sugar which has one calorie per teaspoon but does not taste like cardboard on your tongue; or the new mobile phone that charges by itself using sunlight; better still, the car that can run on sunlight as they have made solar cells small, light and efficient enough; or the revolutionary Viagra in a tube, just rub it on, non-toxic and works within 5 seconds, edible too...comes in strawberries, banana, apples,...." (I think the Viagra idea will be BIG man...).
p/s however, the last subprime bubble in the US and Europe is the kind of bubble we could have and should have avoided, its plain greed by some, plain failure by ratings agencies blinded by profits, consumers who were lulled into a false sense of security of ever rising property prices, its plain poor oversight by some regulators, its plain miscalculation by some major heads of central banks ... and there was nothing revolutionary about the packaging of dubious loans ... there was nothing revolutionary about banks using the least amount of capital to leverage their profits and risk ...