"The nutshell is this: the old line economy stocks just don’t work because they have earnings and eventually rising interest rates impact earnings. New economy stocks have no earnings, so investors don’t see a need to exit."

– Wall Street analyst on CNBC, early March 2000, said with a perfectly straight face

Nothing so animates a speculative herd as a parabolic price advance in an asset detached from any standard of value. I am convinced that future generations will use the present moment to define the concept of a reckless speculative extreme, in the same way our generation uses “1929” and “2000.”

I included the CNBC quote above in an investment research letter I published on March 7, 2000, at the peak of a bubble that would ultimately take the technology-heavy Nasdaq 100 down by an improbably precise -83%. I say “improbably precise” because this is how I opened that same letter:

“On Wall Street, urgent stupidity has one terminal symptom, and it is the belief that money is free. Investors have turned the market into a carnival, where everybody “knows” that the new rides are the good rides, and the old rides just don’t work. Where the carnival barkers seem to hand out free money just for showing up. Unfortunately, this business is not that kind – it has always been true that in every pyramid, in every easy-money sure-thing, the first ones to get out are the only ones to get out. We’ve seen two-tiered markets before: most prominently in 1929, 1968-69, and 1972. Even at those pre-crash extremes, the S&P never sold above 20 times record earnings. The market clearly faces problems at a multiple of 32. Technology stocks will ultimately fare worse. Over the past 5 years, the revenues of S&P 500 technology companies have grown at a compound annual rate of 12%, while the corresponding stock prices have soared by 56% annually. Over time, price/revenue ratios come back in line. Currently, that would require an 83% plunge in tech stocks (recall the 1969-70 tech massacre). The plunge may be muted to about 65% given several years of revenue growth. If you understand values and market history, you know we’re not joking.”

– John P. Hussman, Ph.D., March 7, 2000

One of the hallmarks of every bubble is a loss of interest or ability of investors to distinguish between investment and speculation. Once that mentality has taken hold, and prices become wildly elevated, it is impossible to sustain the bubble without also making its consequences worse. In 1934, Benjamin Graham and David Dodd described the spectacular errors of investors that ultimately contributed to the 89% market loss between 1929 and 1932. One error was the willingness to abandon concern for the concept of “investment” – the purchase of securities at prices that provide a reasonable expectation of adequate return. The companion error was a growing enthusiasm for price-insensitive, passive investment approaches.

In the latter stage of the bull market culminating in 1929, the public acquired a completely different attitude to the investment merits of common stocks. Why did the investing public turn its attention from dividends, from asset values, and from average earnings, to transfer it almost exclusively to the earnings trend, i.e. to the changes in earnings expected in the future? The answer was, first, that the record of the past were proving an undependable guide to investment; and, second, that the rewards of offered by the future had become irresistibly alluring.

Along with this idea as to what constituted the basis for common-stock selection emerged a companion theory that common stocks represented the most profitable and therefore the most desirable media for long-term investment. This gospel was based on a certain amount of research, showing that diversified lists of common stocks had regularly increased in value over stated intervals of time for many years past.

These statements sound innocent and plausible. Yet they concealed two theoretical weaknesses that could and did result in untold mischief. The first of these defects was that they abolished the fundamental distinctions between investment and speculation. The second was that they ignored the price of a stock in determining whether or not it was a desirable purchase.

The notion that the desirability of a common stock was entirely independent of its prices seems incredibly absurd. Yet the new-era theory led directly to this thesis. An alluring corollary of this principle was that making money in the stock market was now the easiest thing in the world. It was only necessary to buy ‘good’ stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic.”

– Benjamin Graham and David L. Dodd, Security Analysis, 1934