Everyone can see a bubble after it pops, but to identify one in the earlier innings is extremely hard. How do you differentiate a bull market or some legitimate business trend from one that has turned into the kind of dangerous speculative frenzy known as a bubble? It is more of a art than a science, and so often it seems strange anecdotes and various real world observations are just as effective as looking at data about asset prices. In the late ’90s there were lots of stories about day-trading cab drivers and other non-experts all of a sudden spending all of their time and money trading tech stocks. Similarly, in the mid 2000’s there were hairdressers who flipped dozens of houses for big profits overnight. Unfortunately, these stories often don’t come out in the press until after the bubble bursts.
Vikram Mansharamani who is an economic forecaster and bubble expert has helped popularize an interesting real-world test: the skyscraper indicator. It turns out that societies tend to build very tall buildings around the peak of bubbles. He traces this back as far as the years leading up to the Panic of 1907. Mansharamani writes that since the first one was built in Manhattan in 1887, “the skyscraper has been a symbol of economic and financial success, the mark of one’s ascent.” They also require large amounts of borrowed money, and usually the builder builds the tower before actually finding the tenants to fill it, making it an inherently speculative venture. Though exact calculations are difficult to estimate, the marginal costs of building architectural support of additional floors above a certain point outweigh the marginal benefits that comes from the extra floors. This makes their extreme heights irrational from a financial perspective. Mansharamani says, “we can look at the tallest skyscrapers under construction to see where money is easiest, speculative juices are flowing and confidence is high.”
In a 2011 article in Forbes, Mansharamani compiled a table of the world’s tallest skyscrapers along side the financial busts that followed their construction:
So where are the tallest skyscrapers being build right now? Mostly in China. The new tallest building in the world according to plans will be Sky City in Changsha, the capital of the Hunan province. If all goes according to plans, Sky City will be slightly taller the Burj Khalifa (formerly the Burj Dubai). Sky City is planned to be a prefabricated modular building and the builders recently constructed a 57-story tower called Mini-Sky City in only 19 days. A time lapse video of the construction has circulated widely on YouTube. Some engineers think that the big Sky City building will not be structurally sound, and others say that the plan is a publicity stunt, and it will never be built. Either way, the ambition and confidence of the Chinese builders has more than a whiff of bubble to it. Sure enough, the Chinese stock market has plunged dramatically this year.
Even if Sky City is built, it will not enjoy its reign as tallest building for very long. There is an even taller building in the works, the Kingdom Tower that will be completed in 2019 in Jeddah, Saudia Arabia. Though its height is still unconfirmed, it is rumored to be over 1000 meters, towering over the Burj Khalifa. The plans were drawn up, no doubt, when oil was over $100 per barrel, just in time for its 50% plunge in value. Once again, it seems, the planning of the world’s largest tower preceded a financial calamity–if not a typical bubble–for Saudi Arabia.
In the US a major tower is planned in San Francisco, and though not in the running to be the tallest in the world, it will be the tallest west of the Mississippi. It will tower over San Fransisco, a city with few very tall buildings because of the engineering challenges in an area prone to earthquakes and heavy winds. The company that bought the naming rights to the building and much of its office space is called Salesforce. Salesforce is a large and fast-growing but still not yet profitable cloud software company. Traditionally the types of companies that have been able to put their name on a huge skyscraper were only the largest and most stably profitable pillars of industry. For a still unprofitable company to build (or at least put its name on) a billion dollar skyscraper could be a sign of a peak in the red-hot tech sector.
Mansharamani recently appeared on NPR to discuss the Salesforce building. While he didn’t come out and call a tech bubble, he said that the skyscraper indicator is still an effective way to call bubbles: “It’s hubris and overconfidence embodied in this chest-thumping behavior of wanting to have the region’s tallest or the city’s tallest. It’s not particularly rational.”
After the housing bubble burst in 2008, people began seeing potential bubbles everywhere. The skyscraper indicator, however, appears to be fairly robust over a long period of time, though statistical significance is difficult to prove because of the small sample size of such buildings. These real world indicators are a good reminder not to get too bogged down in technical analysis of markets. In addition to studying PE ratios and earnings trends and the like, it is important to simply look around for common-sense signs of the sort of human behavioral foibles that create irrational excesses in the market. Such indicators, of course, are only one piece of the puzzle in understanding the market and cannot predict the precise time when the bubble will pop. But they are good reminder that the market is not a totally impersonal force but rather a collection of individuals that can be carried away by extreme emotions and behavioral lapses in the same way an individual can.