History of Economic Bubbles

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History of Economic Bubbles

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Representative Article Image
The Chandos Portrait of William Shakespeare
Artist Attributed to John Taylor
Year c. 1600s
Dimensions 55.2 cm × 43.8 cm ( 21 3⁄4 in ×  17 1⁄4 in)
Location National Portrait Gallery, London

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What is a bubble?

A bubble is the sharp rise and fall of asset prices over a period of time. The rise of the bubble is often caused by speculation of future prices causing the asset to be overvalued. When the asset is overvalued it is being traded or sold at a price above its actual value or intrinsic value. After the people come to the conclusion that the asset is overvalued the price crashes and returns back to its intrinsic value bursting the bubble.

Examples of Bubbles

Tulip Bubble

The first recorded bubble in history was the tulip mania bubble that took place in holland in the mid 1600s. Tulips were a new addition to the garden in Holland and became very popular. Then a virus started to infect the tulips leaving them with fire like patterns. These new tulips became in demand by almost all of holland, driving the price up. Eventually the continual rise in price caused the tulips to be viewed as a good investment because the price should continue to go up. The price escalated to the point of people exchanging land, jewels, and cows for the tulips. By the time the tulips had reached their peak the price had increased 20 fold. With the price so high people some people decided that it would be advantageous to sell the tulips and collect their profits. This lowered the price of the tulips for the first time. Because the tulips had no reason for escalating in price other than speculation the prices crashed with no reason to speculate on the tulips.

South Sea Bubble

The South Sea bubble is a bubble of new company stock caused by the desire for investment opportunities in 18th century England. The East India Company was hugely successful and paid out huge sums of money to its investors. However, only very few people were able to invest in the East India Company leaving many wealthy people without investment opportunity. In France the Mississippi Company had just started up and was bringing lots of money for the French investors. The wealthy Englishmen wanted an investment outlet and the South Sea Company offered that. The South Sea Company was set up to trade with South America and hopefully be as successful as the East India Company. However, South America was under the control of Spain and Portugal leaving little hope for the success rivaling the East India Company as the East India Company had full control over India. The South Sea Company attempted many trade ventures such as slave trading and and wool trading. However, the mortality was too high on the slave boats and they could not sell the wool stuck rotting on docks for many of them to be profitable.

Internet Bubble The invention of the internet was one of the single greatest achievements of recent years and changed the way people interacted and obtained information. Many companies were created to use the new technology. These companies were heavily invested in because of how exciting and promising the internet seemed to be. With all these investments the stocks rose quickly over time attracting more and more investors. All that was needed was just and idea to obtain insane amounts of investment capital from investors wanting to get in on the internet boom. With the rising amount of people investing in internet companies, more and more people pitched their ideas in an attempt to grab money.

Companies often changed their name to have “com” in it hoping to cash in on the internet craze. New start-ups were created and raised money from investors with silly or non-existent business plans that were eerily similar to the start-ups during the South Sea Bubble. All that mattered was having a cool sounding name and a registered internet domain name. The rest would be figured out later. And, the money came pouring in.

Growth Stock New Issue Craze Investors had a huge appetite for space-age stocks in the Soaring Sixties. More new issues were created in the 1959-62 period than in previous period in the history of the stock market. It was labeled the “tronics” boom. Many of the stock offerings had names with some garbled version of the word “electronics” in their name, even if the company had nothing to do with electronics. Investors quickly bought up shares in just about any company with “tronics” in its name.

Conglomerate Boom What investors wanted was growth in earnings per share. By the mid 1960’s businesses found a way to create this with conglomerates touting “synergies”. Synergism is the quality that 2+2 = 5. Thus because of supposed synergies two companies combined would create more earnings per share than the two of the separately. Essentially a firm with higher price/earnings multiples would buy another company which trades at lower price/earnings multiples. The combined company would have higher earnings per share, thus having an increased earnings per share growth. But, all that was happening was the conglomerate (the combined companies) revaluing the earnings of the lower multiple company at the other firms’s higher multiple. It all worked until the conglomerates could not keep buying up cheaper companies and pulling in their earnings into their own at high multiples. When that happened the conglomerate boom collapsed.

Concept Stock Bubble This fad was in stocks with a good story to tell, or a “concept”. This became known as the “go-go era”. Often these concept stocks had something to do with marketing to youth. It was the youth culture of the 1960’s and one of the concepts was that only youth could market to and sell to youth. Only they understood other youths. One such stock was NSM, National Student Marketing”. Each of its divisions had something to do with the college-age youth market from posters to records sweatshirts.

The Nifty Fifty After the last couple of bubbles, investors decided they needed safe growth stocks. About 50 stocks were considered safe premier growth stocks. These included familiar names such as IBM, Xerox, Avon, Kodak, McDonalds, Polaroid, and Disney. As more and more investors purchased these supposedly safe growth stocks they pushed their prices to higher and higher levels till many of them were trading at as much as 80 times earnings, compared to a typical stocks 15 times earnings. Ultimately this bubble ended and the Nifty Fifty stocks cam crashing back to earth.

Roaring Eighties - Return of the New Issues Just like in the early 1960’s, the 1980’s were a new issue market. This time around the craze centered around Biotechnology and Microelectronics stocks. Most Biotech companies were not profitable, and the potential for profits was very far in the future. But, still investors flocked to them, bid their prices up to very high levels. The results were predictable. A lot of stocks with names and business plans in the Biotech or Microelectronics areas were sold, went up, and then ultimately crashed to earth. In the late 1980’s most biotech stocks lost 75% of their value, or more.

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