Bubbles-in-the-sun

Nothing new under the sun, part 1

There’s no question U.S. equities once again entered bubble territory in 2021. Depending on the metric, they were close to or even higher than the peak valuations of the late 1990s U.S. tech bubble. As we’ve hopefully learned from past bubbles, bubbles have far-reaching consequences for investors.

2021’s everything bubble, which may still be deflating (more on that in Part 2), shares many parallels with the irrational exuberance of the late 1990s U.S. tech bubble and the soaring stock market of the Roaring Twenties (the 1920s). As I’ve written before (This Time is Different), contemporaneous accounts of prior bubbles can help us learn from the past.

As Cliff Asness, co-founder of AQR, described in Bubble Logic in 2000, “it is always different all the time. However, what is the same is far more important than what is different.” Bubble Logic, in perhaps only the way Asness can, critically examines the many flawed justifications for the record-high valuations of U.S. equities and especially tech stocks in the late 1990s. He labeled the justifications “bubble logic.”

When Asness published Bubble Logic in August 2000, the NASDAQ was down more than 20% from its March 2000 high. It would bottom in late 2002 at 22% of its peak (yes, down 78%). The S&P 500, down only slightly in the summer of 2000, would nearly be cut in half.

What were the justifications used at the time?

“We Have Heard the Bears Wrongly Scream ‘Over-valued’ for So Long Now”

“[this] argument simply uses the mania to justify itself.” That’s the nature of bubbles – the market starts off reasonably priced or even cheap, starts to become expensive, and then reaches rarefied territory before the end. For the tech bubble, the move from reasonable to expensive to rarefied took about five years. A blink of an eye when looking at a price chart; a chunk of a career when living through it.

Greenspan’s Irrational Exuberance speech was in December 1996. And, from there, the exuberance would only become more irrational. The NASDAQ would go on to nearly quadruple in a little more than three years after Greenspan’s speech.

Just because the market is expensive doesn’t mean it can’t get more expensive. In late 1997, the market surpassed its 1929 valuation high; then it kept going up. Anyone anchored in valuation was inevitably early. They were called washed up (Buffett), closed up shop (Julian Robertson), or lost clients (GMO).

“The Market, and Tech in Particular, Will Rally as Soon as the Fed Stops Hiking”

“…the stock market, and the growth/technology sector in particular, is rallying sharply on the prospects of slower economic growth, and thus a greater chance the Fed will stay their hand.” Many believed the Fed was taking away the punch bowl, but an economic slowdown would let them restart the party. However, as Asness noted, “It is only long-term spectacular real earnings growth that can come close to justifying current stock prices, and that is not going to occur without very strong economic growth.”

The Fed’s last hike in that cycle was in May 2000 (to 6.50%). Did that help? No. The NASDAQ would tumble 70% after the last hike and nearly all the S&P’s decline occurred after.

With the NASDAQ down nearly 50%, Greenspan rode to the rescue, cutting rates in January 2001. And Greenspan kept cutting, taking the Fed Funds rate from 6.50% to 1.75% by the end of 2001. Yet the market kept falling. From the date of the first rate cut, the NASDAQ and S&P would drop another 57% and 42%, respectively.

What was missed? Discount rates matter, but so do starting valuations, especially when they are at extremes. U.S. equities, particularly tech stocks, were more expensive than they had ever been before (by a wide margin). The market assumed perfect conditions (spectacular earnings growth, etc.) would continue forever; and they couldn’t (and didn’t). Even if the perfect conditions had continued, the valuations at the time would still have been too high.

“We Recommend Stable Tech Stocks with Earnings, Not Speculative Internet Stuff”

“Tech is the place to be, the driving force of the economy, you have to participate.” In the later stages of the tech bubble, the “in opinion” was to avoid high-flying dotcom stocks and invest in “tech stocks with large and growing earnings.” The largest tech stocks in late 1999 were all real companies – the top three, by market cap, were Microsoft, Cisco, and Intel. These companies were market leaders, with revenue and earnings, but they were also trading at historic valuations.

As expected then (and we now know), the internet did indeed change the world. As with many past bubbles, even changing the world could not live up to the hype. Many of the companies that participated did not exist in the late 1990s (e.g., Tesla, Meta), were not public at the time (e.g., Alphabet) or later reinvented their businesses (e.g., Apple introduced the iPod in 2001).

“We Have Just Lived through a Bear Market”

The 1990s were exceptionally good to U.S. investors. Starting in 1991, the NASDAQ returned 30% per year and the S&P 500 18% (before dividends). The market was up eight of nine years. In the one down year (1994), the NASDAQ dipped just 3% and the S&P fell only 2%.

Investors came to believe stocks were a sure thing. They mostly went up. If they went down, it was a buying opportunity as stocks would quickly bounce back and then rip higher. Although there were bumps along the way (e.g., the near collapse of Long-Term Capital Management), there were no prolonged pullbacks.

2000 marked the first sustained market pullback in a decade. Many were convinced (or at least hoped) that a 20% drop would be enough (at the time Asness was writing, the NASDAQ was down more than 20%). But, in the summer of 2000, the worst was still ahead. The NASDAQ would decline another 34% by the end of the year, ending 2000 down 50% from its peak (and 39% for the year). The S&P would end 2000 down 10%. But, perhaps appropriate for a bubble that took years to reach its peak, the bottom was still nearly two years away.


Every once in a while, there is something new under the sun. But the present is more like the past than we think. More bubble logic as well as my thoughts on 2021’s everything bubble to come in Part 2.

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