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A Tale of Three Bubbles

By Ichiro Suzuki The Nasdaq composite index has closed above 10,000 on June 10. The closing level of 10,020 was exactly twice as high as 5,010 at the height of the tech bubble 20 years ago. It was July 17, 1995 when the Nasdaq closed above the 1,000 milestone for the first time. The index returned an annualized 9.6% (plus dividends that are not much) since then. For those who were unfortunate enough to have bought it at 5,010 on March 10, 2000 at the apex of the frenzied late 20th century bubble, the Nasdaq still retuned 3.5% per annum (and dividends) that is not overly shabby considering the worst possible timing. Amid the tech bubble, we intensely debated how the advent of the Internet would change the world, and of course no one was sure what kind of future the new technology would bring. Looking back on, we are currently living the future that we tried to envision two decades ago. Proliferation of video conferencing this year is a tiny part of it, as the latest phase of the application of the Internet. Preceding where we stand, tech has evolved from the original Internet boom to Web 2.0, then mobility, social media, Internet of things and continues to make progress. While the financial market always rewards champions of innovation lavishly, innovation without fail took place in two areas that greatly enhance productivity: transportation and communication. Among a number of bubbles the financial markets have witnessed in their history, the Internet resembles railroads more than anything else. Railroads are the network that carries people and goods while the Internet is the network that carries information. Throughout the 19th century, railroads experienced several phases of investment booms and busts. There is little reason, therefore, to think much of the great internet booms is already behind us. Too many people failed to understand what innovation does to the equity market through substantial productivity gains, narrowly confined in traditionally available valuation metrics such as price/ earnings ratios. These people, often seen in London and Tokyo, scorned those companies that were flying high despite burning cash. One such typical example of such company was Amazon. From a different perspective, Amazon was the only company that succeeded and still stands triumphantly, having been financed by the great late 20th century bubble. There were other companies that had their shining days but everything else has either folded or has been acquired by someone else, be they Yahoo!, AOL, etc. Among today’s tech giants, Apple and Microsoft already existed long before the tech bubble and have adapted skillfully to the new age. Alphabet (Google), Facebook and Netflix came around after the burst of the bubble. The late 20th century tech bubble foresaw what would come in the distant future, perhaps in 2015, 2020 or 2025 and beyond. The markets two decades ago assigned outrageous valuations such as 200 times revenue, not earnings, to what might come one day. What the market foresaw at that time was not wrong. After two decades, tech giants that made it through are almost minting money. Within a relatively short period of less than 25 years beginning in 1986, there were three mega bubbles in the global equity markets. The first one was Japan in the 1980s, followed by technology in the U.S. in the 1990s and emerging markets in the 2000s. All of them had registered compound annual rate of returns of 40% or higher in USD terms for a five year period through the peak of the bubble, more than quintupling the value of assets in five years. The Nasdaq in 1995 - 2000 was on a communication revolution, already described above. The other two, on the other hand, proved to be bubbles that were mere illusions created by excessive liquidity. The Japan bubble was essentially a real estate bubble that spilled over into an equity market, since the value of real estate-owning companies and banks that lend property developers also skyrocketed. It was believed at that time that Japan was running out of real estate to develop, constrained by the size of the country. The Bank of Japan delivered a series of aggressive interest rates cuts in response to the super normal surge of the yen after the Plaza Accord in September 1985. Amid a surging yen, inflation remained subdued, allowing the BOJ to be aggressive in liquidity injection into the market, creating a monster bubble. The burst of the bubble at the outset of the 1990s, as the BOJ finally moved to tighten its monetary policy, left a mountain of bad debts and the crippled banking system for a decade. The emerging market bubble had a similarity to the Japan Bubble. A WTO membership made China an export powerhouse. Sharp rises in current account surplus drove the renminbi upward against the U.S. dollar. An upswing in currency made the People’s Bank of China (PBOC) to reduce interest rates, driving up the value of real estate. Of course, the Chinese economy’s double digit growth made demand for office space and apartments soar. The government owned premier real estate in cities at essentially zero cost allowing Beijing to rake in money. The other pillar of the EM bubble was a surge in commodity prices, boosted by China’s appetite for them at a time when the economy was growing well over 10% every year. Be they crude oil, iron ore, copper, soy beans, China consumed them in a relatively wasteful fashion and that accelerated demand for these products further. Countries that produced these commodities experienced substantial windfalls, and their economies boomed, from the Gulf States, sub-Sahara Africa to Latin America. Emerging markets or unknown lands have always fascinated people in the developed world, especially those in Europe, since the days of, perhaps Marco Polo, often creating a bubble. The early 21st century EM bubble was merely its latest round. Either in real estate or commodities, when a boom was over, there was not so much left in the economy. The enormous amount of funds that went to a variety of projects failed to generate hoped-for returns, as are often the cases with bubble era projects, leaving bad debts to the baking system. Equity markets remain well below the bubble era peak, for Japan 30 years later, and for emerging markets 13 years later at this moment. The Chinese market are suffering in part because it was crowded with state-owned enterprises (SOEs) that do not pride themselves in productivity. There are some bright spots in Chinese tech firms that are listed outside the mainland China, but their effects on the overall Chinese market remains relatively small. In contrast, the tech bubble in the U.S. was everything about productivity and this is why it came back relatively quickly. Weeding out weak firms through the bubble’s burst laid a foundation for a fresh new start, and the industry has learned some lessons. In addition, the tech bubble was totally equity-financed, and hence did not weaken the banking system. (That sad, the system suffered a near death amid the 2007-09 Global Financial Crisis that was caused by sub-prime debts.) After all, these the bubbles in Japan and EMs failed because higher prices in real estate and commodities don’t change the world through enhanced productivity. Investors in these assets can make money, but these bubbles don’t make the world a better place. While Japan and EM still trade considerably lower than their bubble highs, only tech, or the Nasdaq, has delivered long-term performances. As of June 10, Apple has the title of the largest company in equity market capitalization with $1,528 billion, narrowly followed by Microsoft’s $1,492 billion. It’s been nine years since the death of Steve Jobs and Tim Cook took over the company. Apple’s value has quintupled since then. In early 2014, Satya Nadella took over Microsoft that looked a dull company in every sense as Windows was aging. Nadella reignited Microsoft’s growth focused on Azure, cloud services, and has overtaken Apple. Both of these men are amazing. Leadership matters.

About the author: Mr. Suzuki is a retired banking executive based in Tokyo, Japan.


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