by Archie M. Richards, Jr., CFP^®
April 14, 2003

Some say that the run-up in stock prices from 1996 to 2000 was a bubble, unsupported by fundamentals. Not me. I think the run-up stemmed from extraordinary technological developments that caused the growth of the Internet to exceed everyone's expectations.

The subsequent decline was also based on fundamentals. Its primary cause was the damage done to high-tech industries by the U.S. Federal Communications Commission. (See www.ArchieRichards.com for the column dated 3/3/03.)

The market most often cited as a bubble was the tulip trading in the Netherlands in 1637. Peter M. Garber's book, "Famous First Bubbles: the Fundamentals of Early Mania," explains that this wasn't a bubble after all. Here are the pertinent facts:

• Until 1634, most buyers of tulips were professional growers. But in 1634, wealthy Parisian women began pinning fresh tulips on their gowns, driving up demand significantly.

• When the seller of a tulip had the item in his possession, the Dutch courts at the time enforced the terms of the sale, meaning that if the price fell after a trade, the buyer had to pay the amount originally agreed to. But trading in tulips that had yet to be grown (futures contracts), was considered by the authorities to be immoral gambling. The courts generally didn't enforce such contracts. When the price of a tulip that was bought for future delivery subsequently fell, the authorities generally required that the buyer pay only one-tenth (or less) of the original price. This probably explains why authors who later described the so-called mania wrote that tulip prices fell almost immediately by 90 percent.

• In 1936 and 1937, the Netherlands was engaged in a war with Spain. At the same time, it was also ravaged by bubonic plague (the black death). In the three months from August to November 1636, Harlem, the center of tulip speculation, lost 14 percent of its population. Citizens were miserable and afraid. Much of the speculation in tulips took place in taverns. From November 1636 to February 1637, the height of the speculation, all tulip trades were futures trades. This was because specific varieties of bulbs couldn't be verified until the tulips flowered in June. The participants almost certainly knew that the contracts were unenforceable at full prices. As author Peter Garber puts it, the trading "was no more than a meaningless winter drinking game, played by a plague-ridden population that made use of the vibrant tulip market."

• Shortly after February 1637, Dutch authorities arranged for the publication of pamphlets that attacked the sort of trading they considered immoral. The pamphlets exaggerated the degree of speculation. All subsequent descriptions of the trading were based on those pamphlets and were exaggerated as well.

• In February 1637, the prices of very rare tulips reached about the level of an expensive home. But such prices are not unusual. Even in 1987, a small quantity of prototype lily bulbs sold for $480,000.

• An essential feature of a "bubble" is that prices fall sharply after the bubble breaks. But the prices of rare tulips, because of rapid propagation, normally fall rapidly. All available evidence shows that the prices after February 1637 declined at normal rates.

• A key feature of a "bubble" is that its bursting causes widespread economic distress. The Netherlands suffered no economic distress after February 1637. The nation's economy remained vibrant. In 1639, the Dutch even defeated a Spanish Armada as large as the one England defeated in 1588.

When so-called investment "experts" observe a rapid rise in prices followed by a decline, and they don't know the reasons for the rise or the fall, they often refer to the rise as a bubble, unsupported by fundamentals.

In my opinion, all market trends are supported by fundamentals. In 1637, no bubble occurred in Dutch tulip trading. In 2000, no bubble occurred in U.S. stock trading.

During the bear market we're now enduring, some companies have gone out of business, because of their own mismanagement or the damaging policies of the FCC. But for those companies that have survived, the stock prices reached at the peak three years ago we will undoubtedly see again.