Question Of The Month –June,  2009

              When  Bubbles Burst?

A Tale:  From Tulips To Technology

Risk - Reward and Chasing Performance

In Holland in the 1630’s, prices for tulip bulbs soared.  At the height of the mania, traders bought and sold futures on third rate bulbs for sums greater than what they could have hoped to earn in a decade.  That speculative frenzy couldn’t go on forever and it didn’t.  The bubble burst.

In the 18th century we had the “French Mississippi Scheme.”  This involved both the refinancing of the French government debt and the issuing of vast quantities of money in the novel form of paper.  This frenzy couldn’t go on forever and it didn’t.  The bubble burst.

Also in the 18th Century, there was “Britain’s South Sea Episode.”  A company formed to refinance government debt quickly turned into a pyramid scheme.  This couldn’t go on forever and it didn’t.  The bubble burst.

The first century of industrialization in this country saw repeated cycles of investor euphoria--for canals, railroads, electricity, and scores of other innovations--each followed by busts in which many companies went down and thousands of speculators lost their shirts.

In March, 1928, Radio Corporation of Americans share price rose from $95.50 to $160 in only 10 days.  When the market bottomed in 1932, it sold for $2.50 a share.  From the gold fever days of the "Forty-Niners" to the allure of day-trading, Americans have always been convinced they can bring the rags-to-riches mythology to life.

The initial offering of Akamai (AKAM) was in late fall, 1999.  The initial offering price was $70 a share.  It did not stay there long.  In January 2000, it hit $345 a share.  It then started to fall and by April 2001 it was $8 a share. In 2002, it was priced under $1 a share.  In August 2003, it was $3.87 a share.  In 2004, it was as high as $18.47   In June 2005, it was $14.13 a share.  In October2006, it was $47.96 a share.  In April, 2008,  $30.93.  In May, 2009, it was $21.75 a share,

Will Akamai rebound?  Will it once again hit $345?  Are the people who bought in at $345 still in and waiting for a rebound?  I don't know what will eventually happen with Akamai.  But, what I do know is that I am happy that I didn't buy in at $100, 200, 300 or $345 a share.

Then, there is TheGlobe.com.  TheGlobe.com was started up by two Cornell University students ,  Todd Krizelman and Stephan Paternot in Ithaca, New York in 1998.   The Globe was a social networking service ---  a place where visitors go to check the weather, stock quotes and all sorts of other daily information.

On the initial day of trading, the opening price was $9 a share and it went all the way up to more than $90, making it one the most successful IPO's  on record.  The company raised $27.9 million.  In May 2001, it was selling for about 8 cents a share but it rebounded.

In August 2003, it was $1.24 a share.  In February 2004, it was $1.05.   In July, 2006, it was priced at  $0.19 cents a share.  On March 13, 2007, the company ceased operations.  There were a lot of dotcom stampedes in a run-away market. 

Then you have Bernard "Bernie" Madoff,  businessman and former non-executive chairman of the NASDAQ stock exchange who was convicted in 2009 of operating a Ponzi scheme that has been called the largest investor fraud ever committed by a single person.   Madoff pled guilty to an 11-count criminal complaint, admitting to defrauding thousands of investors. Federal prosecutors estimated client losses, which included fabricated gains, of almost $65 billion.  

We do not live in patient times.  We heard about a stock going up 600% a day, or Madoff was earning 12% a year for his investors,  many of us wanted a piece of the action.

What is the moral of this story?

There is a long history of investment bubbles that helped to pave the way for major technological economic advances.  This has been true for railroads, electricity and automobiles.   However, in many instances, the advances become generally apparent only long after the bubble burst.

Akamai is a very interesting story.  It reinforces the notion that you can’t latch on to every rising star in the market.  Buying and selling at the right time are so important but it is impossible to know when to do so.  Even all the experts don’t get that right.  The trick is to figure out what is a fair price for the company.

Do you think a stock which sold for $345 back in January, 2000, is worth $21.75 --- the price in May, 2009?   If you owned Akamai back in October, 2006 ($47.96), should you buy more shares now because you think it will go up or should you sell now because it may drop even lower?  Akamai  has had a bumpy ride but if you had bought in at $3.87 (8/2003), you have seen a nice increase --- if you  had the patience to hold on.

The NASDAQ composite peaked on March 10, 2000 at 5048.  By mid April, it had fallen to 1638.  The frenzy couldn't go on forever and it didn't.  In September 2006, it was 2173.  It was 2370 in April, 2008.  It was 1751 in May, 2009.    When will it return to 5000?  The bubble burst.  

Burton Malkiel, in his book "A Random Walk Down Wall Street", states, "In their frenzy for money, market participants throw over firm foundations of value for the dubious but thrilling assumption that they too can make a killing by building castles in the air.“

It's great to be the first in line, numero uno, at the top of the ladder.  However, being ahead of the herd and the stampede isn't so smart if it means you're the first one to plunge off a cliff.