Boom, bust and correlations

Every now and then a new concept or a new invention causes hype among people, and market participants.

In the 1990’s the Internet was introduced to Wall Street. The stock market climbed higher year after year,  and market participants felt invincible and gifted with God-like investing skills as equity prices increased almost fivefold in the mid-2000. The annualized returns between 1990 and 1995 was ~11% with the market capitalization doubling in that period. This was followed by annual returns of ~20% between 1995 and 2000 and a tripling of market capitalization. Rapid increase in stock prices and a subsequent dramatic decline in the beginning of the 2000’s were the hallmark of the bubble. With stocks rallying like this, one should question the legitimacy of the market price of a given share to its intrinsic value but who am I to judge? “In the business world, the rearview mirror is always clearer than the windshield”.

Initial public offerings flooded the market back then. In 1999 alone; more than 450 companies went public with more than 25% of those companies doubling their prices on the first day of trading. To embody the scale of the bubble and the speculative behavior in the markets allow me to add a paragraph from one of my favorite books: “The Intelligent Investor” by Benjamin Graham with commentary by Jason Zweig

“In late 1998, (an) analyst… jacked up his “price target” on from $150 to 400$ in one fell swoop. shot up 19% that day-and despite (the analyst’s) protest that his price target was a one-year forecast it soared past $400 in just three weeks. A year later, another analyst predicted that Qualcomm stock would hit $1000 a share over the next 12 months, the stock already up 1842% that year-soared another 31% that day hitting $659 a share.”

“In 2000 and 2001, and Qualcomm lost a cumulative total of 85.8% and 71.3% of their value, respectively.”

With the market priced for more than perfection, market values of companies began tumbling, as they are failing to generate profits. The bubble started bursting, dragging the whole market down with it.

A new craze emerges: Cryptocurrencies

Although the first blockchain was created by Satoshi Nakamoto in 2008 after the financial crisis, Bitcoin wasn’t as famous as it is today. In 2017 alone the price of a single Bitcoin shot from $1000 to almost $20000, going from $15.4 billion in market cap to $321 billion by the time it peaked.

The blockchain is a masterpiece and it is already changing some industries. It is also a catastrophe, because it will encourage speculative behavior among buyers of ICO’s or other cryptocurrencies that already exist.

With eye popping returns in the cryptocurrencies, it shadows pretty much any return one could achieve. In this short period of time, initial coin offering (ICO’s) are becoming more common and investors are there pumping money into them. A recent research was conducted by the Wall Street Journal, found that 271 ICO’s out of 1450, raised “red flags that include plagiarized investor documents, promises of guaranteed returns and missing or fake executive teams”. Of course the hype managed to reach Wall Street too. A biotech company called Biopix Inc., changed its name to Riot blockchain on October the 4th of 2017 and saw its share price shooting higher from $8 a share to almost $40 a share in a matter of two months. Do you wonder what happened to that company? Take a look at the chart below.


What happens next in the Crypto market or in Wall Street is unknown. The most interesting question is how much of a correlation there is between those two markets? How imploding or rising prices in one market might affect the other? On January 26th of this year the major U.S indexes start tumbling, before that on December 17th the price of the Bitcoin started tumbling from $19715 until it reached bottom on February 6th. Other cryptocurrencies like Bitcoin Cash, EOS, Litecoin, Cardano, Stellar, IOTA, Tron and more hit their bottom two days before the sell off in major indexes on Wall Street ended on February 8th. Ether, on the other hand hit its all-time high on January 15th of this year and also reached its bottom on February 6th. Ether showed some signs of life but then again it continued to go down and now it is selling at the price of $548. Of course, one cannot depend on these one-time results to indicate that there is a correlation or that the cryptocurrencies might be the new gauge of fear/greed on Wall Street. Yet it is an interesting question we should ask ourselves, how much those two markets are correlated?