Kindle Notes & Highlights
All speculative bubbles go through four stages, each with its own internal logic. The first stage, which is sometimes referred to as the “displacement,” starts when something changes people’s expectations about the future—a shift in government policy, a discovery, a fabulous new invention.
the explosion of scientific research—also provided two potential solutions to it: microphotography and the cathode ray tube. The former could reduce the Encyclopaedia Britannica to the volume of a matchbox. The latter could be used to display text and pictures on glass screens. Put them together, Bush wrote, and you could construct a device “in which an individual stores all his books, records, and communications, and which is mechanized, so that it may be consulted with exceeding speed and flexibility.”
The other essential component of the PC age is Moore’s law, named after Gordon Moore, the founder of Intel, which decrees that the processing capacity of microchips doubles every eighteen months or so.
On October 1, 1969, the ARPANET went online. A researcher at the University of California at Los Angeles tried to send a message to the Stanford Research Institute. In one of history’s little ironies, the network crashed, but the Pentagon persisted. Within months, the ARPANET was delivering messages between UCLA, Stanford, the University of California at Santa Barbara, and the University of Utah. Eventually, the network was expanded to other universities across the country.
“If you don’t stop doing old things, then you can’t start any new things. And when something gets to the point that it becomes a commodity product there is no reason for the NSF to be supporting it.”
Many bubbles, such as the 1840s railway mania in England and the Wall Street boom of the 1920s, are associated with exciting new inventions that create exaggerated hopes of profits.
represented a new paradigm for human development. Paradigms are stories (not necessarily true stories) that help people to organize their thoughts. Most of us use paradigms, even though we sometimes don’t realize it. The straight line is a paradigm. Nobody has ever seen a perfectly straight line, but it’s hard to imagine the world without the concept.
In 1983, the wealthiest 1 percent of households in America owned 90 percent of all stocks. The vast majority of households—about three out of four—owned no stocks at all. Most of these families, if they had any surplus income, kept it in the bank. Fifteen years later, in 1998, things had changed substantially. Almost half of American households owned stocks,
At the end of 2000, mutual funds contained more money than the banking system—about $7 trillion, of which more than $4 trillion was in stock funds. New funds were being created every day, and the mutual fund listings were taking up almost as much space as the stock tables. At the start of 2001, the point of absurdity was reached. The number of mutual funds topped eight thousand, which meant there were more mutual funds than there were stocks listed on the New York Stock Exchange and the Nasdaq combined.
Dent’s work yielded a simple prediction: the more people that were turning forty-five, the more saving there would be, and the higher the stock market would go. Since the number of boomers in their forties was increasing rapidly, Dent concluded that the Dow could “streak to around 8500 between 2006 and 2010.” In 1992 this seemed like an outlandish prediction.
Whenever a new industry emerges, or an old one goes into decline, investment bankers rub their hands.
size. With only two airports in the country, an airline is of limited value. With dozens of airports, air travel is indispensable. The same applies to the phone system. If just one person has a phone it is useless, but when two people have one the network comes alive. As the number of people connected increases, the number of ways to communicate grows exponentially. With three people, there are 6 possibilities.
One of the fundamental lessons is that market share now equals revenue later, and if you don’t have market share now, you are not going to have revenue later.”
When liquidity dries up, as happened in many Asian countries during 1997 and 1998, asset prices fall sharply. In the United States during the second half of the 1990s, there was an unprecedented amount of liquidity in the financial system, and this was an important factor underpinning the stock market’s rise.
The IPO price would have to be raised, but by how much? Pricing a stock issue is as much an art as a science. Ideally, the price would be low enough for the stock to enjoy a decent “bounce” when it started trading but high enough to ensure that Clark and Barksdale didn’t feel like they had left too much money on the table.
Everybody on Wall Street, it seemed, wanted in on the Netscape offering. Many of the bidders were mutual fund managers, but there was also heavy demand from individual investors. The Netscape IPO had captured the public imagination in an unprecedented manner. At Charles Schwab, the discount brokerage, the recorded phone message had been changed to say, “Press one if you’re calling about Netscape.”
Clark’s statement contained a lot of truth, but it wasn’t anarchy in the usual sense of the word that had been legitimized. Some of the early Internet enthusiasts harbored anti-authoritarian, anticapitalist instincts, but they were now in a small minority. Anarchy in the post-Netscape sense meant that a group of college kids could meet up with a rich eccentric, raise some more money from a venture capitalist, and build a billion-dollar company in eighteen months.
The average cost of an Internet ad was about $4 per hundred page views, which meant that advertisers were paying about $2 for every person that clicked on their ad. Glossy magazines like Vogue charged about $50,000 for a full-page ad. Assuming that half of Vogue’s 2 million readers looked at the page, the advertiser was being charged about five cents per set of eyeballs.
The Internet Report was important for two reasons: it made buying Internet stocks seem like a respectable activity; and it contained the genesis of a new valuation model for Internet stocks. Investors could read the report and tell themselves they were contributing to an industrial revolution, not just speculating wildly.
Instead of concentrating on earnings and revenues, many analysts would promote “mind share” and “market share” as key valuation indicators. The only way to quantify these concepts was to look at the traffic on a company’s Web site. If this appeared to be increasing dramatically, the company was worth more, even if its losses were also rising, as was often the case.
CyberCash had no shortage of media attention, but it did have a shortage of customers. In the seventeen months between its incorporation and its decision to go public, the firm’s total revenues were zero—though it did manage to accumulate losses of more than $10 million.
For years, Bill Gates’s company had been making things for a dollar and selling them for ten dollars, thereby demonstrating the vast potential for any company that could combine digital technology with market power. Both Microsoft Windows and Microsoft Office benefited from economies of scale and monopoly positions. Once they had been developed, the cost of replicating them and putting them on CDs was negligible. Yet Microsoft was able to charge hundreds of dollars for some versions of Microsoft Office, having seen off most of its competitors.
Microsoft’s strength isn’t based on money and resources alone. More than nine out of ten PC users see a Windows screen when they switch on their machines. In the past, Microsoft had ruthlessly exploited this monopoly to cripple competing products like WordPerfect and Lotus 1-2-3.
America Online’s success was based on what economists call vertical integration. It provided both access to the World Wide Web and its own Web content. This allowed it to exploit the self-reinforcing network effects that had spurred the growth of the Internet in the first place.
This didn’t happen by accident. As audiences splintered under the impact of the new media, the remaining mass-market mediums became more valuable, even if their numbers were falling. When Ford wanted to launch a new car, or Paramount Pictures wanted to promote an upcoming movie, they needed to reach the entire country, which wasn’t possible via the Internet. The major networks, while they didn’t deliver as many eyeballs as they had done in the 1970s, still had tens of millions of viewers. USA Today sold more than 2 million copies a day. Herbert Simon, a Nobel Prize–winning economist at
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In August 1995 it spent $19 billion on an old media asset, ABC. The merger of Disney and ABC created an immensely powerful company, but it also helped create the impression on Wall Street that Disney had been left out of the multimedia age. In order to counter this impression, Disney would eventually spend hundreds of millions of dollars to launch its own updated version of Pathfinder, Go.com, with similarly dismal financial returns. But by that stage losing money on the Internet would be nothing to be ashamed of. To the contrary, it would be viewed as the inevitable and, indeed, desirable
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Both Biggs and Wien were willing to accept that there were gradations in the collective insanity they spied around them. The rise in technology stocks, such as Microsoft, Dell Computer, and Intel, they saw as bordering on irrational. The rise of Netscape, Yahoo! Excite, and the rest of the Internet sector they viewed as inexplicable.
“He was early, and there’s no difference between being early and being wrong.”
“A fad is a bubble if the contagion of the fad occurs through price; people are attracted by observed price movements,” Robert Shiller, an economist at Yale, explained in his 1989 book Market Volatility.
Bezos justified taking the risk using what he called a “regret minimization framework.” He told Spector: “I knew that when I was eighty there was no chance that I would regret having walked away from my 1994 Wall Street bonus in the middle of the year. I wouldn’t even have remembered that. But I did think there was a chance that I might regret significantly not participating in this thing called the Internet that I believed passionately in.
Michael Lynton, the head of Penguin Putnam, told The New York Times that selling books over the Internet would bring “enormous benefit to the [publishing] business because it’s not about selling big, best-selling authors. It’s about selling our back list, and it’s very rare that opportunity comes along.”11
Economists developed the winner-takes-all theory to explain the success of technology companies like Microsoft and Intel. In technology markets, consumers tend to settle on one or two dominant products, such as Microsoft Windows, which generate big profits. One reason why this happens is that technology goods are complicated. After people have learned how to use them they are reluctant to incur the financial and psychological costs of adopting a rival technology.
“Switching costs” of this nature represent one major barrier to entry. “Positive feedback loops,” which reinforce the dominant product’s position, represent another.
is a property of speculative booms, from tulip mania to the Japanese stock market and real estate bubbles of the 1980s, that they don’t remain contained in one sector.
Eventually, they go to such extremes that they distort behavior throughout the economy. This is what happened in 1929, and it forced the Fed to act. In August, Young, against his better judgment, raised the interest rate that the Fed charges commercial banks for loans. A couple of months later the stock market crashed, and Young’s reputation was destroyed.
When you overlay the high valuation of many “start-ups” with the relatively high valuation of the general market, well, we are where we are, just trying to do our jobs and find some early stage great companies. If they execute, the valuations will take care of themselves. Again, it’s about monster markets, great management teams, and good products.
of the biggest headlines reserved for Internet stocks. Nineteen ninety-eight was the year that Internet fever turned into an epidemic, with investors of all types succumbing. In just twelve months, America Online’s stock rose by 593 percent, Yahoo!’s stock rose by 584 percent, and Amazon.com’s stock rose by an astounding 970 percent.
Old media companies sought desperately to clamber aboard the Internet bandwagon. The Walt Disney Company took a stake in Infoseek, the search engine, and also created the Go network as a potential rival to Yahoo! and America Online. NBC invested in C-Net’s Snap site.
Journalism, like all commodities, is subject to the laws of supply and demand. As the demand for skeptical reporting dropped, the supply fell
back to match it. Similarly, as the demand for upbeat coverage increased, the supply expanded to meet it.
The only newspaper that enjoyed much success in attracting online subscribers was The Wall Street Journal. Financial information and pornography were the two items that people seemed willing to pay for online.
In easing policy in such circumstances, Greenspan seemed to indicate that his policy of not letting the financial markets dictate monetary policy only applied while prices were rising. When prices had started falling, Greenspan had quickly changed policy. His actions added to the growing belief that the Fed would always be there to bail out investors if anything went wrong, and this made investors even more willing to take risks.
allowing investors to look to him as a potential savior, Greenspan, however inadvertently, ended up further inflating the Internet bubble. The two interest rate reductions confirmed to many people on Wall Street that in a crisis the Fed chairman could be relied upon to take prompt and dramatic action to protect their interests.
“Amazon’s valuation is clearly more art than science, and we believe that the stock will continue to be driven higher in large part by the company’s astounding revenue momentum.”
In its most recent quarter, Amazon.com’s revenues had tripled compared to the same quarter in 1997. Since launching its music store earlier in the year, it had sold more CDs than all other online stores combined. Blodget interpreted this as evidence that Amazon.com could become the Wal-Mart of the Web.
“If there must be madness,” John Kenneth Galbraith wrote of September 1929, when the ill-fated Shenandoah and Blue Ridge investment trusts made their debut, “something may be said for having it on a heroic scale.”
Any currency that is expanded recklessly—be it the German mark during the 1920s, or the U.S. dollar during the 1960s—is sure to be devalued at some point, because investors will eventually lose faith in it. In the case of U.S. dollars, the Fed bank controls the rate of expansion, and it usually does a decent job of retaining the currency’s value. But the supply of Internet stocks was determined by VCs and investment bankers, both of whom had a strong incentive to speed up the printing presses, which is precisely what they were doing. If they were to keep this up, they would eventually flood
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1999, the stock market was putting a negative value on caution and common sense. Since everybody involved in the Internet bubble—entrepreneurs, VCs, investment bankers, stock analysts, mutual fund managers, ordinary investors, even journalists—was reacting to the incentives provided by the market, these traits became harder and harder to find.
“The companies underneath these stocks are (1) growing amazingly quickly, and (2) threatening the status quo in multiple sectors of the economy.”5
As Blodget also pointed out, the laws of supply and demand, not revenues or earnings, were now determining the prices of Internet stocks. Despite the ongoing
