Saturday, July 30, 2005

Crashes & Bubbles

Crashes and Bubbles in the market

A bubble is a type of investing phenomenon that demonstrates the weakness of some facets of human emotion. A bubble occurs when investors put so much demand on a stock that they drive the price beyond any accurate or rational reflection of its actual worth

Like the soap bubbles a child likes to blow, investing bubbles often appear as though they will rise forever, but since they are not formed from anything substantial, they eventually pop. And when they do, the money that was invested into them dissipates into the wind.

A crash is a significant drop in the total value of a market, almost undoubtedly attributable to the popping of a bubble, creating a situation wherein the majority of investors are trying to flee the market at the same time and consequently incurring massive losses. Attempting to avoid more losses, investors during a crash are panic selling, hoping to unload their declining stocks onto other investors.

Great Market Crash :  Tulip – Bulb Craze (1634-1637, Holland)

 

In 1593 tulips were brought from Turkey and introduced to the Dutch. The novelty of the new flower made it widely sought after and therefore fairly pricey. After a time, the tulips contracted a non-fatal virus known as mosaic, which didn't kill the tulip population but altered them causing "flames" of color to appear upon the petals. Thus, tulips, which were already selling at a premium, began to rise in price according to how their virus alterations were valued.

The true bulb buyers began to fill up inventories for the growing season, depleting the supply further. Soon, prices were rising so fast and high that people were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs. Needless to say, the prices were not an accurate reflection of the value of a tulip bulb. As it happens in many speculative bubbles, some prudent people decided to sell and crystallize their profits. A domino effect of progressively lower and lower prices took place as everyone tried to sell while not many were buying. The price began to dive, causing people to panic and sell regardless of losses.

The government attempted to step in and halt the crash by offering to honor contracts at 10% of the face value, but then the market plunged even lower, making such restitution impossible. No one emerged unscathed from the crash. The effects of the tulip craze left the Dutch very hesitant about speculative investments for quite some time.  

The Dot-Com Crash (March 11th, 2000 to October 9th , 2002  - Silicon Valley)

Percentage Lost From Peak to Bottom: The Nasdaq Composite lost 78% of its value as it fell from 5046.86 to 1114.11.

Synopsis: Decades before the word "dot-com" slipped past our lips as the answer to all of our problems, the internet was created by the U.S. military, who vastly underestimated how much people would want to be online. Commercially the internet started to catch on in 1995 with an estimated 18 million users. The rise in usage meant an untapped market--an international market. Soon, speculators were barely able to control their excitement over the "new economy."

Companies underwent a similar phenomenon to the one that gripped 17th century England and America in the early eighties: investors wanted big ideas more than a solid business plan. Buzzwords like networking, new paradigm, information technologies, internet, consumer-driven navigation, tailored web experience, and many more examples of empty double-speak filled the media and investors with a rabid hunger for more. The IPOs of internet companies emerged with ferocity and frequency, sweeping the nation up in euphoria. Investors were blindly grabbing every new issue without even looking at a business plan to find out, for example, how long the company would take before making a profit, if ever.

Obviously, there was a problem. The first shots through this bubble came from the companies themselves: many reported huge losses and some folded outright within months of their offering. Siliconaires were moving out of $4 million estates and back to the room above their parents' garage. In the year 1999, there were 457 IPOs, most of which were internet and technology related. Of those 457 IPOs, 117 doubled in price on the first day of trading. In 2001 the number of IPOs dwindled to 76, and none of them doubled on the first day of trading.

Many argue that the dot-com boom and bust was a case of too much too fast. Companies that couldn't decide on their corporate creed were given millions of dollars and told to grow to Microsoft size by tomorrow.

 


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