An echo bubble is a temporary post-bubble rally that occurs after a major stock market crash, caused by investors trying to determine what is happening with the market. It is usually not as pronounced or long-lasting as the original bubble and prices never recover what they originally reached. The NASDAQ provides a good example of an echo bubble after the dot-com bubble collapsed in 2001.
An echo bubble is a situation that occurs after a major bubble in the stock market crashes. Usually after this occurs, there is a brief but temporary post-bubble rally that takes place within a couple of days, after the crash. This rally is called an echo bubble because it is usually not as pronounced or as long as the original bubble, so it resembles an echo.
The echo bubble occurs when investors are still trying to determine what is happening with a market crash. They must answer a series of questions. Investors may wonder if this is a temporary situation caused by the failure of a company. They may also wonder if there is a knee-jerk panic reaction based on emotion, not a good deal. Investors must also consider when the market will settle.
As investors grapple with these questions, the normal course of business must continue. Some, whether through their own day-to-day business practices or perhaps through a financial advisor, may believe that they see opportunity. Stocks that looked like a bad value before a crash suddenly look significantly better at a lower price. There are speculators who get involved in the buying action causing an echo bubble.
This buying action temporarily lifts stocks because demand increases. However, in a true echo bubble, prices never recover what they originally reached, at least not in the short term. When a shock occurs, there may be a period of slower, sustained growth, but this is not a bubble. This is normal market behavior.
Post-bubble manifestations almost always occur. When the dotcom bubble collapsed in 2001, there was a brief recovery, but it was not sustained. The NASDAQ, which features heavy tech stocks, at one point peaked at over 5,000 points. It quickly fell to around the 3,500 level and then rallied back to above 4,000.
In October 2002, the NASDAQ bottomed out at 1,110 points. Between March 2001 and October 2002, there were big losses and not that many gains, so they all turned into echo bubbles. Since that time, the NASDAQ has slowly begun to rebuild itself, though not at the pace it had during the bubble years.
An echo bubble is generally quite easy to see. It has a defined starting point just after a major market loss, followed by an ending point where the loss will be almost equal to the echo bubble gain, although it can be more or less. While the NASDAQ, during the dot-com bubble, provides a good example, all other markets can also have post-bubble rallies.
Smart Asset.
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