Bubbles burst, cookies crumble

Bubbles are created when something expands factored mainly by nothing but pure air. In the realm of business and economics the bubble allegory has been applied for some time to describe economic events that appear on the upswing fueled by speculation and little else.

While there are bubbles that are self-fulfilling such as those rabbit runs in the capital markets where a stock races in value due to abnormal trading where bystanders who imagine prospectively higher levels start buying and therefore pursue the proverbial “rabbit,” most of the bubbles in the exchanges are of the typical kind. The typical bubble in the stock market is that equity issue that is overvalued relative to the current earnings per share (EPS) computed by simply dividing a listed company’s total net income by its outstanding shares.

The EPS ratio is a benchmark by which a market price might be set when stocks are offered for trading. When the listed price is below the EPS, then a stock is undervalued. It is overvalued when it is higher.

Save for the force that constantly pulls values towards the EPS level, there is really nothing wrong with an overvaluation where investors are fully aware of the relative margins compared to the EPS. The overvalue might reflect the perspective of an investor looking to the future and is pricing the stock relative to prospective incomes earned over the horizon.

As opposed to short term investors who base their valuations on current prices and the margins that they might earn should they buy now and quickly sell within a year’s time if only to gain on the margin or the difference between the short term buying and selling price, longer term investors have longer term vision.

This is typically the case for investors in real property. They price their stock based on forecasted earnings of periods spanning over a year. The arithmetic establishes a multiple on the difference between the price of the stock divided by the EPS. This is called the Price-Earnings ratio and is computed by multiplying a factor based on forecasts against the ratio between a stock price and the EPS.

The caveat for investors is that this type of Price-Earnings pricing is not based on supply and demand as most goods are valued under a capitalist system. It’s largely based on an analysis of the future and those are dependent on a handful of quantifiable valuation models.

Otherwise, bubbles are all about speculation. In the natural world, apart from the surrealism that economics and the stock markets might provide, all bubbles eventually burst.

A bubble that had very recently inflated within our economy in the last couple of years is the price of specific kinds of real estate. This bubble has to do with gambling operations illegal in China with its mutations likewise illegal in many Asian countries.

Typical of our tendencies towards such things we’ve welcomed online gambling with open arms partly due to the increased demand for rental and sales of dormant property and the prospective revenues from taxes charged on Philippine offshore gaming operators (POGO).

At the onset the demand directly attributable from these POGO had led to an increase in sales and rentals and seemed like a bonanza for strategically located real property developers proximate to the offshore gambling hubs.

The recent revelation that China had actually considered these criminal and a loophole to their anti-gambling statutes plus the unfortunate coincidence of increased tensions between the United States and China in their escalating trade and currency war had combined to temper the listed and traded stock values of specific developers invested in the POGO phenomenon.

One claims quite belatedly that their sales and lease exposures are limited to approximately 12 percent to 13 percent of gross marketable area. Another however claims exposure is as high as 44 percent of sales. The disparities are as alarming as the declaration that POGO licensing will be placed on hold.

Amid the uncertainty, what is certain is that this fortune cookie seems to be slowly crumbling.