The Trouble With Bubbles[Fool on the Hill] April 13, 2000

An Investment Opinion

The Trouble With Bubbles

By Bill Barker (TMF Max)
April 13, 2000

I'm going to take a wild guess that if I were to read or watch much of the mainstream media's offerings on the stock market these days, I'd come across a series of questions and answers about: a) whether the market is a bubble right now; b) whether the bubble has already burst; and c) is the bubble finally about to burst?

Although these questions would seem mutually exclusive, nevertheless they seem to be competing for attention. If you've been following the market over the last five years or so, you'll know that the concept of "The Bubble" in general, tech stocks more specifically, and Internet stocks most specifically, has been a source of daily pontification for content-starved media outlets. Given that Bubble pontificators get almost as much media attention as Elian Gonzalez, you would think that there would be some sort of consensus on how to define a bubble, or some sort of evolution of understanding of what does and does not signal a bubble, but I'm afraid that I haven't witnessed either. It's just good copy, I suppose, to raise the spectre that there's mass hysteria over every stock in the market.

I think I understand why the media keeps returning to this series of questions. After all, an actual bubble in the stock market would be a pretty good thing for everybody to avoid, and finding a channel or an expert that could accurately predict the timing of a "burst" would provide the opportunity for nearly incalculable wealth. But the willingness to call nearly everything that isn't fully understood a bubble is far too pervasive, and I don't see many lessons learned.

Take the September 1996 issue of Red Herring, which devoted several articles to "the Internet bubble," how it started, and how it "burst" on July 16, 1996. In a series of articles with titles such as "Internet Mania R.I.P." and "The IPO Bubble," Red Herring buried the possibility that investors could ever have been thinking straight when their irrational exuberance led them to do such patently absurd things as:

  • value all public Internet companies at a total market cap of $9.5 billion
  • value Excite at a split-adjusted $9 a share (it would ultimately merge with @Home (Nasdaq: ATHM) at a price of $133 a share)
  • value Lycos (Nasdaq: LCOS) at $5 a share
The articles are dismissive of almost everybody involved. "Thinking of the private investor who purchased the stock of Internet companies in good faith, some pundits were angry. 'It's my privilege to say they're behaving criminally,' Bob Metcalf, the founder of 3Com (Nasdaq: COMS) said of investment banks and venture capitalists just before the crash." People who ever would have done such things as buy America Online (NYSE: AOL) at a split-adjusted $4.50 a share are summed up by using such vapid tautologies as "The speculation ended for no reason better than that such episodes always end: They must."

And yet, and yet... obviously nothing at all was ending in 1996, nor "must" it have been. Lycos is now up 800% from its high at the time the article was written, and the total market capitalization for all Internet companies must be well over $500 billion these days. At the time the article announcing the death of the Internet mania was being written, AOL was at a market cap of about $2 billion, and (Nasdaq: AMZN) and eBay (Nasdaq: EBAY), among many others, weren't close to being public.

I don't want to pick on Red Herring or its writers here. Believe me, there are lots and lots of articles that have come out since 1996 that puffed their chests up just as much about the "mania" that has gripped investors and the surety that it would "all end badly" -- and the need to revisit the bubble theorizing ad nauseam continues today. This week's Business Week cover asks, "Is the Party Over?"

I can think of two main problems with the form that all these questions take. First, there's no standard definition of "bubble" though the term is tossed around with abandon. Does it mean something that has, or could, lose 40% of its value? 60%? 90%? 100%? Does the loss in value have to be permanent? Take the most common use of the question and answer about bubbles -- the television. You've got the interviewer, the person who writes the questions for the interviewer, the interviewee, and the viewer, and all four might have different definitions of what a bubble means. How, then, is any useful information to be communicated by the media expert, and received by the listener?

The bigger problem about speculating on the existence of a bubble is that accusing the entire market of being a potential bubble skips over the easier and more useful information that could address discrete areas of the market. Here are a couple of sectors that seem to me to have already gone through a bubble, almost regardless of how you would choose to define the term:
Providers         High     Current   % Loss   $71 1/4    $6 1/4      91
iVillage         $130     $10 13/16    92      $45 3/4    $2 11/16    94

Linux             High     Current   % Loss
Red Hat, Inc.     $151       $31       79
VA Linux          $320     $40 1/4     87
Corel Corp.     $44 1/2     $8 1/4     82

Brokers           High     Current   % Loss
Siebert Fin.      $58      $11 3/4     80
JB Oxford         $25      $5 23/32    77
E*Trade         $72 1/4    $23 7/16    67
Ameritrade      $62 3/4    $18 1/16    71
Please don't send me flame mails if I've listed one of your favorite stocks here. My point in choosing these companies is not that they have failed. Actually the companies listed above have performed about as well as, and perhaps better than, one reasonably would have expected even since their high points as stocks. The companies have demonstrated the growth (in revenues) that was probably projected by analysts issuing strong buy reports on their businesses, but that growth could never have justified the high prices each of these companies had in the first place.

I don't know about you, but I take a small amount of comfort from the fact that the sectors that flew too high to the sun have already had the wax melted off their wings, yet the market indices aren't succumbing to the same sort of death spiral that the market-is-a-bubble theorists keep postulating. The fact that bubbles in the market might be speculated on too much and too early doesn't mean they don't exist. They just don't exist nearly as often, and they're not nearly as widespread, as one would expect if they believed every word they read and heard on the subject.