At the turn of the millennium, we experienced the largest bubble that ever had occurred
up to that time. What distinguished the Internet Bubble from others was its association with
both new technologies and new trade opportunities. Also exceptional is the fact that this bubble
set new records. It emerged simultaneously as the greatest creator and the greatest destroyer
of wealth: During this economic episode, Goldman Sachs
proclaimed that investor sentiment was not a long-term risk. Unfortunately, this sentiment
proved to be a short-term risk with dire consequences for many investors and companies. The NASDAQ
Stock Exchange listed the lion’s share of Internet and related technology stocks. This
is significant because during the boom Internet Price-to-Earnings ratios climbed to over 100
to 1. By 2000, investor expectation for the future
reached 25% or higher. However, even though Cisco surpassed a Price-to-Earnings ratio
of greater than 100:1. The earnings of Cisco grew at a rate of 15% per year.
Unfortunately, Cisco lost 90% of its value when the bubble burst. Other companies, such
as Amazon, Lucent Technologies, and Yahoo, lost between 93% and 99% + of their value
from the high-water mark of 2000 to the low tide of 2001-02.
Security analysts at Merrill Lynch, Morgan Stanley, and Salomon Smith Barney provided
much of the hot air for the bubble. They based their success on their ability to steer lucrative
investment banking business to their firms by promising ongoing, favorable research coverage
that would support the Initial Public Offerings (IPOs) in the aftermarket.
Analysts pushed the line that traditional valuation metrics lose relevance during the
big-bang stage of an industry, which is a time to be reckless, though rational. Individual
stock prices soared while security analysts refrained from biting the hands that fed them.
Traditionally, analysts rated ten “buys” for every one “sell.” However, during
this bubble, the ratio of buys-to-sell neared 100:1. “Investment gurus” marching in
lockstep helped to convince the public that investing was easy. When the bubble burst,
celebrity analysts or others in their firms faced lawsuits, investigations, and SEC fines.
By 2001, the United States Secret Service and the SEC had commenced prosecution of more
than 5,000 cases in respect to the market structures and conducts that led to the collapse.
Sadly, most of their original files were destroyed along with their Manhattan offices in Building
7 of the World Trade Center when it collapsed in the late afternoon of 11 September 2001.
As a result, we never may know the extent of the fraud and market manipulation that
accompanied fee-based underwriting, cheer-leading research and analysis, and the infectious
greed that contributed to this very destructive bubble.