7 famous market bubbles

The investment bubbles in this article should act as a warning to investors that if something looks too good to be true, then it probably is.A bubble is an economic cycle where the price of assets rises very quickly, and then collapses dramatically. Bitcoin, for example, has seen tremendous highs and lows. To avoid investing in bursting bubbles, we take a pragmatic approach, diversifying and creating portfolios designed to rise with the market but also to be resilient if the market falls.

1. Tulip mania

The tulip mania is recognised as the world’s first investment bubble. It began in 1634, when speculators in the Dutch Republic began frantically buying up tulip bulbs. The tulip was prized because it was different from other flowers in Europe at that time, due to its vivid petal colours. Their bulbs were considered a status symbol and the most desirable varieties saw their value surge.

The craze for tulips grew until at its height each bulb cost more than the year’s salary of a skilled worker or a townhouse in Amsterdam. By 1637, things reached a head when even the cheapest bulbs reached absurd prices. Demand collapsed soon after and values nosedived. Contracts for tulip bulbs were no longer honoured, and the trade of tulips ground to a halt. Investors lost huge sums. The tulip mania is a valuable lesson in investors losing rational expectations, and a warning to investors who may be tempted to get caught up in the latest craze.

2. South Sea bubble

The South Sea Company was formed in 1711 to supply slaves to Spanish America. In 1720, the South Sea Company underwrote a large proportion of the UK government’s debt to the tune of £9.5 million – equal to £1.6 billion today – and was granted an exclusive charter to trade in the south seas. The South Sea Company was willing to provide such a huge guarantee because it believed this would be the start of valuable trading with South America and massive profits from slave trading, which ultimately never came.

The South Sea Company spread extravagant rumours of the value of its new trading rights. Shares in the Company quickly rose tenfold and it issued more and more to meet the insatiable demand. The South Sea Company issued shares for many ventures all offering riches, including the ludicrously described venture ‘for carrying on an undertaking of great advantage but no-one to know what it is’.

Speculators paid inflated prices for the stock, leading eventually to the company’s spectacular financial collapse in 1720. The South Sea Company’s executives were arrested, members of the government saw their personal fortunes evaporate and the collapse was followed by suicides.

3. Railway mania

The Railway Mania was a stock market bubble in the UK rail industry in the 1840s. At that time the UK was in the midst of a speculative frenzy as new railways were built. The British government stoked the demand for railway company shares by cutting interest rates and passing hundreds of Acts of Parliament in 1846 setting up a multitude of railway companies. As the price of railway shares increased, speculators invested more money, which further increased the price of railway shares.

The bubble burst in 1846 after an increase in interest rates and the share prices slowed then began to fall as enthusiasm for investment dried up. In the end only a third of the proposed railways were built and many investors lost out. Many of the railway companies collapsed under the weight of bad management, were taken over by competitors before they could build their line, or turned out to be engaged in fraud.

4. The roaring twenties

The raging US stock market of the late 1920s was hailed by many as evidence of a new era of economic fundamentals. Despite the inherent risk of speculation and growing bubble, it was widely believed the stock market would continue to rise forever. The creation of the United States Federal Reserve, the extension of free trade and anti-inflation measures were some of the reasons considered to be behind the rapid expansion. In reality, the real driving factor was the increasing use of debt by individuals and companies.

After a number of economic warning signs and stock market sell offs in the Spring, the Wall Street bubble began bursting in earnest in September 1929 and exploded on 24th October 1929, which became known as ‘Black Thursday’, the day of the largest sell-off of shares in United States history.

Reasons for the crash included overinflated share prices, growing bank loans, agricultural overproduction, panic selling, stocks purchased on margin, higher interest rates, and a negative media industry. The collapse is now called the Great Crash or the Crash of '29, and ushered in The Great Depression of the 1930s.

5. Japan’s real estate bubble

The Japanese asset price bubble occurred in Japan from 1986 to 1991. A surge in the value of the yen triggered a Japanese recession in 1986 and Japan introduced a programme of monetary and fiscal stimulus. This worked so well that it led to unbridled speculation. Asset prices rose quickly and economic activity overheated, as the money supply and credit expansion grew uncontrollably amid overconfidence and speculation. Japanese stocks and urban land values tripled.

At the peak of the real estate bubble in 1989, the value of the Imperial Palace grounds in Tokyo was greater than that of all the real estate in California. But by August 1990, Japan’s main Nikkei stock index had collapsed to half its peak, as the Bank of Japan frantically scrambled to tighten monetary policy. The bubble fully burst in 1991, leading to the years of price deflation and a stagnant economy known as Japan’s Lost Decade.

6. The dot com bubble

During the second half of the 1990s internet stocks began to rise rapidly in price. Speculative investors jumped on the new technology trend, against a backdrop of generous venture capital funding for startups, even while many internet companies were not profitable. Caution was thrown to the wind among many investors and venture capitalists, who had a fear of missing out on the growing adoption of the internet.

Reflecting this fervour, often driven more by advertising than any evidence of revenue, profits, or even a finished product from many of these new dotcom companies, the technology-focused index the NASDAQ rose from 743 points at the beginning of 1995 to a height of 5,048 in March 2000, more than doubling in the final six months.

When the dotcom bubble finally burst in 2002, the NASDAQ saw 78% of its value wiped away and most shares in internet companies saw their values plummet. Some companies that had previously been valued at hundreds of million of dollars had their worth marked down to zero virtually overnight. The value of the tech-heavy S&P 500 was nearly halved and the shockwaves were felt around the world.

7. The US housing bubble

The 2000s United States housing bubble was a sharp increase and then collapse in residential real estate asset prices, which hit over half of the US states. Some experts believe the dotcom crash led to the 2008 financial crisis because investors switched their money from technology to real estate, believing it was safer.

US house prices nearly doubled between 1996 and 2006 but two-thirds of the increase happened after 2002. Even as prices were increasing there were ominous signs, such as rampant mortgage fraud and houses being acquired by subprime borrowers. Housing prices peaked in early 2006, then started to decline into 2007, amid increased foreclosures that led to a full blown crisis in August 2008. This spread from the real estate sector to the wider debt, financial, banking and insurance markets. The average US house had lost a third of its value by 2009.

The bursting of the US housing bubble contributed significantly to the 2007–2008 global financial crisis, which triggered a severe economic recession, with millions of people losing their jobs and homes and many businesses going bankrupt, leading to the biggest global contraction since the 1930s.