Bubble Markets • Despite the Wide Range of Assets That Have

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Bubble Markets

Bubbles

• Despite the wide range of assets that have witnesses bouts of irrational exuberance (tulips, sugar, coins, bonds, cotton, wheat), bubbles follow a similar pattern • As Marx noted, history repeats itself, first as a tragedy, second as a farce.

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Anatomy of a Bubble

Anatomy of of a a Bubble Bubble

• Time after time we see the same sentiment and the same fundamental mechanics at work. • In each case, we see massive supply/demand imbalances. • The supply build leading up to the bubble persists for years and sometimes decades as irrationality grips markets.

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Anatomy of of a a Bubble Bubble

• Despite the disparate nature of assets on which bubbles have formed, there is an uncanny similarity about the phases through which each moves. We identify five stages of a bubble

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Five Stages Five Stages

• Displacement • Credit Creation • Euphoria • Financial Distress • Revulsion

• “Kindleberger/Minsky” model

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Example 1 Irish Property Bubble

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Example 1 Irish Property Bubble

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Example – Shewsbury Road

• In 2005, houses on Shrewsbury Road were among the most expensive in Europe after 12 years of almost uninterrupted nationwide rises.

Example – Shewsbury Road

• In 2005, houses on Shrewsbury Road were among the most expensive in Europe after 12 years of almost uninterrupted nationwide rises.

• For example, in 2005, a 4,000 sq ft (372 sq m) house on Shrewsbury Road (Dublin 4) set an Irish record when a buyer paid more than €58m for a home with extensive land to the rear that remains undeveloped. • Despite having a guide price of €35 million, the house eventually reached €58 million due to a rumoured six potential buyers vying to purchase the property. • In September 2011 the house went on the market again for a price of €15 million, down €43 million from its sale value in 2005, but was withdrawn presumably because it never met the guide price

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Example: Walford Shrewsbury Road

Dublin Second-hand House Prices

€800,000 €700,000 €600,000 €500,000 €400,000 €300,000 €200,000 €100,000 €0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: Sherry Fitzgerald Research (2007)

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Residential Real Estate Prices, Rents & Income Ireland

600

500

400

nominal house prices 300 price/income price/rent

200

100

0 . 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source OECD

Property Lending and GDP

250000

200000

150000 total property lending 100000 nominal GDP

50000

0 2000 2001 2002 2003 2004 2005 2006 2007

Source: Irish Central Statistics Office, Annual Statistical Summary 20

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Proportion of Total Bank Lending attributable to Property- related Lending

0 2000 2001 2002 2003 2004 2005 2006 2007 Source: Irish Central Statistics Office, Annual 21 Statistical Summary

Sectoral Decomposition of Increase in of Bank Lending 2000-2007

900

800

700

600

construction 500 real estate personal mortgages 400 total lending nominal GDP 300

200

100

0 2000 2001 2002 2003 2004 2005 2006 2007

Source: Irish Central Statistics Office, Annual Statistical Summary 22

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ECB Interest Rates and Interest Rates on House Purchase Loans 2000-2013

ECB - marginal lending rate

3 House purchase loans - average interest rate

1 Source: Department of the Environment 0 . and Local

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Government

Property – related Tax Revenues as a Proportion of Total Government Income 2000-2010

10 % of total tax revenue

4 Source: European 2 Commission and Goodbody Stockbrokers 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

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Performance of Irish Share Indices 2000-2014

18000

16000

14000

12000

10000 ISEQ General 8000 ISEQ Financial

6000

4000

2000 Source: Irish 0 Stock Exchange 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Quotes

• “While short-term economic prospects for AIB’s main markets are somewhat mixed, the medium outlook is more positive. • Irish GDP is forecast to slow to 2.5% this year, reflecting the slowdown in the housing sector and a weaker global economy. • However, economic fundamentals remain solid and growth is expected to pick up again in 2009 and beyond” (AIB annual report, 2007)

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Quotes

• “Economic fundamentals remain firm- demographics, job creation, income growth and the government’s fiscal position all remain positive while the interest rate environment is now more supportive. These fundamentals support ongoing demand for housing” (Anglo Irish Annual report, 2007) • • ”The banks performance in 2008 demonstrates the resilience and strength of our business model. “The bank has no exposure to US or other sub- prime sectors and does not sponsor any off-balance sheet activities. ” (Anglo Irish Bank, Interim Report, September 2008)

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• The following extract reported in McDonald and Sheridan (2010) about a circuit court repossession case in February 2009 illustrates: • .. a Dublin father of three on an Air Corps pilot’s (Irish airforce) salary of around €53000 a year had managed to build up a twelve- house property portfolio, with loans of €8 million from nine separate financial institutions

Sunday Business Post, Nov 2006

• Free boat with special price house. – Close to Lough Allen, a select development of 20 homes offering a 17- foot Star craft with every purchase

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Example 2 Dot Com Bubble

Dot Com Bubble

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Question

• Why did USA stock markets reach such high levels by March 2000?

Displacement Displacement

• Displacement – Displacement is a shock that triggers the creation of profit opportunities in some sectors

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Displacement Displacement

• Displacement – Displacement is a shock that triggers the creation of profit opportunities in some sectors – Investment and production pick up to exploit new opportunities

Credit Creation Credit Creation

– Monetary expansion/Credit Creation: (new credit instruments; expansion of personal credit) – Sooner or later the demand for the asset will outstrip the supply; resulting in price increases – These price increases will give rise to further investment – A positive feedback loop ensues

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Euphoria Euphoria

Euphoria The virtuous circle: risings assets, rising Leverage

Euphoria Euphoria

Euphoria • The virtuous circle: risings assets, rising Leverage – Adam Smith referred to such developments as “overtrading.” – Kindleberger, “An over estimate of prospective returns or excessive gearing.”

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Financial DistressFinancial Distress

Firm may not meet its liabilities ‘Financial fragility’ grows – 1. Meet liabilities from reliable earnings (‘hedge finance’, because hedged against changes in credit market) – 2. Meet liabilities by rolling over debt (‘speculative finance’) – 3. Meet liabilities by increasing debt (Ponzi finance)

Revulsion Revulsion

• Revulsion – Doom: the big unwinding – Speculative and Ponzi financiers have to liquidate – Fisher: debt deflation

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The Magic ofThe Leverage magic of leverage

• Case 1: Spend $1 on asset, goes up 10% => My return is $.10, or 10% • Case 2: Spend .10 of my own money and .90 of borrowed money on asset, goes up 10% => my return is $.10, or 100%

The Magic ofThe Leverage magic of leverage

• Case 1: Spend $1 on asset, goes up 10% => My return is $.10, or 10% • Case 2: Spend .10 of my own money and .90 of borrowed money on asset, goes up 10% => my return is $.10, or 100% • Case 3: Spend $1 on asset, goes down 10% => my loss is 10% • Case 4: Spend .10 own and .90 borrowed, asset goes down 10% => my loss is 100%, & I still owe .90: may have to sell this or other assets to get my leverage down

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Balance Sheets Balance Sheets

Assets Liabilities Stock shares Bank loans Real estate Bonds

Equity = Assets minus liabilities

Hyman Minsky’s theory of financial crises

• A theory on how changes in balance sheets drive phases of boom-bust cycle • Displacement: External event touches off investment wave • Boom: expectations of a sustained rise in asset prices become entrenched • Liquidity (availability of credit) increases • Leverage increases (debt-equity ratio increases)

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Leverage on Leverage on the way up the way down

Leverage on the way up

The virtuous circle

• The virtuous circle: risings assets, rising Leverage

“Excess” Borrow more money to collateral buy stocks Stock Price rise (liquidity increases)

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• Buying stocks ‘on margin’: Value of Collateral required depends on size of loan. • Must keep ‘rolling over’ loans to stay in market

The virtuous circle

• The vicious circle: falling assets, falling leverage (“deleveraging”)

Insufficient Sell stocks to Stock collateral pay back loans) prices fall

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The virtuous circle

• ‘Debt deflation’ (Irving Fisher)

‘Fire sale’ Prices fall Deflation to pay (deflation) makes debts business fail

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IPOs

• Initial under-pricing • Long-term underperformance • “Hot Issue” markets when IPO demand is especially high

Case Study 1: Boston Chicken Inc.

• Boston Markets rotisserie chicken • Popular attractively priced dinner choice – - quarter chicken; 2 sides; corn bread $3.99 – “They have a terrific product. What they are doing is selling home- cooked meals for fast-food prices.” –fund manager investing for the long term

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Case Study 1: Boston Chicken Inc.

• IPO November 8, 1993 • 1.6m shares @$20 on NASDAQ • 10% of equity

Case Study 1: Boston Chicken Inc.

• IPO November 8 1993 • 1.6m shares @$20 on NASDAQ • 10% of equity • First trading day opened at $45.25 & closed at $48.5 • Over 140% price rise, best 1st day IPO performance in previous 2 years • What happened over the next 5 years?

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Boston Chicken

• Nov 10, 1997: stock closes at $8.50 ($17 pre split price) • 1997: -82% decline – one of NASDAQs 10 worst performing stocks in 1997 • Oct 5 1998: filed for bankruptcy protection – 178 restaurants closed – Stock price 47 cents

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Case Study 2: Netscape Communications

Wall Street Journal: Aug 1995: Market sees Netscape Most Savoury IPO since Boston Chicken

“Its almost impossible for a normal guy to Receive an allocation of the new issue, But when the market opens attack it.” retail analyst quoted

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• Aug 1995: Planned issue of 3.5m shares at $12-$14 increased to 5m shares at $28 • Stock opened at $71 & closed at $58

• Aug 1995: Planned issue of 3.5m shares at $12-$14 increased to 5m shares at $28 • Stock opened at $71 & closed at $58 • Short term outperformance • Long term underperformance • Acquired by AOL for $4.2bn in Nov 1998

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Heuristic driven biases at work?

• First day investor enthusiasm – Betting on trends – Limited share issue – Regret aversion because missed earlier IPOs

Heuristic driven biases at work?

• Winner’s curse hypothesis? • Bandwagon or fad? – Under-pricing to generate interest – Belief that crowd must know something – If a negative outcome, pain of regret is mitigated by being part of the crowd

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• Yahoo! – Listed on NASDAQ April 1996 with 68 employees

• Yahoo! – Listed on NASDAQ April 1996 with 68 employees – Valued at 100 x previous year’s sales – Early 2000, valued at $132bn; p/e = 2150

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• Priceline.com – Online travel agent with a twist – IPO March 1999 – Less than 200 people employed

• Priceline.com – Online travel agent with a twist – IPO March 1999 – Less than 200 people employed – Valued at $10bn – Shortly afterwards it was worth more than the whole US airline industry

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• Priceline.com – Two years later market value less than Two 747s

• “Speculation tends to detach itself from really valuable objects & turns to delusive ones.” Kindleberger (1996)

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• “Speculation tends to detach itself from really valuable objects & turns to delusive ones.” Kindleberger (1996) • The magic of the internet... Firms adding .com to their names • Academic studies only explore whether Internet stocks are rationally priced relative to each other – Not on an absolute basis © 69

Internet Stocks

• Internet stocks were viewed as something different; could be valued in a different manner ( Displacement) • Rush to possess – internet stocks generated a headlong euphoric craze driven by unconscious intergenerational & intra-generational rivalry ( Credit Creation)

• “psychic” defence” – predicts internet stock would remain mis-valued despite all evidence to the contrary ... normal reality is not necessarily salient in psychic reality ( Euphoria)

• Panic & Loss – predicts once reality ultimately intrudes internet stocks would collapse overnight & become hated objects. A culture of blame develops ( Financial Distress)

• Learning from experience predicts Internet stocks, impact of crash impacted on subsequent sector and more general market valuations for some time ( Revulsion )

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Displacement

• 69 dot.com IPOs between August 1995 & October 1998 • “Boom” stage characterised by the idea of the “New Economy” which would overthrow the “Old Economy” • An adolescent paradise • Lack of any attempt by regulatory authorities to curb super egos

Euphoric Stage

• Euphoric Stage: Oct 1998-March 2000 – 325 IPOs with average 1 st day returns of 90% – Totally implausible business models – How could analysts make sense of it? • The Internet “... Has introduced a brave new world for valuation methodologies....we believe that we have entered a new valuation zone.” Mary Meeker, Morgan Stanley Dean Witter, September 26 th 1997

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Panic & Loss

• (Financial Distress) – Realisation of the silly valuation • Panic • Dramatic dumping • Halving in value in 8 weeks of peak and further halving by end of 2000 • Predicting the next bankrupt dot.com became a popular spectator sport

• Rolls-Royce, Maserati, 16 others seized in Dotcom raid

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Panic & Loss

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Learning from Experience

• Stock Valuation implications – Whole Internet sector tainted and “devalued” for a considerable long time – Equity markets generally similarly affected – A long time for markets to recover – We must recognise how asset values may be driven by emotion than cognition

Current IPO Market (April 2016)

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Today

• Current Examples?

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• Netscape was expected to price at $12-14 and instead priced above its range at $28 • LinkedIn was supposed to price at $32-35, instead priced above its range at $45

• Netscape was expected to price at $12-14 and instead priced above its range at $28 • LinkedIn was supposed to price at $32-35, instead priced above its range at $45 • Netscape ran to $75 on the first day (2.7x) and closed at $53, about a 2x • LinkedIn ran to $122.70 on its first day (2.7x) and closed at $94.

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• LinkedIn IPO Soars • Share Price

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LinkedIn Share Price

•

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LinkedIn Share Price

• •

• April 5 th 2016 • 115.31 • http://finance.yahoo. com/q?s=LNKD

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Web 2.0 Transactions

MySpace bought for $580m by Newscorp in 2005 YouTube bought for $1.65bn by Google Skype bought for $2.6b by eBay (2005) Microsoft bought for $8.5bn 2011 (eBay made 1.4bn on original investment) Bebo Bebo was acquired by AOL on March 13, 2008 for $850 million; In June 2010, sold to Criterion Capital Partners for an undisclosed sum which was reportedly under $10m Facebook May 18, 2012 IPO Twitter Nov 2013 IPO WhatsApp Oct 2014; $19 billion (bought by Tuesday, April 12, 2016 Facebook) 87

Facebook IPO

• Facebook, Inc. held its initial public offering (IPO) on May 18, 2012. • The IPO was one of the biggest in technology, and the biggest in Internet history, with a peak market capitalization of over $104 billion. Media pundits called it a "cultural touchstone.“ • The stock went on to lose over a quarter of its value in less than a month. • And ½ its value in less than 6 months • Video (TechCrunch Facebook) – (Zuckerberg on Mobile, min 24; Search min 25) – Share price

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There’s Facebook, then there’s everybody else

YouTube

• October 9, 2006 Google buys YouTube for $1.65 billion. • http://www.youtube.com/watch?v=QCVxQ_3Ejkg • http://www.youtube.com/watch?v=GLQDPH0ulCg

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Twitter IPO (Nov 2013)

• On the surface, the Twitter IPO was a success. • The company filed their IPO with an original range of $17-$20, then priced the initial public offering at $26. • Despite next-day headlines that Twitter appreciated 73%, the real story is that most investors have lost money buying Twitter stock.

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Twitter

Link

Chart

2014-2015

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TWTR

• Apr 5, 2016 • Current Price $17/Share

Bitcoin price in USD from begin 2013 to June 2014

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Google searches for ‘Bitcoin

Bitcoin

• https://www.coinbase.com/charts

• Current Price (April 1 2016: $416 )

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