3 Valuable Lessons from the NASDAQ Bubble

The NASDAQ Bubble

Looking back, one can recall that the big capitalization technology stocks which controlled the NASDAQwere wildly overrated by out-dated measures. The Wall Street Journal had published on March 14, 2000, a prominent article - `Big Cap Tech Stocks are a Sucker Bet’. This article was contributedby the Wharton School finance professor and fellow Kiplinger’s columnist, Jeremy Siegel. He was of the opinion that `several investors of present time are undisturbed by history and by the failure of any large cap stock ever to justify, by its subsequent record, a (price-earnings) ratio anywhere near 100’. 

 

Bubble is a change and the nature of bubbles is that no one can predict when they could pop. If Nasdaq seemed to be overvalued in 2000, it was also overvalued in 1999 as well as 1998 and 1997. This resulted in investors rushing to buy stocks in late 1990s with the intention of not missing out on profits which their colleagues would be making. Most of the buyers overloaded their portfolios with big cap tech stocks with the belief that they could later sell to make a profit.


Education from the NASDAQ Bubble

Three of the most valuable education from NASDAQ bubble -

• Diversification - The main lesson from Nasdaq COMP, -0.63% bubble was diversification. Having ones’ savings in one high beta sector of financial markets would give rise to substantial risk of long lasting loss. Though the NASDAQ took fifteen years to break, an investor owning a 60%/40%stock/bond portfolio beginning on March 1, 2000 was at risk for less than four years. Besides, while NASDAQ was scrabbling its way back to break even, one generated an annualized return of 5.5% though not bad at buying while it was at its peak
• Price compression creates tail risk–Investors get involved in years’ worth of future returns into a very short time period. If the underlying entity does not give the actual value which it was priced in, this would give rise to disequilibrium. In other words, you would get investors who priced in high growth that does not seem to be profitable. When understanding dawns, the price decompresses and the bigger the compression, bigger is the decompression. As the Nasdaq bubble tend to get expanded, investors were looking forward to gain profits of the Internet, pricing in years’ worth of profits in a very short span of time. This means that they priced in a 15 years value of profit in a few years. When one fails to diversify accurately, one could be exposed to their savings being at risk. They should allocate their savings accurately to avoid being exposed to huge risk to their portfolio.
• Avoid chasing the next hot thing for maximizing returns –If one intending in maximising the primary source of income and allocating some of the income in, with the intention of planning for the future, proper allocation of saving is essential. The purpose of savings is not actual return maximization; on the contrary, return maximization within the boundaries of suitable risk taking. If one is a real saver on the lookout for stability, then the main portfolio goal is not simply a protection against purchasing power loss but the risk of long lasting loss. This means that it could be probably unwise to overweight the portfolio in favour of purchasing power protection.

Conclusion 

Most of the investors unfortunately turn to the stock market as a place where they could raise their profit and improve their financial status. In their eagerness to reach high, the risk factor is often overlook and sometimes ends in disaster. Caution needs to be exercised in every plan of investment to earn the fruits of a good labour.

More About Financial Bubbles

But why economic agents do not learn a lesson from history and what is the origin of the observed market euphoria? It should actually wonder more generally about the rationality of agents. By their individual actions, they participate in effect to create a gap between the actual value of a thing and its market value. And this gap increases; more the bursting of the bubble is near, even if the term is unknown. This process can be summarized by the metaphor of the beauty contest Keynes in Chapter 12 of the General Theory. So imagine that you are in a competition against a host of other competitors. You are facing a hundred photos of girls all equally charming as the other, and you are asked to select six, the six prettiest. The person whose choice is closest to the average choice (that is to say the girls who got the most votes) will be the winner of this competition and win the jackpot. Three techniques are available to you and to win. First, you choose a simple, even naive strategy, which is to choose the six most beautiful girls according to your standards of beauty. But you can also adopt a strategy. which is more vicious this time to copy your selection on the other competitors with your expectations. Finally, you say that there is no reason for you to be the one to embrace the second strategy you determine an ultimate, which includes the fact that each competitor will not only formulate expectations about choice other participants, but also on your own. The metaphor of beauty contests and shows that speculation is mainly due to expectations that each agent makes about the behavior of other agents. Worse, it seems rational to participate in this type of competition because there is a real jackpot game now apply this reasoning to any other market (financial, real estate or even tulips) and you now understand that when Prices are disconnected from reality is that economic agents engaged in a competition of beauty contests guy and that large batches are obviously involved other words, do not enter a speculative market generates a cost (opportunity) that corresponds to the potential gain that you would not have achieved; corollary, it is rational to participate in inflating a bubble in order to enrich themselves, knowing that sooner or later the bubble will explode . If the game mirrors expectations promote the creation of speculative bubbles, it should be noted that favorable market conditions may also participate in this movement. Thus, over the last ten years, it is interesting to note that each period of financial euphoria is a situation of low interest rates and abundant liquidity. Thus to extinguish the fire of the Internet bubble of the early naughtier, the Federal Reserve has made successive rate cuts that have led to a rise in private debt and the emergence of a real estate bubble The subprime; Belated. Again, the response of central bankers involved in the reduction rates that, this time, encouraged the public debt; replete. And since it seems that we are now cured syndrome "this time is different" (Reinhart and Rogoff), the current historically low interest rates could facilitate the emergence of a new bubble. What will be the nature of the next big crisis? An early response, rather obvious, is of the bond market, when many experts welcome historically low borrowing rates, especially for states but also for corporate, bond bubble continues to swell to form a time bomb. And if some commentators are trying to alert the markets inevitable future rise in interest rates, the warnings remain almost unnoticed as the general euphoria is great. But other risk factors may also be highlighted. Real overheating in China, seven-fold during the decade gold bubble carbon and financing of energy transition and finally growing attraction for bit coin. Yes, this totally paperless currency created in 2009 by a computer meeting the pseudonym Satoshi Nakamoto, who was at the center of media talks some time ago, due to the sudden surge in its course and all its fall brutal. At its inception, the parity bit coin stood indeed one thousandth of a dollar before reaching on April 10 to a high of 266 dollars, then lose in just a few days over 70% of its value to pass under the below 80 dollars. All bubbles eventually burst and one day or the other. But the man never lacks imagination to always find a new source of enrichment. And when he is not at the origin, it adopts a mimetic behavior that allows him to achieve his goal. This process can really be repeated ad infinitum? Or, maybe it does not itself amount to a giant bubble that would only swell for centuries?