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<h2>Is Wall Street in a 'New Paradigm Era'... or merely an 'Old Bubble' carried to New Extremes?</h2>
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<p>A critical look at the unprecedented events that unfolded on Wall Street during the high-tech bubble of the late 1990s. Was it a New Era? Or was history repeating itself? What were the danger signs every investor should have known?</p>
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<p>Santayana, an early 20th Century philosopher, once said, “Those who do not learn from the past, are doomed to repeat it.” And Sir Isaac Newton, who lost the equivalent of over $1,000,000 investing in the South Sea bubble of 1720,  remarked, “I can measure the motions of bodies, but I cannot measure human folly.” However to this day, analysts cannot agree as to what constitutes a bubble… or how to recognize a bubble before the inevitable washout and aftermath.</p>
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<p>It is widely perceived that the U.S. economy and stock market have embarked on a “New Paradigm Era” in which old rules no longer apply and traditional barriers have been broken. Yet as Federal Reserve Chairman Alan Greenspan warned Congress on February 26th 1997, “Regrettably, history is strewn with visions of such ‘new eras’ that, in the end, have proven to be a mirage.” This is an insight into one such likely mirage…</p>
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<h2>What Constitutes A Bubble?</h2>
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<blockquote class="wp-block-quote has-text-align-left"><p>“That the free enterprise economy is given to recurrent episodes of speculation will be agreed… This process, once it is recognized, is clearly evident, and especially so after the fact. So also, if more subjectively, are the basic attitudes of the participants. These take two forms. There are those who are persuaded that some new price-enhancing circumstance is in control, and they expect the market to stay up and go up, perhaps indefinitely… Then there are those, superficially more astute and generally fewer in number, who perceive or believe themselves to perceive the speculative mood of the moment. They are in to ride the upward wave; their particular genius, they are convinced, will allow them to get out before the speculation runs its course… For built into this situation is the eventual and inevitable fall. Built in also is the circumstance that it cannot come gently or gradually. When it comes it bears the grim face of disaster. That is because both of the groups of participants in the speculative situation are programmed for sudden efforts at escape. Something, it matters little –although it will always be debated– triggers the ultimate reversal.”<br></p><cite><strong>A Short History of Financial Euphoria<br></strong>John Kenneth Galbraith</cite></blockquote>
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<p>Historically, bubbles have always been a part of the lessons of investing. There was the Japanese stock market and real estate bubble which popped in 1989. In domestic real estate, there was the not so “recession-proof” California, as well as the price deflation or washouts of condominiums in Hawaii… residences in the Northeast… commercial office space in the oil belt… and numerous other regions in the 1980’s. Many investors may also remember $850 gold… $50 silver… $37 oil… numismatics… baseball cards… and the list goes on.</p>
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<p>In the stock market, bubbles are usually limited to individual sectors which ride high on excessively exuberant expectations – only to plunge back to earth later. Yet history has left several notable eras which were recognized as “bubbles” only in the eventual and inevitable devastation. Seasoned investors may remember the “Nifty Fifty” era… the “Go-Go Fund” era… or even the “Investment Trust” era of the 1920’s.</p>
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<h3>A Short History of Financial Euphoria</h3>
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<p>In essence, a bubble is created when objectivity, reasoning, and valuation give way to greed and the desire for profits. In “A Short History of Financial Euphoria,” author Galbraith describes the common seeds of past manias that inevitably give way to disastrous consequences:</p>
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<p>1) The basic premise that investing involves a trade-off between risk/reward is lost as investors are “captured by the wondrous satisfaction from accruing wealth. The very increase in values thus captures the thoughts and minds of those being rewarded.”<br>2) The belief that “some new price-enhancing circumstance is in control” – that there is “something new in the world” that justifies a permanently higher level of valuation.<br>3) The illusion that, except for temporary setbacks, “values are going up permanently and indefinitely.”<br>4) The “condemnation at those who express doubt or dissent. … because of defective imagination or other mental inadequacy they are unable to grasp the new and rewarding circumstances.”</p>
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<h3>Healthy Bull Market to Dangerous Bubble</h3>
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<p>Yet only in the aftermath, is a “bubble” identified as a bubble. While in progress, it can only be recognized by its symptoms which are common with speculative eras of the past. At what point does a healthy bull market turn into a bubble ripe for the popping? Here are a few differences:</p>
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<h2>Time For A Reality Check...</h2>
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<p>Wall Street consensus is that the U.S. has entered a “new era” of tame inflation, low interest rates, and rising productivity that will carry economic prosperity well into the new millennium. If so, say pundits, then today’s extreme valuation levels in the stock market are justified. Just how extreme is stock overvaluation? The figure below shows the S&amp;P 500 Price-to-Dividend Ratio on the vertical scale, and the S&amp;P Industrials Price-to-Book Value Ratio on the horizontal scale. Simply, the higher on the chart, or the farther to the right a year appears, the more overvalued it is. Clearly, when compared to overvaluation at some of the most historic market tops such as 1929, 1968, 1972, and 1987… today (1998) is off-the-chart!</p>
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<p>Consensus on Wall Street is also that today’s investor is smarter, better informed, more patient, and longer-term oriented than in the past. Consequently, it is believed that today’s mutual fund holder will never panic in a bear market. However, not all agree with this consensus:</p>
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<blockquote class="wp-block-quote is-style-default"><p><strong>Investors may overreact to a downturn, SEC warns</strong><br>“Inexperienced investors who have known only the bull market of the last decade could react ‘precipitously’ to a downturn and ‘at great cost to themselves and our markets’, Mr. Arthur Levitt, chairman of the Securities and Exchange Commission<br>warned yesterday.”</p><cite>London Financial Times – Feb 26, 1997</cite></blockquote>
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<p>And Federal Reserve officials also appear nervous as evidenced by this Congressional Testimony in early 1997:</p>
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<blockquote class="wp-block-quote is-style-default"><p>“History demonstrates that participants in financial markets are susceptible to waves of optimism… Excessive optimism sows the seeds of its own reversal in the form of imbalances that tend to grow over time. When unwarranted expectations ultimately are not realized, the unwinding of these financial excesses can act to amplify a downturn”</p><cite>Federal Reserve Chairman Alan Greenspan<br>– Feb 26, 1997</cite></blockquote>
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<p>Meanwhile, the cold fact remains that the assets in equity mutual funds now total $3,164 Billion, as compared to $226 Billion in October 1990 at the start of this bull market. Quite simply, 93% of the money in stock mutual funds has not experienced a bear market or even a -15% correction in blue chip averages!</p>
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<p>Perhaps more ominously, an overwhelming majority of fund investors believe they never will experience such a decline. This late 1996 Lou Harris poll reveals that 85% expect the next 10 years to be as spectacular or better than the past decade. 78% are not expecting a mild bear market of -20%. And almost half think that minor -10% corrections are a thing of the past:</p>
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<p><strong>Just how far out of touch are these investor expectations with reality?</strong> Compare the “actual risk” for all the years of this century (above right). A -10% correction has occurred in 65 years, or once every 1.5yrs on average – yet 7 years have lapsed since the last. A -20% decline has triggered every 2.5yrs – again, over 7 years since the last. A -30% bear hits every 4.6yrs – last seen during the ’87 Crash. And a major bear, with -40% losses, strikes about every 8.7yrs… last felt by investors 23 years ago!</p>
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<ul><li>Is it a contest to see who can forecast the highest level for the stock market? No… more likely it’s just a not-so-mild case of “irrational exuberance” feared by the Federal Reserve.</li></ul>
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<p class="has-maroon-color has-text-color"><strong><em>Reality Check: Bull or Bubble?</em></strong></p>
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<ul><li>Public investment funds placed with the nation’s largest discount brokerage firm have risen over 19-fold in less than a decade.</li></ul>
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<p class="has-maroon-color has-text-color"><strong><em>Reality Check: Bull or Bubble?</em></strong></p>
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<ul><li>Since 1981, the number of mutual funds have multiplied at a rate far above any historical experience… far above the “Go-Go Fund” era of the 1960’s… and far above the “Investment Trust” era of the 1920’s.</li></ul>
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<p class="has-maroon-color has-text-color"><strong><em>Reality Check: Bull or Bubble?</em></strong></p>
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<ul><li>The number of investment clubs has increased over 5-fold in the current bull market. Today, more than 1 in 3 adults own mutual funds – a 66% increase in four years. That easily surpasses the “Go-Go Fund” era in which 1 in 4 adults owned stocks when the washout began in 1969.</li></ul>
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<p class="has-maroon-color has-text-color"><strong><em>Reality Check: Bull or Bubble?</em></strong></p>
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