I remember back in the late 1990s living through the “TMT” stock market bubble.“TMT” stood for “Technology, Media and Telecommunications”. Anything to do with technology was seen to have limitless potential. The most famous of these technology stocks were the “dot coms”, named after their websites. It’s hard to imagine now, but the internet was a new phenomenon at the time.
It was said we were living through a “new paradigm”. Old style value investors were thought to be dinosaurs that didn’t “get it”.
But when caught in private, after a couple of drinks, they would admit that the whole thing was basically a hoax.
At the time I worked in a big investment bank and had several friends who were technology analysts. They were busy cheerleading the increasingly ridiculous valuations of the tech stocks, and raising capital for them. But when caught in private, after a couple of drinks, they would admit that the whole thing was basically a hoax. A bubble.
Anyone that didn’t wear a tie and who was under 35 could come up with a crazy idea and then raise tens or hundreds of millions of dollars of dumb money from investors. Most of it was spent on fancy offices, corporate jets and expensive champagne.
These companies had no earnings. In many cases they didn’t even have any income to speak of. And yet they would have stock market valuations of billions of dollars. Prices were justified by new and bizarre concepts for that time such as “eyeballs” (people looking at website/prints) and “stickiness” (how long they stay in the website). Some of them didn’t even have a business plan. A few just existed to invest in other dot coms without business plans.
Of course a lot of these companies sold stock using the same kind of sales pitch as the infamous South Sea Company from Britain, which created a massive bubble and crash in the years up to 1720. It was described as “a company for carrying out an undertaking of great advantage, but nobody to know what it is”.
The South Sea Bubble was an investment mania – and great fortunes were lost. Even Sir Isaac Newton – the famous physicist – was caught up in it, which perhaps proves that emotions can be more powerful than intelligence. Technology may change, but human nature does not. People were greedy and short sighted 300 years ago. They are just the same today.
South Sea Stock Price Chart
Back in the late 1990s dot com bubble, I didn’t even realise that I was a value investor. I was still in my late 20s and didn’t have much to invest. But I did intuitively feel that something was wrong. So I kept out of the whole thing. It looked too risky – too full of hype. So I took my punches in bar room discussions as the true believers kept reminding me what a heathen I was.
Fortunes were made by the early investors and insiders. Investment bankers made a pile of money from the fees charged for separating fools from their capital. And then the little guys got in on the act. Everyone wanted to be a “day trader” – setting up online brokerage accounts (also new) and speculating on the huge one day price moves of the dot coms. People even gave up their professional careers to become full time speculators.
The NASDAQ Composite index, dominated by tech companies, went ballistic. It rose 240% between October 1998 and March 2000. By September 2001 – one and a half years later – it had lost all of those gains – a fall of 82%. It bounced a little then kept falling into early October 2002 – for a total fall of 87%.
NASDAQ Composite price chart (late 1998 to early 2003)
Any buy and hold investor over those three years made no money. Elation turned to despair. But they were the lucky ones. Many people lost a fortunes – especially if they had “invested” with borrowed money, which still had to be paid back. I remember one friend telling me he’d lost almost all of his pension fund.
It was a roller coaster ride. A whole generation of investors learnt all about bubbles. In the carnage that followed, people realised that markets are not efficient mechanisms for working out the value of things. Instead they are the product of the views of the herd. And the herd is made up of emotional animals. Most of the time they are happy grazing. But from time to time they stampede. People came up with charts like this to explain what happened.
Stages of a Bubble
And now a new generation – or at least a niche part of one – has been learning about bubbles again. I’m talking about bitcoin.
Bitcoin is an electronic form of currency. A group of computer programmers decided to create a payment system outside of the government oligopoly of fiat currency. The idea was also to bypass the international banking payments system. Bitcoins are created by computers that solve complex problems. They are transferred anonymously via the internet.
A maximum of 21 million bitcoins can be created, and at time of writing there are about 11 million out there. As the number in existence increases it becomes harder and harder to create, until the maximum is reached.
There has been a lot of debate about bitcoin, and whether it will work. I won’t get into all of the detail here. But one of the main criticisms is that bitcoin only exists electronically and isn’t backed by anything. The counter argument is that this is true of most money these days.
…one of the main criticisms is that bitcoin only exists electronically and isn’t backed by anything. The counter argument is that this is true of most money these days.
Rupees, dollars, renminbi yuan, reais, pounds, pesos, euros – most of them exist as accounting records on a computer system. Very few are in physical notes form. And none are backed by real assets, such as gold.
Bitcoin is a bit like Facebook. A social network in other words. The more people that join the network, the more useful it is. And because there is a limited supply, the price curve is steep as more and more users (buyers) decide to come in.
But I don’t really want to talk about whether or not bitcoin is going to be successful. It may disappear in a few months and be remembered as a currency curiosity. Or it may find a number of highly successful niches in the global online economy. It’s too early to say.
What I really I want to talk about are the risks of speculation. We have just seen a huge bubble in the bitcoin price, measured in US dollars. This was quickly followed by a spectacular collapse.
In just two months, since 13 February 2013, the price went from $30 all the way up to $260 during the 10 April trading day. That’s a staggering rise of 767% in under a month. In fact the price was still under $50 on 17 March, meaning it rose 420% in just three weeks. This makes the NASDAQ bubble look tame by comparison.
But then the bitcoin bubble burst in spectacular form. In just two days from 10 April to today the price fell 77% all the way back down to under $60 at one point. Where it goes from here is anyone’s guess.
It’s interesting that the NASDAQ took one and a half years to achieve the same magnitude of fall that bitcoin has achieved in just a couple of days. Volumes of trading bitcoin reached such levels that the main exchange for them had to shut down. It couldn’t cope.
Bitcoin price chart (in under a month!)
This was the “bit com speed bubble”. It’s a highly concentrated version of previous bubbles, in both the size of the price moves and the time it took for them to happen.
It’s the same old story. Early adopters – the insiders – accumulate the asset. The price starts to rise. Media interest picks up and the word spreads. As the price accelerates the latecomers – the speculative crowd that follows the hype – starts to buy in. The insiders start selling out to “greater fools” and make a fortune. The speculators lose a fortune and go away to lick their wounds.
This is a great illustration of the risk of short term speculating and trading. This is why we recommend long term value investing here at OfWealth.
Successful investment is about buying assets with real value when the price is cheap. It’s about going against the crowd, and then patiently waiting for the price to rise to its true value.
Remember: if you speculate, your wealth and investments are likely to be smashed to bits.
Until next time OfWealthers,