KEY POINTS:
The 20th anniversary of the stock market's brutal 1987 crash last week has triggered explosive debate about whether today's raging, yet dubious, bull market in world stocks is headed for the same fate.
Who can blame them? After all, investors know all too well that there is a
persistent common thread in each and every financial crisis over the past 20 years: All collapses have been caused by excesses.
Many economists and investors call them "bubbles".
Just look at the current examples:
* MSCI's main index of world stocks is up 14 per cent in 2007 and has notched double-digit gains in three of the past four years.
* China's Shanghai Composite Index has more than doubled this year on top of a 130 per cent gain in 2006.
* MSCI's index of Asia-Pacific stocks excluding Japan has risen more than 40 per cent so far this year, and is up 260 per cent since the end of 2002.
In the United States, where stocks this month completed the fifth year of a bull market, the bubble is of a different variety.
Here, it happens to be in the housing and credit markets, whose deterioration continues to threaten world financial markets and rattle nerves.
"All asset bubbles formed and imploded for the same reason: naive extrapolation," Jeffrey Gundlach, chief investment officer of TCW Group in Los Angeles, told clients.
"Choose your crash. Some of us witnessed the collapse in precious metals in 1980. More folks probably can recall the emerging market debt crisis of 1998. All but the most inexperienced among us lived through the tech stock and corporate bond debacles which opened this decade."
Gundlach is referring to American homeowners who in this cycle took advantage of rock-bottom interest rates, buying a slice of the property boom. That was aided by the Federal Reserve, which slashed benchmark interest rates to 1 per cent in 2003 to pump the economy back to life after the 2001 dot-com bubble burst, and kept them there for a year.
But then the Fed raised rates 17 times, ending the cycle in late June 2006, when it had taken the Fed funds rate back up to 5.25 per cent, and the housing boom lost steam.
Delinquencies are still rising on subprime mortgages and defaults piling up at record rates as home prices sink, pressuring consumers' desire to spend. The housing turmoil continues to exact a heavy toll on hedge funds and Wall Street banks that used leverage to invest in pools of bonds tied to the risky subprime mortgage market.
But while the good times in housing and credit markets are over, the lessons from this and past boom-to-bust cycles or crashes continue to reverberate.
"A continuous rotating bubble is the result of wealth creation," said Tom Sowanick, of Clearbrook Financial in New Jersey. "Think about the Nikkei 1989, the savings and loan crash of the early 1990s, Orange County and the Mexican peso crisis, LTCM and Asian Tigers, the tech wreck and corporate scandal of 2000-01, and now the credit bubble. Rotating bubbles are the nature of capitalism."
It's worth noting where the three major US stock indexes stood for the year to date at midday on Friday.
The Dow average was still up 9.8 per cent, while the Standard & Poor's 500 Index was up 7.3 per cent, and the Nasdaq Composite Index was up 14.5 per cent.
