During the early 1690s, England experienced a 'Financial Revolution.' It was described by financial historian Edward Chancellor as "a wave of exciting new technology companies coming to market, of rising share prices and record stock turnover, of new fangled financial derivatives, of credit wildly extended, of stock market rumours and sharp practices, and of naïve investors rushing to buy shares." Sound Familiar? Shortly after in 1695, the English stock market peaked and subsequently crashed. Simultaneously it was recorded that "women's fashionable headdresses which reached a height of 7 feet" during the mania became shorter and more somber. While this may seem a ridiculous coincidence, extravagance in culture and fashion historically coincides with the peak of a mania.
As Edwin Lefevre said in 1923:
"Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics, the one thing that strikes you most forcibly is how little either stock speculation or stock speculators today differ from yesterday. The game does not change and neither does human nature."
With this in mind, we have decided to highlight a few instances where the speculative extremes of 2000 are being revisited and even surpassed right now.
Internet Bubble 2.0
Nothing characterized the market peak in 2000 more than the extreme valuations of the dot-com stocks traded at the NASDAQ. As speculative froth returns to the marketplace as 2007 approaches, Youtube.com, MySpace.com, and Facebook.com are at the forefront of investing news. Youtube.com, a video sharing website, was just bought for $1.65 billion by Google. MySpace.com, a social networking site, was bought for $580 million. In a moment that truly harkens back to 2000, Yahoo.com, who participated in the NASDAQ bubble, is considering a bid for Facebook.com for $1 billion dollars. The sums being paid for these websites are outrageous since these companies have little startup cost and are dependent on revenue from fickle teen fads.
Not only are the dot-coms back, the tech kids are back as well. In 2000, business school students were dropping out to get rich in the Dot-com boom. On March 3rd, 2000, two weeks before the S&P500's all-time high, a BusinessWeek article discussed dilemmas for Dot-com millionaires who were under 30. With newly obtained wealth, they were struggling with their inexperience towards charitable organizations. What troubles! And now the rich nerds are back. Founders "Chad and Steve", both under 30, made between $100-200 million off the Youtube.com deal. On October 30th 2006, Business Week ran a Special Report: Best Entrepreneurs under 25. One article was titled: Young, Fearless, and Smart. One company expects "100 fold growth in 2 years." Youthful naiveté is the perfect symbol for a speculative top.
Investment bankers are also now in bubble mode. "As of Monday, the total value of announced acquisitions worldwide reached $3.46 trillion for the year, exceeding the $3.33 trillion level of announced deals reached in 2000, according to Dealogic." A Wharton Business professor Robert Hothausen says that researchers estimate between 50-80% of mergers fail. So why are bankers so willing to put companies together and why now? As happened in 2000, "the intense acquisition activity is driven by the surplus of cash held by private equity firms and public companies alike as well as interest rates that are at historic lows and the willingness of banks to provide financing." (Emphasis mine.) As one S&P analyst stated "This is merger mania." According to the AP "If current economic conditions persist, the whiplash pace of acquisition activity may go on." Of course this is the current emotional mindset. These mergers, however, happen late in the boom cycle and are an indicator of the coming down wave.
Another interesting reoccurrence is the record breaking contracts awarded to athletes, especially baseball. For instance in February of 2000, Ken Griffey, Jr. signed a 9 year deal for $116.5 million. Later that year in early December, Mike Hampton received an 8 year $121 million contract from the Colorado Rockies. A few days later, Alexander Rodriguez signed a deal with the Texas Rangers for a 10 year deal for $252 million in December of 2000. At the time it was the most lucrative contract in sports history. Less than a week after that deal, Manny Ramirez signed an 8 year deal for $160 million with the Boston Red Sox. Shortly afterwards in Feb 2001, Derek Jeter signed a 10 year $189 million dollar contract. These explosive spending sprees aren't random. As you can see this rush to spend was synchronous to the bull market peak of 2000. Now with sentiment running higher than in 2000, one would expect a repeat of the same from baseball owners. Sure enough, the purse has been opened. In April, David Ortiz signed a 4 year deal for $50 million with the Boston Red Sox. Last week Alfonso Soriano signed an 8 year deal for $136 million dollar deal. Carlos Lee also signed a 6 year deal for $100 million, the largest deal in Astros history on Nov. 24th. The Boston Red Sox also recently paid $51 million just for the right to negotiate with Japan's Daisuke Matsuzaka. To quote Yogi Berra, "it's déjà vu, all over again."
According to The Economist, "Sotheby's and Christie's have chalked up record volumes this month as well as record prices for individual works of art. On November 15th a sale of post-war and contemporary art at Christie's in New York brought in more than $200m, a new high, barely two years after a similar sale crossed the $100m mark for the first time. Works by Andy Warhol, Willem de Kooning, Clyfford Still and Richard Diebenkorn all sold for record prices. In London, the same day 30 records were broken for British artists of the 1930s and 1940s, and 13 records for Greek painters of the 19th and 20th centuries, even though many of them, frankly, were sentimental and second-rate." While art seems to us always overpriced, the fact that even admitted "second-rate" art is breaking price records should be a sign of speculative overly-optimistic buyers.
Against the Crowd
With optimistic extremes similar to 2000 appearing now, it is tough to remember that the good times don't always last. Wise investors should look at the similarities to 2000 and remember the effect the following years (2001-2003) had on their portfolio. Much like in 2000, market participants will be hoping for a "soft landing" in the bubble market. However history shows that "Era's of Good Feeling", "Gilded Ages" or "Roaring" periods are followed by economic and speculative downturns. Investors should be calmly exiting their stock, mutual fund, real estate, and long-term bond positions and acquiring cash.
In our next article we'll display some of our research done on a 20-year crash cycle that has continued since at least 1761. Hint: It doesn't bode well for 2007.
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***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions.