Bubbles and crashes
We've always had rising and falling markets, and we always will. When they continue to a significant extent, they're called bull markets and bear markets. Even further and they're called booms, manias an crazes; busts, crises and panics. The most popular terms today for describing extreme bull and bear markets are "bubble" and "crash"
These latter terms have been around for a long time. The "South Sea Bubbles" a mania for investing in the company that supposedly would pay off the national debt by exploiting a monopoly to trade with South America, caught England by storm in 1720. And the market collapse that kicked off the Great Depression is called the great crash of 1929. But it was the "tech bubble", "Internet bubble" and "Dot com bubble" of 1995 - 2000 - and the housing and mortgage bubbles that ended in 2007, bringing on significant crashes in markets around the world - that brought the word "Bubble" into everyday use. As a result of the foregoing, there's a tendency these days - especially on the part of the media - to call any big market rise a bubble. In 2017, the S&P 500 index of U.S. stocks had roughly quadrupled (including dividends) from its low in March 2009, and the yield on U.S. high yield bonds had fallen to a 5.8% . Thus rose the market whisper whether we're in a new bubble of one kind or another, perhaps implying a crash is imminent. That's why I want to spend some time on my conviction that not every big rise is a bubble. For me, the term "Bubble" has special psychological connotations that should be understood and looked out for.
I've lived through battles much older than those in tech stocks and housing. One of the best examples was a mania for the "Nifty Fifty" stocks - the shares of the highest - quality, fastest - growing companies in America. As far as I'm concerned, there's a common thread that runs through bubbles and was exemplified by the Nifty Fifty: conviction that, as far as the subject asset is concerned, "there's no such thing as price too high" And of course it follows that no matter what price you pay, you're sure to make money. There's only one form of intelligent investing, and that's figuring out what something's worth and buying it for that price or less. You can't have intelligent investing in the absence of qualification of value and insistence on an attractive purchase price. Any investment movement that's built around a concept other than the relationship between price and value is irrational.
The idea of "growth stocks" began to be popularised in the early 1970's, based on the goal of participating in the rapidly growing profits of companies benefitting from advances in technology, marketing and management techniques. First National City bank (the predecessor of Citibank), the Nifty Fifty stocks - the fastest growing and best - had appreciated so much that bank trust departments that did most of the investing in those days generally lost interest in all other stocks.
Everyone wanted a piece of Xerox, IBM, Kodak, Polaroid, Merck, Lily, Hewlett - Packard, Texas Instruments, Coca - cola and Avon. These companies were considered to be so great that nothing bad could ever happen to them. And it was accepted dictum that it absolutely didn't matter what price you paid. If it was a little too high, no matter: the companies fast - rising earnings would soon grow into it.
The result was predictable whenever people are willing to invest regardless of price, they're obviously doing so based on emotion and popularity rather than cold-blooded analysis. So Nifty Fifty stocks that had been selling at 80 - 90 times earnings in 1970, in the vanguard of a powerful bull market, came down to earth when matters cooled. Thus many sold at 8 - 9 times earnings in the much weaker stock markets of 1973, meaning investors in "Americas best companies" had lost 80 - 90 % of their money. And note that several of the "flawless" companies mentioned have since gone bankrupt or experienced serious brushes with distress.
So much for "no price too high" No asset or company is so good that it can't become overpriced. Certainly that notion must have been banished forever.
But lest you think this lesson truly was learned, let's fast - forward to the late 1990's now it was technology stocks that were commanding widespread attention. Just a corporate innovation has sparked the growth stock fad, now going in telecommunications ( mobiles and transmission via optical fibre), media (including the limitless demand for "content" to fill the new entertainment channels), and information technology (especially the Internet) were firing investors imaginations.
"The internet will change the world", was the battle cry followed as usual by "for an e-commerce stock, there's no price too high" Whereas the Nifty Fifty stocks had sold at inflated multiples of their companies earnings, that wasn't a problem with Internet stocks: these companies had no earnings. Not only was the investing purely conceptual, but so were many of the companies. So instead of P/E ratios, the stocks sold at multiples of revenues (if there were any) or "eyeballs" the number of consumers visiting their websites.
Just as with the Nifty Fifty, there was a grain of truth underlying the investment fad; one is usually required in order for a bubble to get going. But investors slipped the moorings of reason and discipline when they concluded that price didn't matter. They were right; the Internet certainly did change the world, which is unrecognisable today from what it was twenty years ago. But the companies behind the vast majority if the Internet stocks of 1999 and 2000 no longer exist. The Nifty Fifty losses of 80 - 90% are enviable; these companies investors lost 100%
The bottom line is clear: I think "price doesn't matter" is a necessary component - and a hallmark - of a bubble. Likewise, in bubbles, investors often conclude that you can make money by borrowing money to buy into the mania. No matter what the interest rate is on your loan, the asset is sure to appreciate at a rate above that. Clearly this is another example of the suspension of analytical disbelief.
"No price too high" is the ultimate ingredient in a bubble, and thus a foolproof sign of a market gone too far. There is no safe way to participate in a bubble, only danger. It should be noted; however, that "overpriced" is far from synonymous with "going down tomorrow" many fads roll on well past the time when they first reach bubble territory. Several prominent investors threw in the towel in early 2000 because their resistance to the tech bubble had proved so painful. Some saw clients withdraw a large part of their capital, some became dispirited and quit the business, and others gave up and bought into the bubble..... just in time to see it collapse, compounding their error.
The following progression serves to sum up regarding the upswing of the market cycle. It shows how cycles in economics, profits, psychology, risk aversion and media behaviour combine to move market prices well beyond intrinsic value, and how one development contributes to the next.
These latter terms have been around for a long time. The "South Sea Bubbles" a mania for investing in the company that supposedly would pay off the national debt by exploiting a monopoly to trade with South America, caught England by storm in 1720. And the market collapse that kicked off the Great Depression is called the great crash of 1929. But it was the "tech bubble", "Internet bubble" and "Dot com bubble" of 1995 - 2000 - and the housing and mortgage bubbles that ended in 2007, bringing on significant crashes in markets around the world - that brought the word "Bubble" into everyday use. As a result of the foregoing, there's a tendency these days - especially on the part of the media - to call any big market rise a bubble. In 2017, the S&P 500 index of U.S. stocks had roughly quadrupled (including dividends) from its low in March 2009, and the yield on U.S. high yield bonds had fallen to a 5.8% . Thus rose the market whisper whether we're in a new bubble of one kind or another, perhaps implying a crash is imminent. That's why I want to spend some time on my conviction that not every big rise is a bubble. For me, the term "Bubble" has special psychological connotations that should be understood and looked out for.
I've lived through battles much older than those in tech stocks and housing. One of the best examples was a mania for the "Nifty Fifty" stocks - the shares of the highest - quality, fastest - growing companies in America. As far as I'm concerned, there's a common thread that runs through bubbles and was exemplified by the Nifty Fifty: conviction that, as far as the subject asset is concerned, "there's no such thing as price too high" And of course it follows that no matter what price you pay, you're sure to make money. There's only one form of intelligent investing, and that's figuring out what something's worth and buying it for that price or less. You can't have intelligent investing in the absence of qualification of value and insistence on an attractive purchase price. Any investment movement that's built around a concept other than the relationship between price and value is irrational.
The idea of "growth stocks" began to be popularised in the early 1970's, based on the goal of participating in the rapidly growing profits of companies benefitting from advances in technology, marketing and management techniques. First National City bank (the predecessor of Citibank), the Nifty Fifty stocks - the fastest growing and best - had appreciated so much that bank trust departments that did most of the investing in those days generally lost interest in all other stocks.
Everyone wanted a piece of Xerox, IBM, Kodak, Polaroid, Merck, Lily, Hewlett - Packard, Texas Instruments, Coca - cola and Avon. These companies were considered to be so great that nothing bad could ever happen to them. And it was accepted dictum that it absolutely didn't matter what price you paid. If it was a little too high, no matter: the companies fast - rising earnings would soon grow into it.
The result was predictable whenever people are willing to invest regardless of price, they're obviously doing so based on emotion and popularity rather than cold-blooded analysis. So Nifty Fifty stocks that had been selling at 80 - 90 times earnings in 1970, in the vanguard of a powerful bull market, came down to earth when matters cooled. Thus many sold at 8 - 9 times earnings in the much weaker stock markets of 1973, meaning investors in "Americas best companies" had lost 80 - 90 % of their money. And note that several of the "flawless" companies mentioned have since gone bankrupt or experienced serious brushes with distress.
So much for "no price too high" No asset or company is so good that it can't become overpriced. Certainly that notion must have been banished forever.
But lest you think this lesson truly was learned, let's fast - forward to the late 1990's now it was technology stocks that were commanding widespread attention. Just a corporate innovation has sparked the growth stock fad, now going in telecommunications ( mobiles and transmission via optical fibre), media (including the limitless demand for "content" to fill the new entertainment channels), and information technology (especially the Internet) were firing investors imaginations.
"The internet will change the world", was the battle cry followed as usual by "for an e-commerce stock, there's no price too high" Whereas the Nifty Fifty stocks had sold at inflated multiples of their companies earnings, that wasn't a problem with Internet stocks: these companies had no earnings. Not only was the investing purely conceptual, but so were many of the companies. So instead of P/E ratios, the stocks sold at multiples of revenues (if there were any) or "eyeballs" the number of consumers visiting their websites.
Just as with the Nifty Fifty, there was a grain of truth underlying the investment fad; one is usually required in order for a bubble to get going. But investors slipped the moorings of reason and discipline when they concluded that price didn't matter. They were right; the Internet certainly did change the world, which is unrecognisable today from what it was twenty years ago. But the companies behind the vast majority if the Internet stocks of 1999 and 2000 no longer exist. The Nifty Fifty losses of 80 - 90% are enviable; these companies investors lost 100%
The bottom line is clear: I think "price doesn't matter" is a necessary component - and a hallmark - of a bubble. Likewise, in bubbles, investors often conclude that you can make money by borrowing money to buy into the mania. No matter what the interest rate is on your loan, the asset is sure to appreciate at a rate above that. Clearly this is another example of the suspension of analytical disbelief.
"No price too high" is the ultimate ingredient in a bubble, and thus a foolproof sign of a market gone too far. There is no safe way to participate in a bubble, only danger. It should be noted; however, that "overpriced" is far from synonymous with "going down tomorrow" many fads roll on well past the time when they first reach bubble territory. Several prominent investors threw in the towel in early 2000 because their resistance to the tech bubble had proved so painful. Some saw clients withdraw a large part of their capital, some became dispirited and quit the business, and others gave up and bought into the bubble..... just in time to see it collapse, compounding their error.
The following progression serves to sum up regarding the upswing of the market cycle. It shows how cycles in economics, profits, psychology, risk aversion and media behaviour combine to move market prices well beyond intrinsic value, and how one development contributes to the next.
