The 2000 Dot Com Bubble Burst Explained in Simple Terms.
A new era was on the horizon. The internet has presented limitless opportunities to revolutionize the world of business and many wanted to join in either through an enterpreneurship spirit (1 in 7 Americans said they were building a business in a survey in 1999) or through acquiring stocks of internet-based companies.
Now, to put things into perspective, what caused the bubble? The answer is excessive speculation from both institutional and retail rades in internet-based companies. The 1990s saw an explosion in internet companies which prompted market participants to buy these shares in anticipation of a further appreciation. By disregarding the fragile fundamentals, people kept buying into the bubble until it was no longer sustainable. Hence after rising about 400% during the mid-90s, the NASDAQ composite found its doom during the beginning of the new millenium by losing around 80% of its value.
The promise was that we will be moving into an economy that is based on information technology and if you were one of the first ones to invest, then you would’ve become rich by being at the beginning. The stock market culture in the United States further fuelled many to invest their savings into a field that is not very well-known to them. but why were there many internet companies?
Well, aside from the technological revolution, venture capital funds were practically investing everywhere. Investment banks that led IPOs also tried to spark more speculation and buying so that they make more money on their exit.
The issue wasn’t that the companies were bad, but it was due to the fact that they were fragile and badly managed. For example, some companies spent an enormous amount of their budget on Marketing expenses and have neglected their main business. It was a race to be noticed and cash out as soon as possible. The revolution happened at an astronomical speed and this is one of the first signals of a bubble. Of course, in hindsight, this is very easy to say and had we been given the opportunity to invest in the 90’s we would have done it.
The term irrational exuberance surfaced in December 1996 by Alan greenspan the then Fed’s chairman. This is just another word to say “Buying without fundamentals to justify the decision”. Of course, having coined that term, Alan Greenspan didn’t do much about the markets until 2000 where he decided to raise the interest rate and decrease money supply. A tight monetary policy is supposed to cool down an overheating economy by trying to decrease inflation through interest rates and money supply. Remember, a higher interest rate discourages businesses from borrowing money to conduct their operations or to open up new businesses.
Not all companies were bad. Some were solid companies founded by very smart people. We still have Amazon, Oracle, Ebay, Intel, etc. But other companies were absolute failures such as Pets.com and Webvan.com. Some investors were smart enough to allocate most of their internet-related funds to the solid companies but other were unfortunate enough to place all their baskets into the failed ones.
The moral of the story is that you should never forget fundamentals. It is what actually makes prices go high or low over the long-term. You cannot expect to invest in something without understanding its prospects. There is another term for that, it is Gambling.