Of Tulips, Twitter And Other Bubble Phenomena

One of the first historically recorded speculative bubbles happened with tulip bulbs in the Netherlands in the 1630s, when intense speculation caused an investor mania for the flower. Eventually, this mania drove the price of certain tulip bulbs to over ten times what a skilled artisan or craftsman might expect to earn over the course of a full year.

It may sound incredible to many of us today, that a flower with no true intrinsic value or practical use in creating economic productivity could suddenly become the target of an investor mob mentality, but it’s important to realize that these events are, in fact, hardly rare. Fed by a herd mentality among investors, many of whom will pay any price and bear any risk to be a part of the next big thing, bubbles happen all the time and continue to happen around us, even now.

Here’s a relatively recent example: Experienced investors have clear memories of the dot com bubble of the late 1990s. Despite generating little or no profit, companies like AOL and a string of internet start-ups experienced sharp stock price growth over a very short period of time, producing one of the largest wealth creation events in recent history.

Alas, the dot com wealth creation event of the late 1990s proved to be short-lived. Within just a few years, many of these same firms suffered a precipitous fall, which brought the equity markets – not to mention many investor portfolios – down with an earth-shattering thud.

The numbers can attest to the investor pain felt at the time: On March 10, 2000, the NASDAQ closed at 5,048 points. Within a year, it declined more than 50% before ultimately bottoming out in October 2002, when it dipped below 1,110 in intra-day trading. To this day, it has not fully recovered, even as the markets are coming off the best calendar year in more than a decade. Dot com companies were the tulip bulbs of the late 1990s.

Probably the only reason why the dot com meltdown is not referenced as frequently as it should be in the public domain is because of a much more recent and even more ruinous bubble – the real estate meltdown. The enormous public appetite for housing up until 2008 was matched only by the willingness of banks and other lenders to extend credit to buyers who, in many cases, were most assuredly not qualified to receive it.

But when the bubble finally burst it nearly brought down the entire global financial system, and nearly six years later the recovery is far from complete, as stagnant growth and stubbornly high unemployment continues to plague the economy at home and abroad. In other words, houses have become the latest tulip bulbs that surged in price and crashed in value.

With this in mind, what are the tulip bulbs of the equity markets today? The following are some of the top potential bubbles that investors should be wary of:

Twitter Inc – Perhaps the most talked about stock of 2013, Twitter’s IPO price in November was $26 and before December was over, insatiable investor demand had driven the price to over $70. It has since come down slightly, pin balling between $69 and $57. But even at those valuations, by most investment metrics the price is outrageously high for a company that is having trouble attracting new users, has limited value to advertisers – who increasingly are having trouble reaching targeted audiences on it platform – and, importantly, is not generating any profits. Everyone seems to want in on social media but paying any price for it might be fools gold.

Facebook- Unlike Twitter, it has a proven ability to lure advertisers to its platform, generating more ad revenue than any other web company outside of Google, according to the research firm eMarketer. What’s more, Facebook is succeeding where many other social media platforms are struggling to gain a foothold: Mobile ads. But underneath the surface, there is cause for considerable investor concern. By its own admission, it is attracting fewer and fewer young users, who are increasingly flocking to micro-messaging services like Snapchat, which incidentally turned down a recent $3 billion, all-cash offer from Facebook. And though it is largely considered the safe social media bet by many analysts, the space is still in its infancy relative to other industries and no one really knows what the market for such companies will be a year from now, let alone five. Look no further than My Space to see how quickly things can change for supposed leaders within this space. Don’t you remember how cool My Space was ten years ago, today its virtually worthless.

Netflix – While the stock price – which at one point last year shot up more than 300% – suggests that Netflix has an infinite runway for growth, it’s not entirely clear whether it has access to enough bandwidth to adequately support the customers it has, especially at current rates. A recent federal appeals court ruling that could potentially reshape the world of internet streaming by upending net neutrality rules could disrupt their business model even more, prompting the company to raise prices. Meanwhile, more and more entertainment studios are either refusing to provide content to Netflix or attempting to stream it on their own, which is presenting even further barriers to growth. Netflix recently announced it is looking at new fee structures on top of the fact it already has a large portion of the country as subscribers already making it harder to continue to grow. With the cost of content and internet streaming going up, will Netflix subscriber growth continue. Certainly it is priced for perfection.

Bitcoin – Bitcoin is perhaps the most obvious tulip bulbs out of these four bubble examples. The entire point of a currency is to enable a level of measurable stability within marketplaces to empower smooth transactions between buyers and sellers of goods and services. That is not something that can be said of Bitcoin, which is uniquely unsuitable for such a role, having experienced highly variable and fluctuating valuations. Without significant stabilization, Bitcoin is merely a speculative commodity, much like gold, which has gone through its own ups and downs in recent years, and is unlikely to reach peak levels again in the near future. Unlike gold, Bitcoins do not even have intrinsic underlying value as a speculative commodity. Paying $1000 for one Bitcoin seems like an absurd value considering it was worth $10 a year ago.

While some market observers have made the case that equities are overvalued across the board, there is not sufficient evidence to support that theory. Even in today’s environment, valuations remain fair compared to previous stock market bubbles.
However, in each of the above isolated cases hype and hysteria are reigning over common sense, not to mention earnings and revenue.

Investors should be wary, knowing that the best-case scenario has already been priced in – which is in fact very reminiscent of the internet-fueled bubble of the 1990s. Tulip bulbs continue to abound – Investors should continue to look closely at whether certain opportunities really have a shot of being the next big thing. Maybe you’re too late to the party, but the party always ends.

Ross Gerber is CEO and president of Santa Monica, Calif-based Gerber Kawasaki, an independent investment advisory and wealth management firm with approximately $200 million in assets under advisement. Clients and employees may own positions in various companies mentioned in the article, but readers shouldn’t buy anything without doing their own research.