Mad Dog 21/21: Bubbling Over
December 11, 2017 Hesh Wiener
The Turks may have started it, shipping tulips to Vienna around 1554, but during the next century the Dutch finished it. Hollanders dominated a booming market in cultivated tulips and a bumper crop of financial instruments based on the trade. Then, in 1637, tulip prices collapsed, breaking speculators and triggering a financial tsunami. With FANG stocks – Facebook, Amazon, Netflix, and Google – and other tech shares sky high, worriers say a comparable collapse is imminent. Now there’s even a movie, Tulip Fever, built around the old story. Will tech companies get whacked? Will IBM be among them?
The Tulip Mania phenomenon took quite a while to develop. After Viennese and their neighbors became excited about the beauty of tulips, interest in the flowers spread across Europe. So, too, did the sophistication of tulip agriculture, as growers learned when to take the time to get their plants to produce seeds and when to boost the plant population by sowing bulbs. The Dutch were arguably better at this than anyone. As winter came in at the end of 1636, trading in actual tulips, in tulip futures, and in other related financial instruments was boiling. Prices were booming. But then, abruptly, in February 1637, a major auction in Haarlem failed to attract the expected crowd of eager buyers. Other disappointing events quickly followed.
The prices of tulips and related financial instruments collapsed. People and organizations whose fortunes were wedded to the fate of the flowers suffered severe damage or even collapse. By the end of the winter, Tulip Mania was all over except for the aftermath of suffering. There was one boom caused by the tulip bust, a big rise in explanatory stories. Nobody really knows just how the boom became so big so fast or how it blew out so thoroughly and swiftly, but that didn’t stop explainers or commentators.
Of the various accounts of this financial misadventure, the classic tale is in a volume published in 1841, Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay. Mackay’s book, well into its second century, is always in print. It has wonderful examples of foolish financial behaviors, financial and otherwise, including the tulip story and history of the South Sea Bubble. The South Sea Bubble, which occurred during the years 1711 through 1720, showed how little society learned from the tulip mania misadventure, or if the West had in fact learned some lessons, how quickly they were forgotten. Basically, shares in a British company given a monopoly on trade with South America just kept rising in value even though there were some very good reasons the prospects for this business were dim compared to the expectations of investors.
Among the key reasons investments in the South Sea company eventually turned sour was the basic fact that England didn’t actually have much of a grip on South American opportunities; business and political activities in the region were controlled by Spain and Portugal. In any event, after several years of increases in South Sea shares as well as derivative and related financial instruments, the financial facts of the matter caught up with investors. Boom turned to bust, anticipated wealth to dust.
The contrast between the boom in South Sea shares and raging bull markets based on real opportunities is dramatic and, looking back from the present, quite obvious. A relatively recent example of an investment boom with a real foundation, one that eventually overshot rational levels and subsequently fell back, was the success of American blue chip companies known as the Nifty Fifty. Shares of these companies, which included IBM, Kodak, Xerox, Walmart, Disney, Digital Equipment, and dozens of others, rose astronomically during the 1960s and1970s. Most of the Nifty Fifty companies are still with us, their success having outlasted numerous cycles of the economic tides.
During the 250 years between the South Sea Bubble and the time of the Nifty Fifty bull market there were a number of asset bubbles, all of them ultimately ending in collapse. The Western economies and particularly that of the United States, made enormous gains, but the growth and progress that led to today’s wealthy civilizations were hardly steady. There were quite a few ups and downs, some of them notably dramatic. Two of the most dramatic were the Railway Mania rise and fall in Britain during the 1840s and the United States Gilded Age stock market surge during the 1920s that ended in the devastating Crash of 1929.
Like the period during which the Nifty Fifty companies showed phenomenal growth and profitability, the early years of the British Railway Mania reflected real opportunity that enriched many investors. There was a factual, scientific basis for upturn: Railway technology based on steam, steel, and ingenious engineering was moving forward by leaps and bounds. Political forces enabled the railway companies to gain access to routes tying villages together. These routes established paths connecting farms to regional and ultimately central urban markets. They created conduits that permitted factories to be built on cheap land near natural and human resources. They allowed the carries to provide transit services that became a wonderful nationwide information network – Britain’s Post Office, as transformative and stimulative as the Internet of our present era.
But as is always the case with bubbles, all the positive trends led to unwarranted increases in investors’ expectations. The rush to fund what were widely perceived as golden opportunities ran to excess. There were too many errors of overinvestment, too many poorly thought out railway startups, and too many opportunities for the unscrupulous to hide and profit amid the sincere if misinformed majority. Eventually the errors overtook the real achievements and the Railway Mania was derailed. The superb rail networks of Great Britain survived the affair, but many of the corporate participants did not, some totally failing, others getting absorbed by rivals or new entities, a process that entailed the making and the breaking of many investors. To this day, the state of Britain’s rail system remains in flux, portions of it private, portions state owned, all of it subject to acrimonious debate as the country’s conditions evolve.
The American financial boom of the 1920s was spurred by the rise of great industries, the expansion of transportation comparable to that in Britain eight years earlier, the discovery and exploitation of fossil fuel energy resources, and a nearly unprecedented wave of social and political optimism. These were heady times, but they ended badly when, as Variety put it, Wall Street laid an egg in 1929 and soon thereafter the Great Depression gripped America and eventually all of Western civilization in a chokehold. Quite a few fundamentally viable companies, including IBM, suffered badly as their injured customers cut back on orders and attitudes toward technological innovation that had been so positive during the 1920s reversed during the 1930s. For manufacturing companies, such as the IBM of the 1920s, the depression was a real threat to corporate survival. For many of these enterprises, relief didn’t arrive until the onset of World War II, and for some, including IBM, outstanding opportunity didn’t return until well after the war ended.
During the first third of the last century, IBM prospered in peacetime but did not devote a lot of energy to the industrial requirements of the military (even though, ironically, its German operations eventually became a vital part of the Holocaust). Rather, IBM mainly served the needs of innumerable parties engaged in ordinary commercial activities rather than the exploitation of military adventures. In any event, IBM did well in the 1920s, suffered a lot during the Great Depression, had mixed performance during World War II, and took off in the postwar years.
IBM’s history, particularly during the 1920s and 1930s, was shaped by trends and events in the financial universe of the time. IBM, however important, was only one small vessel on the economic sea. Understanding how IBM rose during the 1920s and persisted during the subsequent decade entails not only knowing about the record-keeping industry, in which IBM eventually rose to be a masterful leader, but also taking into account the surrounding environment. Today’s tech bubble, which one of these days might burst, might in some ways echo the economic situation that unfolded about a century ago.
The mass financial foolishness of the 1920s and the resultant disaster that ended the boom was entertainingly explained by John Kenneth Galbraith in his 1955 book The Great Crash, 1929. No books of comparable renown have yet appeared following the stock market plunge of 1987 or the Dot Com collapse of 2000. Perhaps they will arrive in time to help us understand the current bubble and its outcome. But it may turn out that the next great crash book will appear years from now, when scholars look back on the FANG bubble and the way it burst. On the other hand, the phenomenon that looks like a bubble to some observers may be a real and permanent rise in the valuation of companies. These organizations have found ways to monetize activities that are carried out by people using recently invented apps via the Internet.
We cannot know the future. Nevertheless, it’s a safe bet that some of the corporations that investors value highly but which have not yet delivered the traditional gifts that lead to high valuation, such as booming revenue and rising profitability, will have trouble riding out a large and long dip in financial markets. If there is a big stock market tumble, mature companies will be hurt along with their lively young companions.
IBM was hurt in the crash of 1987, when investors in droves liquidated their holdings. IBM was also hurt several years later during the dot com bust, even though IBM’s participation in the dot com boom was tiny compared to the size of its relatively stable legacy activities. The same can be said of many other blue chip companies that didn’t play a role in the dot com boom but were hurt by the general business malaise that spread far and wide in the wake of the dot com bust.
Still, the truly strong companies that suffered during the dot com downturn did not collapse even if their share prices fell. By contrast, a number of pure dot com companies that were floating high, held aloft by the dot com bubble, were killed off by the bust. Their failure severely hurt key technology suppliers, such as Sun Microsystems, which ultimately succumbed to the impact of the dot com bust. Other companies that had gained a lot from the dot com boom, such as Oracle, were able to take the beating of the bust and not merely survive but also to resume growth after the storm had passed.
How will IBM fare if the FANG boom is a bubble and that bubble bursts as so many others have? Some key investors, such as Warren Buffett, are concerned while retaining a considerable investment in Big Blue. Still, the situation that will ensue if today’s FANG bubble pops is going to be pretty bad for some of the current investment darlings. It will reveal which companies can ride out a financial crisis and which ones cannot.
As Buffett himself put it in his 2001 letter to Berkshire Hathaway shareholders, “After all, you only find out who is swimming naked when the tide goes out.”