One of the biggest debates in trading is whether or not cryptocurrencies are in a bubble.
A look at history provides guidance in the current debate.
In the late 1990s, when a similar debate was raging over the potential bubble of internet stocks, a business article quoted an elderly couple whod quit their jobs to day trade.
P/Es [price to earnings ratios] dont matter, the wife was quoted as saying. And she was not alone in her view of the market.
During the late 1990s, EBAY traded at P/E ratios of several thousand; AOL traded at the relatively modest P/Es of a few hundred.
Those were the exceptions since most internet stocks were losing money and had no P/E.
P/E ratios measure currentshareprice relative to per-share earnings.
The current P/E ratio of the S&P 500 is approximately 25.
Back in the 90s, when Warren Buffett refused to invest in internet stocks because of the difficulty in valuing them, he was accused of being a dinosaur.
During the dotcom bubble, even the now venerable Amazon was mocked by traders saying, They lose $5 per book but theyll make it up in volume.
While Amazon turned the corner and then some thousands of companies used the same model to extinction.
Bill Gates started Microsoft in 1973; the company went public in 1986, and this was after nearly a decade of increasing profits. At the time, such a trajectory was required before approval to go public was granted.
In the late 1990s, all you needed to go public was a dot com at the end of your name. Barely established companies many less than three years old with little or no revenue, routinely went public.
In 20/20 hindsight its blindingly obvious, but at the time, when traders believe P/Es no longer matter, when companies go public on the strength of their dot coms, and when the advice of a legendary investor is ignored because it challenged the status quo, youre in a bubble.
All of this, mind you, was a matter of public record: P/Es are found right next to the stock price; all public companies provide extensive financial records; and Buffets comments were broadcast widely (but simply ignored by most traders).
The internet was in a bubble; all it took was for someone to be honest with themselves to recognize it.
Starting in 2003, and continuing for the next half decade, property values in most major American urban areas routinely increased 10-20% every six months. This often happened without any new construction in the area. The same property with the same properties around it would increase in value fueled by nothing more than perception.
The more real estate prices increased; the more desperate people became to buy real estate new buyers and those who already owned property.
The whole thing was fueled by irresponsible loans. Business reporters were well aware of liar loans.
Liar loans is a slang term for stated income loans. These were loans granted on the strength of a borrowers stated income without the necessary documents to prove it.
Theres only one reason why someone would state an income without verifying it: it is not their real income.
If nothing more than perception is increasing real estate values by unsustainable amounts, and this is all fueled by fraudulent loans, youre in a bubble.
In the late 1990s, you could hardly go to a party without someone regaling you with tales of the killings theyd made on the latest hot internet stock. In 2003 and beyond, the same could be said of the latest real estate deal. Though I wasnt around at the time, society parties in the roaring 1920s were likely filled with stories of the latest score on the stock market.
In all three cases, internet stocks, real estate, and stocks became a fad or an intense and widely shared enthusiasm for something, especially one that is short-lived and without basis in the objects qualities.
The best example of this comes from the so-called tulip mania, one of the first recorded speculative bubbles in history. Tulip mania was repeatedly referred to by Gordon Gekko in the 2010 movie Wall Street: Money Never Sleeps.
Suddenly, and without any good reason, in 1636 tulip prices in Europe increased exponentially before crashing spectacularly in 1637.
In the late 1990s, the answer to most concerns about internet stocks was that the internet was so powerful it would change the paradigm. Companies could justify exorbitant P/Es because the internet was going to allow them to grow at multiples wed never seen before; at least thats what the bubble participants kept repeating.
At one time, approximately one hundred automobile makers manufactured cars, most setting up shop in Detroit.
Today, three Chrysler, General Motors and Ford have survived. A few of the others were swallowed up by one of these three, but most faded into the dustbin of history as failed enterprises.
No one would disagree that automobiles and the internet have changed the world in profound ways, but this does not mean that each industry was not susceptible to a bubble.
While the jury is still out on cryptocurrency, it too may very well change the course of human history, but its still susceptible to a bubble.
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