Thursday 20th April 2000
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Are recent stockmarket events indicative of a correction or a crash? The question is vital. If it is a correction, sage investors should buy in now, expecting a recovery around the corner. If it is a crash, then prices will fall for a protracted period.
The Asian crisis bought a sharp correction in 1998. The Japan bubble burst at the end of 1990, bringing a real crash and 10 years of recession.
At times such as these one must expect ministers of finance, bankers, chairmen of stock exchanges and prominent investors to make dutifully reassuring noises. They will speak of excellent fundamental values and hint at tremendous bargain opportunities.
It is necessarily thus. It has been so in every major stockmarket event since markets were first organised.
The "Tulip crash" in Holland in the 1730s is an excellent example of what causes financial panics. The Dutch began to import tulip bulbs from Turkey at the turn of the 17th century. Breeders created wonderful new types.
At first only the very rich were interested in these curiosities and tulips became a symbol of wealth and discernment. Although Dutch society was hierarchical, with great divisions between rich and poor, it had superb social communication and the lower classes were anxious to replicate elite taste. So the less wealthy also caught tulip mania.
Eventually breeders sold options at increasingly silly prices, on new breeds to be released next season.
This experience is instructive. There are two important points to this affair. First, involvement was widespread, penetrating from the elite down to the lower classes.
Second, prices became high because participants were confident they could sell their options at a good profit. Eventually few people were interested in the tulip; most were interested in the option and caught in a speculative mania.
The whole mania collapsed when suddenly the prices seemed too high and no buyers could be found for options.
On one day it seemed reasonable to sell an option on one tulip bulb of novel breeding and characteristics for the equivalent price of a house. But on another day there were no buyers.
There was no more orderliness in the market; an avalanche of sell orders swept through the empty halls. There were almost no buyers because tulips have little intrinsic value.
They fleetingly had exchange value but once the speculative bubble was broken the tulip no longer looked exotic. It ceased to be an asset, creating wealth or income, and was transformed into a measly flower.
It is entirely possible the internet stocks will cease to be tulips and become common flowers. Stocks that sold, despite their 600:1 price/earnings ratios, will find after this recent slaughter that light no longer gleams in the covetousness of their possessors' hearts.
Indeed many will find an overwhelming feeling of revulsion in their buyers' affections. The selling will be brisk. It is always so.
There are times when buying shares as assets is confined to a fairly narrow group of value investors. Periodically increasingly wider social groups begin to acquire shares. The very breadth of the shareholding group becomes a source of weakness.
More buying increases prices, which unleashes euphoric feelings in participants. The market responds with more issues, issues of stocks with increasingly unlikely purposes.
These ignite investors' hopes: manias grow. People sell their homes to buy, sometimes on the margin. It is not a bad rule to sell the moment your taxi driver or hairdresser says they are in a share club.
While at the top of the market there are naive first-time buyers but they are not really significant. The important players are substantial investors who realise markets are prone to excesses.
Greed and fear drive these people: fear of missing out on the boom and fear of getting caught. They knowingly push the juggernaut up, confident of leaping off at the right time, confident of making a soft landing.
Much twaddle was written in the past year about investors being unsure how to value the new-economy shares. I believe they knew and accepted huge risks in return for the chance of doubling their money in a year.
I was not the only commentator to say share prices were too high. My recent article on share volatility concluded volatility was a symptom of "an impending share crash (NBR, April 7). The extraordinary, contemporary turbulence could just be an augury of the last days of a wobbly bubble."
Is it part of the shareholders' psychology, once markets are gripped by panic, to feel revulsion for shares that had once excited their hopes the most? Most investors will retain (and revalue) their dull old-economy shares but they will dispose of the dot.coms by selling into rallies. Some dot.coms will wither and most will even likely be amalgamated. A few, very few, will ever pay a dividend.
The consequences? It's still too early to say. The worldwide Easter holiday could distort the process.
Perhaps another generation is being forced to learn the painful lessons of financial history. Many who felt the "wealth effects" acts of extravagance will now rein in their expenditure. Bonds and gold might return from their recently spurned position to represent security.
The real effects of a share crash are, of course, a massive loss of wealth and confidence. Many proud financial organisations could be destroyed by the leverage which has, until so recently, inflated their assets.
The possible knock-on effects can be addressed in future articles if the markets continue the turbulence of the past few days.
Meanwhile, it is worth remembering the lessons of the Dutch and their passion for tulips. It is entirely possible the internet stocks will cease to be tulips and become common flowers. Despite their 600:1 price/earnings ratios, stocks will find light no longer gleams in their possessors' hearts
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