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Bubbles Now and Then
November 10, 2003

You could argue that the end of the New Economy bubble began when NASDAQ closed over 5,000 in Q1 2000, but when did the bubble begin? As with most things involving finance, the answer lies in Security Analysis, the 1934 book by Benjamin Graham and David Dodd.

G&D; establish that the time of the seismic change in American investment behavior was the late 1920s, �when the public acquired a completely different attitude towards the investment merits of common stocks.� The change in Wall Street that caused the birth of the bubble mentality: �The value of a common stock depends entirely upon what it will earn in the future.�

The sages of fundamental analysis observed that several corollaries � recognizable to observers of the Internet Era -- followed from this simple rule:

  1. A stock�s dividend rate should have slight bearing upon the value.
  2. Since no relationship apparently existed between assets and earning power, the asset value was entirely devoid of importance.
  3. Past earnings were significant only to the extent that they indicated what changes in the earnings were likely to take place in the future.

Sound familiar? These departures from common sense that were the mantras of the New Economy investment craze were actually identified by G&D; over 75 years ago, during the worst years of the Depression, as they wrote their classic investment tome. Yet even the economic privation of the 1930s and the governmental investigations into corruption on Wall Street led by FDR�s zealots did not dissuade investment analysts from attempting to predict the future rather than assess a company�s current financial performance.

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