How a Bubble Works: The General Pattern

A bubble is a state in which the price of an asset stops resting on its cash flow and starts resting on the expectation of a resale. As long as the buyer is paying for earnings, rent or a coupon, what they hold is a valuation. As soon as they are paying for the belief that somebody else will turn up tomorrow, what they hold is a place in a queue. The queue is finite, and all the further mechanics of a bubble are ways of not noticing that it is finite for as long as credit and the inflow of new money allow it to be extended. The pattern repeats not because people grow foolish time after time, but because the same structure repeats: leverage, liquidity and the way those who sell participation in the rally are rewarded.

What exactly inflates

The price of a security breaks down into two parts: what the asset brings its owner, and what the market is willing to pay on top for expectations. The second part is always in motion — it is the very thing the buyer and the seller argue about. A bubble begins where the first part drops out of the conversation: yield becomes "unimportant", financial statements become "a reflection of the past", and the multiple becomes "inapplicable to the new economy".

This distinction can be tested. A multiple is neither a verdict nor a signal, but it shows how many years of earnings the buyer is paying for: 3,96 for SBER is read together with what stands in the issuer's financial statements. When the explanation of a price stops coming down to the figures in the report and starts coming down to a story about the future, that is not a ban on buying — it is a signal that you are buying a story and need to understand what it costs.

Displacement: where the plausible story comes from

Every bubble has a real event at its base: a technology, a reform, the lifting of a restriction, cheap money. This matters, because the market does not lose its mind over nothing. The displacement creates a stretch where the rise really is justified, and that is exactly why the early buyers turn out to be right. Their being right becomes proof for those who follow — no longer proof about the asset itself, but proof that "money is being made here".

From then on the story lives by its own laws. It has to be simple enough to be retold and irrefutable enough for any objection to sound like a failure to understand. At this stage criticism becomes socially expensive — and that is a reliable marker of the stage, not of the theme.

Credit: without leverage a bubble does not grow

A bubble is inflated not by opinions but by money, and almost always by borrowed money. Leverage turns a rally into a self-sustaining process: a position that has gained in value serves as collateral for a new position, the new purchase moves the price, and the price increases the collateral. It works in the opposite direction too, only faster, because a margin call does not ask for your view of the fair price. The mechanics of forced liquidation are worth studying before you need them: on leverage and margin trading.

Euphoria and the turn

Euphoria is recognised by a change of language. Words about revenue and debt disappear, and words about a share of the market of the future take their place. New participants appear for whom this asset is the first in their lives. Instruments appear that were built specifically for the inflow: derivatives, funds, schemes with a promised return. A promised return in a rising market is almost always somebody else's risk being sold to you.

The turn comes unannounced. Often there is no news at all — the supply of those who have not yet bought simply runs out. Deflation is faster than inflation, because the market is pushed up by voluntary buying and pushed down by forced selling: the unwinding of leverage, fund redemptions, the triggering of stop orders. Liquidity, so plentiful on the way up, vanishes precisely when it is needed.

What this means in practice

The pattern does not come with a timer. It does not say when to sell, and anyone who derives an exact date from it is selling you certainty. What it does give is a set of checks that apply to any security on the stock market: what the asset pays you with, who your next buyer is, whose money the position was bought with, and what will happen to it if the price moves against you.

This is also where the practical point of assets with a different payout structure lies. A dividend stream is an obligation, not an expectation: how it is declared and why it can be cancelled is covered in the piece on dividends, and the nearest payouts can be seen in the calendar —

The face value of inflation-linked bonds is recalculated by a rule, not by a mood: how the recalculation works. When you take profits, work out the tax side: 13%.

A caveat

What is described here is a mechanism, not a history. Specific episodes from the past are not examined in this piece: the platform has no data of its own on those markets, and retelling them from memory would mean replacing what can be verified with what merely sounds good. The terms that came up above are explained in the glossary.