The following is a recap of how the Dotcom Bubble built itself through the view of investors. The goal is to illustrate what information was available at different timestamps, not to look at the crisis from the present.

Disclaimer.

This post is for informational purposes only and does not constitute financial advice or a recommendation to buy, sell, or hold any securities or other financial instruments. The information provided is believed to be accurate and reliable, but the author does not guarantee its accuracy or completeness. You should not make investment decisions based on the information provided in this newsletter/signal without undertaking independent research and, if necessary, obtaining professional advice. The author is not responsible for any investment, trading, or other decisions made based on the information provided in this newsletter/signal.

Considered peak: Friday, March 10, 2000 

Context.

The Internet was built as a means to exchange data between universities in 1989 at CERN.¹ 

At the same time, from 1990 to 1997, the percent of households owning computers doubled (from 15.2% to 34.6%).² 

In summary, a new technology (not yet revolutionary) and its support (the computer) saw a huge evolution and adoption. 

This, accompanied by favorable “easy money” (see below) and legal ground for speculation (Taxpayer Act of 1997, which reduced taxes on capital gains), built the terrain for the “2000 crash.”. 

🐅 Tigers' crisis (1998).

In 1997, a financial crisis that started in Thailand soon grew to the entire East Asia region, finally dragging the world economy into dangerous territory. 

East Asia was considered the superstar of emerging markets, with good growth, sound economic policies, and a high saving ratio.³ 

In 1997, doubts emerged. The hype was slowly dying, due to economies being perceived as being too “hot,” meaning inflation, speculation, and, most importantly, high deficit. 

This led foreign investors, who manufactured the growth of these countries, to recalibrate their positions. Speculative attacks began, which forced the Thai government to unpeg the baht from the dollar (keeping it that way needed considerable efforts and resources). 

Capital flew out of the East Asia region, crashing the currencies of the said countries. More followed, like Russia (who defaulted on its debt) and Brazil.⁴ 

The crash shook international markets, pushing the Nasdaq and other indexes lower (-33% drawdown for Nasdaq). The IMF intervened and helped the concerned countries with a “rescue” package totaling more than 100 billion dollars. Central banks curved risks by cutting interest rates.⁵ 

🌐Economy. 

The Federal Reserve had just hiked at the June meeting. This hike served as a preventive measure of an expanding economy, which might have brought a tight labor market and inflation. Stress was present in 1998 due to the Tiger’s crisis, but curved, thus the possibility of backpedaling on easing. 

Members commented that the action in question would reverse a portion of the easing actions implemented during the fall of 1998 that had been undertaken in part to protect against the possibility that unsettled global markets would place even greater constraints on foreign and domestic economic activity than were then evident. As financial markets and foreign economies stabilized and recovered, that added protection was no longer required and policy needed to move to a less accommodative stance to promote sustainable growth in spending. One member did not agree that any tightening of policy was necessary to contain inflation, given the persistence of low inflation, accelerating productivity, and what in his view was an already sufficiently restrictive monetary policy stance.⁶ 

They hiked again in August. 

The members noted at that meeting that there were few current indications of rising inflation; nonetheless, with financial markets and foreign economies recovering since the Committee had eased policy last fall, the persisting strength of demand was enough to put added pressure over time on already very tight labor markets and at some point lead to a pickup in inflation that could threaten the sustainability of the economy's expansion. Because there was substantial uncertainty relating to the extent and timing of prospective inflationary pressures and thus the possibility that further firming of policy might not be needed in the very near term, the directive did not contain any bias relating to the direction of possible adjustments to policy in the intermeeting period. 

Also to be noted. 

In their comments about regional economic developments, the members reported generally favorable business conditions and further growth in all regions, with variations ranging from some acceleration in a number of Federal Reserve Districts to modest deceleration in some others. Several indicated that economic activity in some parts of the country was being held down by shortages of labor. Most industries continued to exhibit strength, but weakness was reported in agriculture and related businesses and in manufacturing industries such as textiles.⁷ 

🪙 Assets.

➡️ Nasdaq slowly recovered from the 1998 crash (memo: -33% drawdown from top) and made a new high.

➡️ Gold saw a jump due to the Central Bank Gold Agreement, which aimed at slowing the downfall of the gold price by capping gold selling by central banks, among other measures.⁸

➡️ Crude oil has been in an uptrend since the start of 1999 due to OPEC cuts and high demand (notably by the US economy performance).⁹

➡️ Bond yields were also in an uptrend (10Y below). 

🔊 Sentiments.

Consumer sentiment was at an all-time high. 

Overall, the Sentiment Index was not only higher than ever before, the quarter-to-quarter changes since the start of 1999 were the smallest in the history of the surveys.¹⁰ 

This means euphoric optimism. 

Consumers judged long term economic prospects more favorably throughout 1999 than at any time since the mid 1960's. Perhaps even more remarkable is that consumers have increasingly adopted optimistic expectations as the current expansion has lengthened.¹¹ 

For the twelfth consecutive month, the majority of consumers in the September 1999 survey reported that their financial situation had improved during the past year. This marks the longest period of sustained financial gains recorded since the mid 1960's. Income gains were reported by the largest number of households since the 1960's, with the frequency of income gains steadily growing during 1999 (see the chart below).¹² 

Gains in Home Values Support High Confidence Levels While rising home prices has shifted the advantage from home buyers to home sellers, the associated gains in household wealth are likely to have the largest influence on consumers’ overall spending and saving behavior. The persistent strength in consumer confidence during the past year has been due to gains in both incomes as well as rising asset values. While increase in stock prices received the most attention, home owners represent an even larger share of all households than stock owners. Over the past decade, the reported gains in home values have closely paralleled changes in the overall level of consumer confidence (see the chart below)¹³ .

In summary, “euphoric” ground even through interest rate hike apprehension territory. It is important to pinpoint that those episodes of “high” interest rates were the norm before the ZIRP period, which shifted perception of consumers. However, as said above, the FED was also starting to relax its policies. 

Market sentiment was also very optimistic, with a Nasdaq gain of around 86% by the end of the year (record return). Tech speculation on what the internet could change in the economy leadss those gains.

“The size of the moves made by the winners reflects the speculative fever gripping the market and is based on hopes that as the Internet transforms the economy, companies that did not exist a few years ago will become giants.” 

This led to waves in return, notably stocks crashed violently (high volatility already present).

“Many Internet-related stocks, after peaking last spring, fell 50% or more by early August, wiping out billions in market value and panicking many investors into selling--at exactly the wrong time, in many cases.”¹⁴ 

The environment was highly speculative.

“Just why that should be so is an interesting question. Perhaps companies think that the amount of money being raised is relatively small compared to the prestige of having a stock deemed to be hot, and figure that in any case, they can always raise more capital later. Perhaps they are happy to be able to provide a quick profit for friends and family members allowed to buy shares at the offering price.”¹⁵ 

Since consumer spending and markets have a correlation, one pushed the other higher and vice versa.

”Fed officials have said repeatedly that the rally in the stock market this year has helped fuel the consumer spending that is keeping the economy growing at a faster pace than policy makers would like.”¹⁶ 

🌐Economy. 

Inflation is getting higher; interest rates follow. The unemployment rate is unmoved. However, consumer confidence is still very high.

”Consumer confidence showed no signs of any further deterioration in the last half of February. The most remarkable finding was that soaring gas prices, higher interest rates, and declines in stock market wealth had only a minor impact on confidence, with the Sentiment Index remaining at a higher level during the first two months of 2000 than at any other time during the past 50 years.”¹⁷ 

🪙 Assets.

Nasdaq is making new HIGH (capitalized). However, Dow is mostly underperforming.

“Since the Fed started tightening last summer, the Dow (and most broader market measures) have lost ground -- demonstrating that most stocks have been hurt by rising rates. The February slide by the Dow under its 200-day moving average has also raised a caution flag.” ¹⁸ 

Tech stocks weren’t impacted by the raise of the rate.

“But technology companies, which are not as reliant on the bond market for borrowing money, are seen as less affected by higher rates.”¹⁹ 

The market seems euphoric, finding bullishness wherever it can.

“What's bad for Main Street proved good for Wall Street. U.S. stocks rallied Friday after a government report showed job growth slowed in February, easing fears the Federal Reserve will aggressively hike interest rates. Stocks soared on the news, snapped up by investors betting that lower-than-expected borrowing costs will mean stronger corporate profits. The frenzy pushed the Nasdaq composite index to its fourteenth record close of the year, its third largest point gain on record, and within striking distance of the 5,000 mark.” ²⁰ 

Only Gold shows a downward move; both Nasdaq and Oil kept rising.

Nasdaq closed above 5000. 

"Fifty-two percent of the households in America are invested in the U.S. stock market and they want to invest in the things that had 70 percent growth last year," Hogan said. "As long as the money keeps flowing into equity mutual funds and they are targeted toward Nasdaq stocks, we are going to see this go on for a while."²¹ 

Dow is still in a downturn. 

On March 10^th, Nasdaq peaked, closing the day on a still joyful note. 

On March 13^th, Nasdaq saw its first (huge) sell-off, notably due to Japan's recession fear and (maybe consequently) suspected taking profit behaviors.

“Japan, the world's second-largest economy, contracted at a 1.4 percent rate between October and December, officially pulling it back into recession. A global market sell-off followed. The news sparked fears that a slowdown in demand could crimp earnings, particularly among technology companies reliant upon exports.”²² 

The week starting April 10^th showed real pain, the index losing almost 25%. The market closed down 35% from the peak.

On Friday the 15th, after the sell-off, the perception wasn’t that something broke, but that this was a reverse of momentum.

“Analysts say there was no single reason for the selling, but momentum kept accelerating on the down side. Investors were rattled by a report showing that inflation may be picking up, reinforcing fears that the Federal Reserve will continue its year-long campaign to raise interest rates. That inflation report, the Consumer Price Index, climbed 0.7 percent in March. 

Surging energy and transportation costs were largely to blame for the boost. But even without the volatile food and energy sectors, the core rate climbed 0.4 percent, the fastest clip in five years. 

The 30-year U.S. Treasury fell 7/32 of a point in price, the yield at 5.79 percent. 

The selling came despite some positive profit reports, as the corporate earnings season kicked into high hear.” ²³

Optimism was, however, still present in some.

“Analysts were cautiously optimistic that the rally could herald stronger moves toward the upside, but warned there could be more selling on the horizon. "I think it's (the market) going to keep taking its temperature," Art Cashin, head of floor trading for Prudential Securities, told CNN's In the Money.” ²³

From there, the bubble unfolded. The next new high was made 15 years later, in 2015.

Lessons?

It is easy to draw conclusions on an event that already happened, much harder to predict the next. Crises look alike but are never the same.

There is, however, always a factor that appears in each bubble: leveraged exposure from retail.

A bubble (on the technical side) is a Ponzi scheme of some sort that runs on fresh liquidity; price goes parabolic because more and more people are buying (not steady; volume is getting bigger at each step, or else the price would go in a straight uptrend). 

When there is a nice uptrend in the market, it is mostly due to big players (institutions, banks) pushing the price. Smaller entities join (like hedge funds), adding liquidity, pushing the price higher. The last pool of liquidity available to continue pushing the price parabolically is non-financial retail investors. 

Once there is no new inflow possible. The price starts to slow. Big players that were there at first and enjoyed the uptrend start taking profit, pushing other players to do the same. Non-financial retailers, who don’t have knowledge on how the market works, are left holding the bag. 

However, to play the uptrend, the common non-financial retail investor's needs “cheap” money. This is where the FED is the second signal of a bubble. Extra loose policy pushes investments that are drawn to the bubble in formation. 

However, “cheap” money isn’t fully necessary; the mere illusion of it is sufficient. It's easy; if the economy seems to be on a good track (as seen above), it pushes consumer spending and investment. 

The rule of thumb is that if XYZ stock, crypto, indexes, etc. are being spoken about in the news or by people with no interest in finance, it might be time to hedge.

¹ A short history of the Web | CERN (home.cern) 
² issues-IM (bls.gov) p.2 
³ Finance & Development June 1998 - The Asian Crisis: Causes and Cures (imf.org) 
⁴ Asian financial crisis | Causes, Effects, & Facts (britannica.com) 
⁵ Asian Financial Crisis | Federal Reserve History 
⁶ FRB: FOMC Minutes - June 29-30, 1999 (federalreserve.gov) 
⁷ FRB: FOMC Minutes - August 24, 1999 (federalreserve.gov) 
⁸ Official Gold Sales and the Central Bank Gold Agreement | Alchemist | LBMA 
⁹ DOB Energy - by geoLOGIC | News | Lower For Shorter? Looking Back At The 1997-1999 Oil Price Downturn 
¹⁰ fetchdoc.php (umich.edu) 
¹¹ fetchdoc.php (umich.edu) p.1
¹² fetchdoc.php (umich.edu) p.2 
¹³ fetchdoc.php (umich.edu) p.5
¹⁴ 1999 Goes Into the Record Book on Wall Street - Los Angeles Times (latimes.com) 
¹⁵ 1999 Goes Into the Record Book on Wall Street - Los Angeles Times (latimes.com) 
¹⁶ THE MARKETS: STOCKS & BONDS; Big Selloff Eases, but Investors Remain Concerned - The New York Times (nytimes.com) 
¹⁷ Corel Office Document (umich.edu) 
¹⁸ Murphy's Mid-Month Update—February 2000—Barron's (barrons.com) 
¹⁹ Nasdaq surges to record - Feb. 29, 2000 (cnn.com) 
²⁰ Party on Wall Street as investors cheer report of slower job growth - Mar. 3, 2000 (cnn.com) 
²¹ Nasdaq finishes above 5,000 - Mar. 9, 2000 (cnn.com) 
²² Nasdaq takes a breather - Mar. 13, 2000 (cnn.com) 
²³ CNN Transcript - CNN International World Business This Week: Summary Of The Week's Business News - April 15, 2000 
²⁴ Blue Chips Rally Wall St. - Apr. 17, 2000 (cnn.com)