Thinking about Scenarios for the Next Bubble

To me, the next bubble is a question of when and what, not if. Articles are already speculating what on the next bubble will be, as in Ten Bubbles in the Making on Tech Ticker on Yahoo! Finance. I've also been having conversations with my father-in-law, my financial advisor, and others on the bubble possibilities. For now, I think there are two likely bubble possibilities in the next five years.

In one of my scenarios, panic buying of investments will be the catalyst. I believe the stock market will be the main area affected, for the following reasons:

Lots of cash available. Investors have taken a lot of money out of the market, that are in accounts with very low interest. These funds have not participated in the rally since March, 2009, and people are waiting for the inevitable correction before reinvesting.

The pullback keeps delaying. Every time a correction seems to start, it appears traders are buying on the dip and preventing a correction from occurring. If this phenomenon continues, there may not be a correction for several months, while the indices advance another 10, 20 or maybe, even 50%.

Investors won't want to miss the rally. It was painful for investors to see their investment lose half their value, and it was even more painful to watch market bounce after withdrawal of funds. Psychologically, I don't believe people will want to watch another significant market advance without being invested. The inflow of funds will cause the market to gain, more funds will be invested and the cycle will continue...until the funds are depleted.

With the current skepticism in the market, I don't think this bubble has started yet. If the Dow crosses 10,000 and then 11,000, in the next few months, I expect this bubble will occur during 2010 to 2012.

In my second scenario, I believe inflation will be the catalyst, creating a bubble in hard assets. Here are the reasons:

Dollar devaluation. Low interest rates and Fed monetary policy will continue to weaken the dollar versus other currencies. As a result, the price of oil, natural gas, metals, mineral and other commodities will increase in dollar terms.

Accelerating inflation. The enormous amount of liquid injected into the economy by the Fed will lead to high inflation in a few years. This will lead to hard assets appreciating faster than other investments.

Fed actions will be late. In the financial crisis of 2008, Fed Chair Ben Bernanke admitted waiting until Congress had no choice before making his recommendations. I expect that Mr. Bernanke will not have the political fortitude to raise interest rates enough to effectively fight inflation. It is more likely Mr. Bernanke will not raise rates until politicians have no other choice, which will be too late.

Investors will flock to assets that appreciate with inflation. The assets may include commodities, especially precious metals, or collectibles, such as art and antiques.

For now, I see stock investments as being the more likely next bubble, especially if the anticipated pullback continues to be delayed. As a result, I'm planning to slowly add more funds to stocks over the next year, with the expectation of taking some profits if a bubble happens. Although I think inflation will occur, I don't expect it to be an issue for at least a year or two, given the severity of the recession. At this point, I have bought some TIPS (Treasury Inflation Protected Securities) as an inflation hedge, but will wait before taking any more action.

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This is not financial or investment advice. Please consult a professional advisor.

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