History Of Market Bubbles And Crashes: Lessons To Be Learned

July 19, 2021 | Prakriti Nepal

Market boom, bubble rise, the utmost incremental margin- all these terms refer to the condition of rise in price of financial assets, stocks or the overall market. The value of these financial assets when surpass the fundamental underlying value, causes bubbles to form.

It is so fascinating for people involved in economics and academics, policy makers and those dwelling in buying and selling of securities and assets- that it has become a topic for study to identify its ripple effect, to know- what makes it happen and also the repercussions associated with it.

The enthrallment is such that, the market analysts have continuously tried to recognize if substantial dramatic rise leads to crashes- “for real”? The analysis of Market Bubble is correlated to the historical trend of market booms inescapably resulting in busts. The BOOM is speculative, it’s like a mind game, intuitive, and consumes periodic time.

Why is it so captivating? Because- eventually, when the bubble rises to its maximum- it touches the ceiling, bursts with sudden spurt and falls like a shooting star,- fast- very fast and crashes.

Then the waiting period starts for the boom to happen again!

The increase can be seen in stocks, assets or the overall market, causing fundamental value to exceed its margin. This has been recently noticed in the world in terms of Cryptocurrencies and is recently seen in the obviously hyped and popular market- The Stock Market of Nepal.

Pump And Dump In Stock Market: How To Recognize It And Protect Your Investment?

Various Historic Market Bubbles And Bursts

The Dutch Tulipmania (16th -17th Century)

Once upon a time- in the 16th century, the Bubble trigger took place. It was caused by something out of the ordinary, yet- impenetrable sensation- sort of a miracle by- oh so beautiful Tulips and it was crazy and savvy- very much could be termed as Tulip fetish. This spontaneous hypnotic craze for Tulips in the Tulips land- The Netherlands, was given the name- “Tulipmania”.

This kind of passionate love affair with Tulips of the Dutch, caused the market price of Tulips to rise exponentially high during the 16th centuries. The demand rose sharply high- reached the peak especially in the Western European countries. The dutch went to the extent of creating a hierarchical prodigy of Tulips by pondering and speculating which breed and variety of Tulips would soar high from among the bulbs. The rich and the famous were the first to buy these expensive tulips in the early 16th century , whereas, the craze got hooked amongst the middle class and the low income gaining class during the mid 16th century. The maximum market high was in the late 16th century.

“Do we see a trend here?” Yes! So, the market bubble in the 16th century was based on speculative trends grounded on passionate flirtation (periodic) causing full fledged romantic affairs by the end of 16th century with Tulips.

It was so crazy that people mortgaged their assets, houses, lands to buy bulbs for it to bloom for the spring season. It was delusional- completely drenched in the love of Tulips and with the expectation to get the sweetness of Tulips’ love- resulting in profits and acceptance in the market.

The people were ready to barter elements like:

Food– wheat, butter, wine, beer, cheese

Animals – oxen, sheep, swine

Things– drinking cup (silver), attire, daily bed

In 1637, before the arrival of the spring- the consumers of Tulips suddenly started diminishing- they showed lack of interest in buying Tulips, which caused the market to crash and collapse. Suddenly, there was no one buying Tulips and bulbs. In 1638 of May- The Tulips contract was made void atop the 3.5 interest settlement.

Can The Nepalese Carpet Industry Learn From Tulipmania?

The Carpet Industry of Nepal- once a prime contributor of export of the Himalayan country, is trying way too hard to survive. There were a lot of carpet industries in Nepal, manufacturing highly priced to low cost, luxurious to affordable beautiful carpets. Recently, these carpets, highly exported to Asia, America and Europe, reported an 80% decline in business due to the Coronavirus Pandemic.

Whereas, OECD in its October 2003 report- Nepal Trade and Competitiveness Study has mentioned that Germany alone used to purchase about 80% of Nepal’s total carpet exports.

The Wall Street Journal, in its article- “Rugs That Are Knot Going To Pile” published in 2001 has mentioned- Tibetans as real collectors of Carpet and Tibet fever in the U.S. and Canada in the mid 1990s increased prices up for Tibetian Carpets. It was the “It thing” back then.

However, The Guardian in 2014 in its article titled “10000 children estimated to work in Nepal’s carpet industry” has mentioned – 10000 children working as child Laborer’s in Nepal’s Carpet Industry. In the same year 2014, as per Central Bureau of statistics- in the Sunsari Morang industrial corridor- 40 units of carpet industry were shut down within the period of 5 years. This was when the Carpet industry’s market crashed in Nepal.

Just like fine wine, carpets become soft with age- it is just that- the purchaser needs to understand how to preserve it. This can also mean that the maker of Carpet needs to understand the longevity of Carpet’s charm to create a longevity of Carpet Industries and factories.

Furthermore, Industrialists/ Investors need to ponder upon political situation, labor market condition and policy changes, technology adaptation and international to grassroots’ market condition comparisons for sustainability of carpet industries.

It can thus be understood that aesthetics (products such as Tulips and Carpets) causing market bubbles and crashes can cause huge profits and huge losses.

So, when there is a slight reflection of unusual craze starting to take place, or even before that- the prediction not just in terms of buying and selling but predictive analysis in terms of expected rise=achievable rise and unwanted/non assumable fall=all risky fall, need to be fully developed and its analysis’ result should be implemented, tactically for a long term benefit.

London- South Sea Bubble (17th Century)

In London, in the 17th Century, nearly around 1720, an enormous number of people got entangled in the South Sea Bubble. The House of the Lords had passed the bill named South Sea Bill, which authorized a company named South Sea Company to perform trade with South America in a monopolistic way. Shares soar high unimaginably,- more than 10 times their original value. Slaves were dispensed to South America. The Royal Museum Greenwich reports that inflated prices paid for stocks by investors caused the bubble burst.

Since South Sea company had to supply 4800 slaves to South America- a lot of illegal companies were formed which when later inquired were found to be one of the prime reasons for the bubble burst. Thus, a market bubble caused by inhuman activities which triggers an unlawful eruption of businesses and increment of stocks can always lead to a burst-some or the other day.

The Decline of Bonded Labor Market And Its Investment In Nepal

Anti- slavery organization in the year 2008, in its article titled; “Freedom for 20000 people as Nepal abolishes bonded labor practice” has mentioned about the government of Nepal’s decision of abolishing bonded labor condition in Nepal. It was the Haliya system, where workers who were termed as Haliya used to perform agricultural duties, moreover a bonded labor condition for money provider landlords. The Haliyas would take loans from their landlords and the Haliyas would be drenched in debt because of unreasonable extortionate interest rates and become confined as they would not have been able to repay their loans. This somehow made the landlords earn from their Haliyas too. The human capitalizing market bursted wide open and the landlords who were seen as inauthentic investors had to face dilemma and loss in the long term.

The Dot Com Bubble (19th Century- Early 20th Century)

Extreme Increase in stock of technology stock equity valuation also known as internet bubble lasted from 1995-2000. This period saw whooping investment in internet based startups with the expectation to gain high returns and profits. It was very speculative as investors were seen more excitedly investing due to the boom of the internet, the .com domains.

There was such a rush as was kicked by the hype of the dot coms, that the investors were ignoring the analytical measures such as P/E ratio also. They seemed to focus on brand image building for attraction, market awareness more than conventional investment. Although, many investors made more money than they thought in the beginning of the dot com bubble.

Later, the dot com bubble burst happened, stock market slam and information was only considered to be prime focus. Although, it was during this time companies like, Google, ebay got settled in the market.

IPO Fascination In Nepal

IPO purchasing obsession can be well enough only to the point, a person starts borrowing money from friends and family members and suddenly there is a bubble burst caused by natural phenomenon like Pandemic because the market value of Initial Public offering (IPO) can decline lower than the price issued in extremely short period of time and in turn give enormous losses to investors.

The investors need to understand that many IPOs take place during the market bubble. This can be because companies want to capitalize/collect funds through their IPO, when the share/stock market is in an upward trend and moving. The bullish market gives stock – sky high valuations when investors are high on investing, considerably ignoring the valuation of stock and its trend- during the bullish phase and market bubble. So, if the market goes crazy haywire- there can be risk of stock not reaching issue price also and it can likely crash.

So, the Macroeconomic measures such as Monetary Policy, GDP, CPI (consumer Price Index), employability conditions need to be more towards a favourable end all together, for healthy upheaval of stock market. Though, market transparency has been a challenge for the IPO market. Interest rates and margin lending of NRB need to be looked at well too.

Also Read:

10 Key Macroeconomic Indicators That Investors Should Look Into Before Investing

6 Financial Ratios To Look Into Before Investing In Stocks

Other Market Bubbles Such As Japanese Real Estate And Stock Market Bubble And US Housing Bubble

The Japanese real estate and stock market bubble and crash (1986-1991) happened when Japan’s real estate and stock market inflated big time due to unconstrained “money supply and credit expansion” as shared in “The Asset Price Bubble and Monetary Policy: Japan’s Experience in the Late 1980s and the Lessons”.

Nepal’s real estate market is surging high even during the time of Pandemic. Bank’s investing in real estate has also been one point of encouragement for people buying and selling real estate. As per records maintained by the Department of Land Management, 76,532 houses and plots of land were bought and sold considering all of the country in the (mid-December to mid-January) 2020. There is a growing bubble which is continuous in the real estate scenario and only with natural uncertain conditions like the flood devastation that took place in Melamchi Nepal this year (2021)- can completely vanish the real estate scenario of a certain place in a blink of an eye. Hence, such conditions need to be pre analyzed before investing.

On the other hand, Nepal’s housing bubble originated with the liberal banking policy and with financial overlap that happened with the civil war of (1996-2006) of Nepal. Back then, remittance had erupted very high, as people swayed to work outside and sent remittance to Nepal. The housing bubble started exploding in 2009. As per (Nelson 2013; Shrestha 2011), the price of land increased to 300 to 400 percent from (2006-2009).

Though, Pamela Liebman has mentioned- “I don’t believe real estate acts in any way that could be a bubble, because bubble pops and real estate doesn’t explode overnight”.

We can also take reference of the US Housing bubble which affected half of the United States. It is also considered to have brought the great recession. According to the International Monetary Fund, these kinds of bubbles can last for several years. It is also because, the demand of houses can be more than the availability of land or houses and if demand exceeds the supply.

So, factors such as population, living standard, relationship or networking done with the broker, who can misquote prices, for e.g., higher pricing than the cost that it has,- may cause a housing bubble to form. Any activity that is unnatural needs to be thoroughly inspected before huge or any investment in housing.

Lessons To Be Learned From Market Bubbles And Crashes

Here are some of the lessons to be learned from market bubbles and crashes;

1. The market bubble can be time and tide driven, pleasure and passion driven and attraction and allurement driven.

2. A proper investment strategy needs to be formulated at government level for citizens, to save from unguided and unstoppable buying and selling of eye pleasing beautiful products.

3. Market- be it any market- a shopaholic instinct of humans can create irrationality causing extreme fluctuation in prices of goods and service.

4. The sense of ownership and security in assets can drive human nuts.

5. The market paves its own path as per time and situation- hence financial safety should be first thought while buying and selling of any goods and services with tendency of over fluctuating prices.

6. Earning money in a market bubble period is risky because gain and loss have equal chances to occur. For example- Nepalese share market bubble reached its peak amid Coronavirus Pandemic and now have been in a downward stature after the SEBON intervention and also because of perception and speculation- which are the base of share market investment and trading.

7. Herd buying and selling cannot be profitable in the long term because once the buying cycle stops, the selling marathon loses its pace too and investment becomes meritless.

8. Economic Indicators need to be well studied and Financial literacy is of utmost importance.

9. Local and international market comparison is very necessary to understand possible market bubbles and crashes.

10. A true investor focuses on 360 degree periphery while investing and not go by the short term gains only.

From The Author:

Developing A Proper Investment Strategy For Financial Success

Basic Knowledge For Beginners In Share Market Of Nepal

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