Memories of a Mania

Alonzo Ewing (OP)

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Memories of a Mania

April 09, 2013, 07:36:58 PM

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I remember the dot-com mania and hope to give some perspective into what happens during a mania. I was burned by it, too. I gleaned some powerful lessons from that mania, and my purpose here is to spread the knowledge.

Before I begin, let me state that if you think I’m spreading “FUD”, feel free to leave this thread. I’m actually long bitcoins, though I’m looking to sell soon (in the next week or two).

During the dot-com mania, the Nasdaq doubled in about 5 months. Given the recent run in Bitcoin’s price, you may not be impressed, but keep in mind that the Nasdaq market capitalization is on the order of trillions of dollars, a thousand times greater than Bitcoin’s. Some companies in the Nasdaq did go up a thousand-fold.

Good companies with solid earnings became wildly overvalued. As an example, Cisco, one of the behemoths of the tech space at the time grew into a crazy valuation. Analysts extrapolated this exponential trend (that’s essentially the only thing most analysts do: extrapolate) and predicted that in 2-3 years, Cisco’s market cap would be greater than the US GDP. Yes, they actually did that.

Despite continuing to grow earnings over the last 13 years, Cisco’s share price is basically where it was in 1998. Overvaluation is a bitch.

Predictions were crazy like that. People simply assumed in 2000 that the Nasdaq’s level would exceed the Dow in a year. Keep in mind that the Dow was about 11,000 at the time.

Henry Blodget became famous in 1998 for making a 1-year price target on Amazon of $400 when the price was $240. He was widely ridiculed. Yet, it reached that $400 price in a month, and went on to $1200 two years later. (It then fell back down to $80, though over the next decade, it would exceed the dot-com peak.)

So lesson #1 is that even good companies can become highly overvalued during a mania. Lesson #2 is that to jump aboard the train, investors will bid up the price of crappy companies like Pets.com into similar prices, and for the average Joe, it becomes very difficult to separate the wheat from the chaff. Litecoin’s recent run-up seems reminiscent of that phenomenon (though I admit I’m not savvy enough to conclude that Litecoin is, indeed, chaff.)

The sociology of a mania is fascinating. There were bearish commenters like Bill Fleckenstein who would warn people that the mania couldn’t last and a lot of people would lose their savings by being reckless. He routinely got mocked on CNBC and elsewhere. People with much less insight and experience than him would accuse him of not understanding what was going on. Yet he was right.

This was cult-like behavior: rather than believing someone who was bearish had analyzed the data and come to a different conclusion, and that perhaps you could learn from this person, the bear took on a moral quality. He was a bad guy. One might even say he was evil. He's probably motivated purely by nefarious intent. If he got enough people to disbelieve, those people would convince their friends, and the whole thing would snowball.

In that mania, the future took on a mystical quality. It was called “The New Economy”. In the New Economy, profits didn’t matter. Only market share mattered. So if there was a company with no profits, investors would say, “They’re spending all of the revenues to get more market share!” and justify a high valuation. The New Economy also threw out the old valuation techniques. The internet was so big that the sky was the limit. There were no constraints.

Yet a decade later, really only 3 dot-com companies remained: Yahoo, Amazon, and Ebay, and Yahoo is a shell of its former stature.

One of the key characteristics is that more people were convinced there was a mania in 1998 than there were in 1999. Late in the mania, many former skeptics began to believe. They stopped thinking there was anything out of the ordinary going on. They bought into the New Economy mysticism. As the Nasdaq rose higher, fewer and fewer skeptics remained. Only believers were to be seen.

People who knew nothing about stocks suddenly became experts. Middle class dads grew to know the balance sheets of the high flying companies and weren’t shy about offering their opinion at the water cooler. Students boasted of their profits and contemplated dropping out of school because it was useless to be a wage slave when the market was so easy to play.

Perhaps the most vital lesson the dot-com mania taught me is that the market will keep going up until the staunchest bear throws in the towel. I became a bear on the dot-com stocks in 1998. The Nasdaq was about 1700. As the market went up, I grew more disgusted with what was going on. I saw my buddies become rich overnight and grew envious. The Nasdaq went up to 2500, then 3500…4000. Eventually, I couldn’t help it. I knew it was a mania, but I couldn’t help but try to get in on the action. My little account grew from about $6000 to $250000 in just a couple of months.

The market peaked at 5100 very soon after I went in. And then it all came crashing down. At the new bottom, it went down to 1200. I lost everything. I know most of my friends also lost everything. Luckily, “everything” was only stuff I invested. The biggest losers were the ones who quit their job to daytrade, or the ones that took loans to invest.

It all makes sense in retrospect. If someone as skeptical as me—if the staunchest bear—buys!—then there’s nobody else left on the sidelines to bid up the price. The lesson for today is: think of the biggest bitcoin skeptic you know, and when he throws in the towel and registers for a Mt. Gox account, it’s time to sell.

I hope this was informative. I see similar things going on right now in the Bitcoin world—exponential price increases, outlandish predictions being made about the price, people quitting their jobs and putting all their eggs in the Bitcoin basket, mockery of prudence, cult-like behavior, mystical beliefs, etc—and I worry about the damage this mania is going to do.

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