The state of our finances can have a significant impact on our lives, yet things can also go wrong. Take, for example, the dangerous phenomenon of stock market bubbles, which in the past have destroyed both individual lives and whole economies.
The most recent rise in stock prices stopped quickly when investors realized how bad it could be for businesses if they had to close in 2020 because of a global epidemic. How can investors recognize a market that has been overvalued? Let’s take a look at the dot-com bubble and see what kind of lessons we can draw from it.
Understanding The Dot-Com Bubble
The Start of the Bubble
The world as a whole made a lot of technological progress in the 1990s, and in 1993, when the Mosaic web browser came out, a lot of people were able to connect to the internet. Personal computers began their slow but steady ascent from the realm of luxury goods to that of indispensable appliances in many homes.
During this time when the internet was just becoming popular, there was a lot of untapped potential for business, which led to a lot of internet businesses being started. One such company is Netscape, which became the industry standard after it distributed its web browser for free and became widely used.
Because of the widespread use of their free web browser, Netscape decided to enter the public stock market. Their stock, which had been valued at $25, soared to $75 on the first day of trading, and the success of Netscape’s first public offering (IPO) sent shockwaves all across the world.
People who had just started using the internet were quick to see the benefits and opportunities it offered. As a result, many of them decided to invest money in its growth. A new act in the United States brought about a reduction in the tax rate applicable to capital gains at about the same time that interest rates were falling.
As a result, investors ended up with more capital and a greater willingness to put it to use in new ventures. This first displacement is typical in every bubble and takes place whenever something new attains a significant level of popularity among the general population. A bubble will typically begin to form if there is a change in the system.
As time went on, an increasing number of investors made a mad dash to locate new internet companies in which to deposit their money. On the Nasdaq stock exchange, a great number of companies that had made very little in the way of profits started to launch initial public offerings.
Instead of focusing on making money, these businesses spent a lot of money on advertising to get a bigger share of the market as quickly as possible. This meant that a good many of them were quite unprofitable, but at the time, this didn’t appear to be a relevant consideration.
In 1999, there were 457 initial public offerings (IPOs), the majority of which were internet startups; 117 of these companies saw a price increase of at least 100% on their first day of trading. The news quickly spread around the world, which led to even higher increases in prices as investors continued to buy despite the fact that prices had already skyrocketed.
Because of this, a positive feedback loop was developed, in which an increase in stock prices caused more individuals to invest, which in turn caused an increase in stock prices, and so on. The confidence of investors had reached an all-time high as the number of people interested in participating in the opportunity continued to rise.
The problem is that some of the excitement is justified, but we don’t know which of the claims is true. Fear of missing out (often known as FOMO) was the main factor behind this price spike in the stock market.
Stock prices were not based on fundamentals; instead, they were based on psychological factors like overconfidence and too much optimism. In addition to this, it was extremely difficult to predict precisely when the bubble was going to pop.
The Burst of the Dot-Com Bubble
Due to the rapid expansion of the bubble, everything would eventually come to an end. As the year 2000 got closer and the Y2K bug stopped being a worry, the Federal Reserve of the United States said it would raise interest rates.
Because of this, there was a lot of volatility in the stock market because analysts couldn’t agree on whether or not technology companies would be impacted by rising borrowing prices. During this time period, the Nasdaq reached a point total of 5000, which would later become an all-time high.
(The Dot-com bubble crash. Source: Wikimedia)
During this time, Japan was also going through a recession, which caused a lot of investors to lose faith and sell in a panic. The bubble had finally burst when investors stopped buying at the inflated stock prices and there was a significant drop in stock prices.
When a bubble is popped, it can not be re-inflated in any way. Panic and fear, which were the main reasons for the large-scale selling, spread to other asset classes and could be to blame for a recession.
The value of internet stocks was decreasing at a rate that was far quicker than it had increased. Most of these businesses, which were once worth several million dollars, were unable to pay their debts in the end.
People are eager to ensure that they are not left behind when it comes to the most recent technological advancements. Also, when people see how much money others are making, it makes them more likely to invest their own money for the same reason.
Frequently Asked Questions (FAQ)
Will There be Another Stock Market Bubble?
Bubbles in the stock market are certainly nothing new; yet, there is a possibility that they will occur once more in the future due to the fact that history tends to repeat itself. Therefore, before you decide to buy into any company, you should always make sure that you conduct your own independent research.
How Can I Avoid a Stock Market Bubble?
To begin with, you must be cautious about what you invest in and avoid allowing your emotions to control you. Always invest in your area of expertise and conduct extensive research before drawing conclusions. Maintain a sense of perspective and make prudent decisions.
What Caused the 2000 Dot-Com Bubble to Burst?
Technology stocks caused the dot-com crash. Internet growth prompted investors to fund new enterprises. These companies went public without a strategic plan, a product, or a track record of earnings. Some of these companies went bankrupt or failed.
Takeaways
- The world achieved a lot of technological advancement in the 1990s, and the mosaic web browser helped many individuals access the internet in 1993.
- As the internet became widespread, there was a lot of untapped commercial potential, so many internet firms were formed.
- One of these companies is Netscape, whose web browser became the industry standard after it was given away for free and used by many people.
- This first displacement is typical in every bubble and takes place whenever something new attains a significant level of popularity among the general population.
- The confidence of investors had reached an all-time high as the number of people interested in participating in the opportunity continued to rise.
- Stock prices were not based on fundamentals; instead, they were based on psychological factors like overconfidence and too much optimism.
- During this time, Japan was also going through a recession, which made a lot of investors lose faith and sell in a panic.
