Chapter 3: Speculative Bubbles from the Sixties into the Nineties
By the 1990s, institutions accounted for more than 90% of the trading volume on the NYSE.
1. The Soaring Sixties
1.1 The Growth-Stock/New-Issue Craze
In the 1959-1962 period, "Growth" was the magic word. Growth companies such as IBM and TI sold at more than 80 multiples of P/E (A year later they sold at multiples in the 20s and 30s). It was called "tronics boom", because the stock offerings often include some garbled version of "electronics" in their title. The tronics boom came back to earth in 1962. Yesterday's hot issue became today's cold turkey.
1.2 Synergy Generates Energy: The Conglomerate Boom
Part of the genius of the financial market is that if a product is demanded, it is produced. The product that all investors desired was expected growth in earnings per share. By the mid-1960s, creative entrepreneurs suggested that growth could be created by synergism.
In fact, the major impetus for the conglomerate wave of the 1960s was that the acquisition process itself could be made to produce growth in earnings per share - manipulation of P/E multiples. The trick that makes the game work is the ability of the electronics company to swap its high-multiple stock for the stock of another company with a lower multiple.
The aftermath of this speculative phase revealed two disturbing factors. First, conglomerates could not always control their far-flung empires. Second, the government and the accounting profession expressed concern about the pace of mergers and about possible abuses.
An interesting footnote is that during the 1990s and early 2000s, de-conglomeration came into fashion. Many of these sales were financed through a popular innovation, the leveraged buyout (LBO).
1.3 Performance Comes to the Market: The Bubble in Concept Stocks
"Performance" fund concentrated the portfolio in dynamic stocks, which had a good story to tell, and at the first sign of an even better story, they would quickly switch. Performance investing took hold of Wall Street in the late 1960s. "Since we hear story early, we can figure enough people will be hearing it in the next few days to give the stock a bounce. even if the story doesn't prove out."
Why did these stocks perform so badly later on? One general answer: their price-earnings multiples were inflated beyond reason. These companies were run by executives who were primarily promoters. not sharp-penciled operating managers.
2. The Nifty Fifty
In the 1970s, Wall Street's pros vowed to return to "sound principles". Concepts were out and blue-chip companies were in. "Big capitalization" stocks (Nifty Fifty) meant that an institution could buy a good-size position without disturbing the market. Hard as it is to believe, institutions started to speculate in blue chips. They once again proved the maxim that stupidity well packaged can sound like wisdom. The craze ended like all other speculative manias.
3. The Roaring Eighties
The high-tech, new-issue boom of the first half of 1983 was an almost perfect replica of the 1960s episodes, with the names altered slightly to include the new fields of biotechnology and microelectronics. During the late 1980s, most biotechnology stocks lost three-quarters of their market value. Even real technology revolutions do not guarantee benefits for investors.
4. What Does It All Mean?
Styles and fashions in investors' evaluations of securities can and often do play a critical role in the pricing of securities. The stock market at times conforms well to the castle-in-the-air theory. For this reason, the game of investing can be extremely dangerous.
5. An International Example: The Japanese Yen for Land and Stocks
One of the largest booms and bursts of the late 20th century involved the Japanese real estate and stock markets. From 1955 to 1990, the value of Jap. real estate increased more than 75 times. By 1990, tot. value of Jap. real estate was estimated at ~20 trillion - equal to >20% of the entire world's wealth, or about double the tot. value of the world's stock market, or five times as much as all American property. The high value of Jap. land was "explained" by both the density of Jap. population and the various regulation and tax laws restricting the use of habitable land.
Jap. stocks sold at >60 times earnings, almost 5 times book value, and >200 times dividends. In contrast, US stocks 15 P/E; UK stocks 12 P/E. Supporters of the stock market had answers to all the logical objections that could be raised. One being that the book values did not reflect the dramatic appreciation of the land owned by Jap. companies. (Sam: "what is the relationship between real estate and stock ?")
Weakness of Jap. economy at that time:
1) Even when earnings were adjusted, the multiples were still far higher than in other countries and extraordinarily inflated relative to Japan's own history;
2) Jap. profitability had been declining, and the the strong yen was bound to make it more difficult for Japan to export;
3) although land was scarce in Japan, its manufacturers (e.g. auto makers) were finding abundant land for new plants at attractive prices in foreign lands;
4) Rental income had been rising for more slowly than land values, indicating a falling rate of return on real estate;
5) The low interest rates that had been underpinning the market had already begun to rise in 1989.
The BOJ saw the ugly specter of a general inflation stirring amid the borrowing frenzy and the liquidity boom underwriting the rise in land and stock prices. And so the central bank restricted credit and engineered a rise in interest rates. The hope was that further rises in property prices would be choked off and the stock market might be eased downward. INSTEAD, it collapsed. The fall was almost as extreme as the US stock crash from the end of 1929 to mid-1932.
The rise in stock prices during the mid- and late 1980s represented a change in valuation relationships. The fall in stock prices from 1990 on simply reflected a return to the price-to-book-value relationships that were typical in the early 1980s. The air also rushed out of the real estate balloon during the early 1990s.
