By Ya-Gui Wei
Since late last year, I have been writing in these spaces (for example, 1, 2, 3, 4.) about the Nasdaq/internet stocks being in a perilous bubble waiting to burst. Well, this spring, the bubble did burst.
While the technology stock market will continue to fluctuate, and money will continue to flow from one sector to the next, it's important not to forget that the U.S. technological stock market is at the post-bubble stage. How will the market behave at this stage? Is it more likely for Nasdaq to get back above 5000 than going below 3000? Perhaps we can gain some insight by looking back at some of the past market bubbles.
The market bubble is not a new phenomenon. Some 380 years ago in Holland, when tulip bulbs became the hot investment vehicle, the price of a single tulip bulb eventually ended up equal to a wealthy merchant's annual income (5). Those who bought near the top still have not recouped their investments four centuries later.
In the 1920s, the Radio Corporation of America was the hot momentum stock, rising more than 2,600% in 3 years before it crashed more than 70%. Then, 5 months later, it rebounded, regaining 50% of the loss, but then the second wave of the crash ensued. RCA eventually fell back to its pre-bubble price a couple of years later. Those who bought near the top had to wait 30 years, when RCA began to make television, to break even. (See 1924-1934 RCA chart.)
The bull market that gave rise to RCA had a lot in common with the current bull market: Then as is now, the U.S. was in one of the longest periods of continuous economic expansion, and the stock market had been rising since 1923. Then as is now, the market was infatuated by a new form of rapidly growing technology for public communication -- broadcast radio. By 1929, the stock market was in frenzy speculative craze with almost everyone wanting to own radio stock, with the talk of a "new era" of technological innovations, productivity increases and that the old rules of valuation no longer applied (6). But suddenly, it all ended. The time was October 1929.
Fast forward to the 1970s, when the U.S. government decoupled the dollar from gold, and the price of the metal began to rise in 1972. By January 1980, the price of gold reached $800 an ounce, a more than 2,000% increase from 1972. But then the bubble bursted.
The gold price bubble, like the Japanese stock bubble mentioned below and the 1920's U.S. bubble earlier, is notable in that it bursted near the beginning of a decade. Coincidentally or not, we are now at the beginning of a new decade in a new millennium.
The Gold Price lost nearly 40% of its value in the initial crash. A few months later, it recovered 60% of the loss in a rebound. But then the second crash began. By 1982 the price of gold has dropped to the $300s where it remains today. (In inflation adjusted terms, where the then $800/oz price tag would equal to about $1500 in today's dollars, the price of gold has not remained steady since it has not kept pace with inflation. To say that gold will insure you against inflation is a bit of a myth. Gold may insure against a currency crash but not normal year-to-year inflation.)
The story with the Japanese market is hauntingly similar. Beginning around late 1982, the Japanese economy began to expand. By the end of the decade, the Nikkei index had risen nearly 1,000%. But then, a few days before January 1st, 1990, the bubble bursted.
The initial crash in the Japanese market in 1990 took away about 30% of its value, but a few months later, it has recover nearly 50% of its initial loss. But then a second wave of the crash follow, in the same fierce magnitude as the first crash. The second crash also saw a nearly 50% recovery a few months later, but then a third crash. Eventually, by 1992, the Japanese market settled on a bottom that is about 1/3 of its peak value.
What is there to be said about the current U.S. stock market? Well, like the previous market bubbles, it began about 2.5 years into the decade. In the summer of 1992, when Bill Clinton ran for President, the Nasdaq composite was at 580 points. (Click here to see how Nasdaq has risen since 1992.) And that the crash began at the dawn of the new decade. And that by mid-year, it has recovered 50% of the initial loss, but it is going down again.
The rest, however, is history not yet written.
One thing we learnt from all this historical review is that, even though the indexes would rebound 50% after each of the major crashes, all of them went on to crash a second time, equal in magnitude to the first crash.
Each of the market bubbles, including the current one, began the third year into a decade. Each reached their apex at the end of the decade and began to go down and crashed as a new decade dawns. They all went to their bottoms about 2.5 years into the new decade. Isn't it comforting to know that, after a bubble bursted and burnt to ash, another bubble of similar scale will begin to rise, perhaps somewhere else on earth? I guess people just cannot sit idly with money in their pockets.
Counter examples do exist. The U.S. economic expansion that began in the 1950s lasted for almost two decades. The difference is that the stock market did not go up parabolically then.
07/28/2000
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