Tuesday, June 05, 2007

Market Bubble: An Eyewitness Account

With all the chatter about a Chinese stock market bubble, I've thought many times about the bubble I experienced first-hand.

Exactly 10 years ago -- in May 1997 -- Gary Kasparov played an epic chess re-match with IBM's Deep Blue. At our shop, work ground to a halt as we all watched that re-match live on our computers via something called a "Java-enabled" chess board (FYI - it didn't work very well).

These were also the glory days of CSCO. I followed Peter Lynch at the time and felt nervous about the prospect of owning CSCO. I didn't understand the company very well, though I knew they were making a lot of money and several friends at work owned the stock. So -- throwing caution to the wind -- during the Kasparov/Deep Blue chess re-match I bought my first shares of CSCO.

As the chart below shows, there was no "sell in May" in 1997, and CSCO rallied a whopping 80% that summer. After a rough fall, the NASDAQ added another 26% in four months, pulled back, and added another 18% in just four weeks. Then, in June 1998, it did the impossible: the NASDAQ broke above 2,000 for the first time ever -- into the Death Zone!

The NASDAQ had now climbed 66% since the Kasparov chess match -- but my CSCO had gone up 240%! I didn't follow the market every day back then (thank heavens), and you can imagine my surprise in learning what a stock-picking genius I had become. In June 1998, the stock market was obviously heading higher.

Image Hosted by ImageShack.us

Yeah, right. The NASDAQ pulled back in Jul 1998 (huh?), and then kept pulling back. I got burned at this point because I stopped following the ball. The market was digesting its first hedge fund melt-down -- Long Term Capital Management -- and things went from bad to worse. I was out by then, but in Oct 1998, the NASDAQ shed 20% in just nine sessions. Even worse, CSCO fell 40% in the same nine days!

This was a terrible time, though it taught me to watch the market more closely. By fall 1998, most felt that the NASDAQ was headed back below 1,000, and the great US Bull Market was finally over. Having lost a lot of my gains, I was very gun shy. The chart below looked very bearish and I was in no mood to buy.

Image Hosted by ImageShack.us

Of course, the NASDAQ unexpectedly shot up hard, though prudent investors remained very skeptical. It was first explained as a "dead cat bounce", then at 1650 it was a "bear flag"; at 2000 (the Death Zone!) it was a "double top". However, it kept going and going and in just 4 months the NASDAQ had rallied an eye-popping 88%! CSCO soared 130%, and thankfully I caught some of the move.

Then, at 2500 the NASDAQ hiccuped. It was Feb 1999, and the great US Bull Market was finally over (really this time). After running so hard, so fast, the market was going down. I sold my CSCO.

Image Hosted by ImageShack.us

Wrong! Investors bought the dips and the market climbed 26% in nine choppy months (I got back in). However, at 2900 after a 140% run in just two years, the great US Bull Market was finally over (really this time...and I mean it). At long last, the bears were in control, and this time it was for real: the market was going down. I wisely sold my CSCO.

Image Hosted by ImageShack.us

Wrong! Instead, the NASDAQ soared an brain-bursting 80% in just five months (I got back in). In less than three years, the NASDAQ had now climbed 300% -- and CSCO had soared 1,300%. In early 2000, the bears were almost extinct, and clearly the only smart thing to do was to be long.

Image Hosted by ImageShack.us

Of course, the rest is history, and the NASDAQ gave back 4,000 points in the next 2 years! Bubbles turn idiots into geniuses, then back into idiots again. However, even with all of my mistakes, I did very well with CSCO. By 2000 I was an avid follower of the IBD100, and it fell apart massively in Mar 2000. Investor's Business Daily kept publishing harsh warnings thereafter and (thankfully) I stayed out. In summer 2000, I left for a couple of months in Japan and watched it all from a distance -- and all in cash.

Image Hosted by ImageShack.us

Though many call the current US stock market a bubble, it certainly doesn't resemble one from a historical -- or personal -- perspective. The current market is incredibly cautious, and a 35-point NASDAQ move brings out choruses of "manipulation!", "sheeple!" and "plunge protection team!" I often wonder what message boards would look like today if they saw the NASDAQ vault 2,100 points in four months.

China is another story however, and they may get a chance to see such a thing. If so, they'll likely learn that calling a top is much, much harder than it looks, and calling a bottom is even worse.

Bubble or not, the Chinese still have their most important lessons ahead of them, and I'm glad I've already taken the course.




Babak said...

An epic tale that brings back so many memories!


dk said...

Thanks, Babak. Glad you stopped by.

Glenn said...

Nice ride!

Here's mine...


Tom said...

Great read thanks.

I.L. said...

Thanks for refreshing my memory.
It's funny how even though I lived (and traded) through it all, I don't remember it quite like it really was, particularly the last few months of the bubble. I think it's partly because, while the indices were going up, many stocks were cratering. Every day had its disaster du jour and the new all-time highs on the indices were but a footnote.

Musings of a Trader

CapitalGame said...

LOL. Good stuff. Todays market cannot be compared to that 98-00 run.