Introduction

In the first part of this series we looked at factors that could contribute to a market bubble on Wall Street – if there is really one, of course. Keep in mind that about 3 out of 4 Americans believe, nay, truly know that the end of the Great Bull Market still lies many years and many thousands of Dow points into the future. The majority of market gurus regularly tell them so, which means it is true.

In the second part we explored certain features that could be used to distinguish when a roaring bull market transforms into a market bubble. While a roaring bull market brings increasing and lasting prosperity to practically all who participate in that market, a market bubble develops the seeds of its own destruction and eventually it brings loss of wealth and in many cases poverty to all.

Where a bull market brings riches to those who were in the market early enough and then stayed in for the ride – finally being lucky enough to select and stick to the 'right' stocks that keep on rising when the rest of the market is already falling – the eventual collapse of a market bubble cuts a wider swath to affect nearly everyone in the economy in a very real and very negative sense. Few prosper when the bubble is pricked.

The four features that can be used to distinguish a bubble, as mentioned in Part 2, are:

• A severe reduction in the share risk premium. When earnings income on investments become negligible to the extent that these bear no meaningful relationship to income derived from alternative forms of investment, the equity market is moving ahead too steeply and too far for its health. The situation clearly approaches bubble status when capital gains appear to be the 'only' or primary criterion for portfolio selection by the traditional investor.
  
  
• In a sound growing economy, most companies benefit from the increased spending that marks the growth in GDP. When the market begins to exhibit signs of a split personality, with market leaders streaking ahead to ever higher prices, while most other companies experience a decline in investor demand, then the greater the degree of the split in its personality, the more the market assumes the character of a bubble.
  
  
• As the average time that a position is held before being closed again shortens, the trend shows a change from an investor mentality to a trader mentality, a transformation that increasingly implies the existence of a bubble.
  
  
• The greater the degree that investment or rather, speculation, is funded by means of debt, the greater the degree to which the market approaches the concept of a bubble.
  
  

From the discussion in Part 2 it might be that the US equity market is no longer merely the strong bull market that began as long ago as 1982, roaring ahead until it picked up even greater speed in 1994 and again in 1998. Some preliminary examples to illustrate the change in these characteristics were mentioned in Part 2, but are too selective to prove the existence of a market bubble. Here, in Part 3 we explore what evidence there is to support a contention that a bubble has really formed.

The current high PE ratio

During 1999 the PE ratio on the S&P500 index settled above 30 – the highest it has been since WWII. Previous peaks were generally at about 23, briefly reached before the PE declined again. This happened in 1946, in 1961 and again in 1987. During the long sideways to bear market of 1966-1982 the PE ratio declined to a low of about 7 on three occasions, before rising steeply to reach a value of 23 in September 1987. After October 87 the PE again fell steeply to reach a value of about 13 in 1988.

In 1992 the PE briefly broke above 25 before returning to the long term average of about 17. Then the Great New Bull market took off in 1994 and the S&P500 PE ratio rocketed to new highs.

A very high PE is not of itself a terrible thing. It is a sign of high expectations for sustained strong growth in the economy, and thus in company earnings as well. High PE's are the natural result of an extended period of strong and sustained economic growth – people are willing to pay more than what traditional measures see as prudent for stocks since the earnings growth is high. Quite soon, the actual earnings reports justify the previously high prices and the investors laugh all the way to the bank, while there erstwhile critics have to eat crow.

Two unfortunate consequences of high PE's in association with high economic growth is that after a few years of this condition, the market come to believe that this situation is the norm; that there is a new paradigm out there that negates all the old rules about how an economy behaves and how companies ought to be valued for investment purposes.

It is not the high PE that is the problem, but the perceptions that evolve in the market – the belief that the fairy tale will last forever – and the problems that arise once earnings begin to level off.

The PE ratio on the S&P500 was at an historical high at the end of the second quarter of 1999. This ratio is based on past earnings, which means that if earnings continue the recent trend by rising steeply, then the high PE ratios would be justified in the not too distant future.

The key question of course is whether this situation is sustainable. Can earnings really continue to increase at a steep rate, quarter by quarter and year by year to keep on justifying the very high PE ratio? Or will a time come when investors perceive that earnings are no longer increasing and then do the wise thing by keeping stock prices relatively stable in order to adjust the PE ratio downward as earnings begin to level off?

Continually rising earnings is a beautiful ideal, but the rate of increase over the past few years has been nothing short of phenomenal and is unlikely to be sustained for many more years. Which means that the continued health of the market will come to depend on the wisdom and insight of investors who realise well ahead of the time that there is no sense in pushing prices higher as they are already becoming ever more difficult to justify in the face of a slowing rate of increase for company earnings.

Once it is anticipated, 6 months, one year or even two years in advance, that earnings are going to level off, investors have to keep prices steady while company earnings complete the final spurt, so that the high PE ratios automatically adjusts to more comfortable levels.

To illustrate: for the PE ratio on the S&P500 to reduce from its recent >30 to a more respectable <20, the S&P500 has to remain steady while company earnings enjoy a final 50% increase from current high levels before they level off to remain there and to form a high plateau.

Of course, a third alternative is that investors who observe the 50% increase in earnings assume that the trend is going to continue. As a result, they eagerly bid prices higher by 50% in the belief that such action is justified by historical precedent. Which means the PE ratio remains at very high levels, above 30, until it becomes quite clear to all observers of the market that earnings really have reached a plateau and is no longer increasing.

At which time everyone tries to take advantage of the now ridiculous PE ratio by locking in profit before the market adjusts to the changed situation. With plenty of sellers and few remaining buyers when this happens, the results are predictable.

To repeat, in the form of 2 scenarios:

Scenario 1: Justification for a very high PE ratio, in anticipation of a sustained increase in earnings, rests on the assumption that the market is truly rational and that investors have very good foresight of how earnings will behave in future. As soon as they perceive that during the next year or two company earnings will enjoy the final 50% spurt, they refuse to bid prices higher and the PE ratio gradually declines to below 20 as earnings level off. The market is stable and prices and earnings remain in equilibrium for some period of time.

Scenario 2: Investors continue to bid prices higher to maintain the PE ratio on historical earnings at above 30, "knowing" that the trend in earnings is here to stay. Suddenly, when it becomes evident that earnings are no longer increasing at all, there is a rapid and quite severe adjustment in the S&P500, to the tune of more than 30%, to bring the PE ratio to its longer term average.

I leave it to readers to judge for themselves which of the two scenarios is the more accurate description of the way the market behaves. Note, though, that while this reasoning raises concerns about how the current situation will end, it does not attempt to predict when this will happen.

When is a bull market no longer a bull market?

To some readers this question may appear deceptive, as there could be two possible answers; either, "When the bull market ends and becomes a bear market", or, alternatively, "When the bull market has transformed itself into a bubble". Either the bull becomes a bear, or it becomes a raving beast intent on devouring itself.

Strangely enough, there are occasions when both these answers are true; and when that happens, the outlook for the market is as bleak as what it can get.

Using the Advance-Decline line as a measure of market health, as discussed in Part 2, the 1929 presumed bull market was in a bear trend for more than a year before the Dow Jones eventually topped out into the Crash that reverberated around the world. Yet all agree that October 1929 was the culmination of a market bubble that roared ahead despite the fact that prices of the majority of stocks on the NYSE had been declining for more than a year.

It would appear from this that there are times when a market experiences both the Hug of the Bear and the Frizziness of the Bubble at the same time. It is a clear indication firstly that the market has become completely irrational and secondly, a warning that reality is calmly waiting in the wings for the right moment to make itself supreme again.

Irrational, because of a split personality. Schizophrenia, to put it mildly. More than 70% of stocks on the NYSE below their 200 day moving averages, which in traditional technical terms mean that better than two-thirds of the market is in bear mode. Much the same applies to Nasdaq. The Advance-Decline line of the NYSE in an almost consistent decline since April 1998, which therefore should be seen as the start of a bear market on the NYSE.

(Chart used with permission: http://stockcharts.com)

Yet, all of 20 months later the major indices – Dow Jones, S&P500 and Nasdaq – closed the year of 1999 at all-time highs, to inform investors that going into 2000 the 17 year old bull market (?) is still very much intact.

From this is clear that the premise that a strong and sound economy should be reflected in a broad advance of the whole stock market is either incorrect or Wall Street is no longer in a proper bull market. If it is wrong to assume that a sound and strong economy and a rising stock market go hand in hand, Wall Street has entered what can only be described as a bubble phase some time ago.

Volatility in the retention period of shares

Investors are known to buy and then hold shares for a matter of years, not for mere weeks or days. While no figures are at hand, there have been indications on the 'Net that the 'float' – the quantity of shares readily available for trading, excluding those tightly held by immediate owners of the company – of even major 'hot' companies, such as E-Bay and Amazon, turned changed ownership in a matter of a few weeks, on average.

This trend of high turnover in popular stocks – and thus decreasing the time that a position in these companies are held before being closed again – is supported by the TRIN indicator The Trin indicator is a ratio that is calculated as follows:

(Number of stocks increasing in price / Number over stocks with falling prices) divided by (Turnover volume op 'up' stocks / Turnover volume of 'down' stocks)

Lets us explore this indicator a little closer. If the number of 'up' stocks (winners) is equal to the number of 'down' stocks (losers) then the first part of the equation is = 1. Similarly if the number of shares traded in the winners is equal to the number of shares traded in the losers, then the second portion of the equation is also =1. Which means the Trin is then also = 1.

The reader is welcome to experiment with various combinations of loser/winner ratios and 'up'- volume to 'down'-volume, but the fact of the matter is that the Trin indicator tended to remain within a band bounded by values of 0.85 and 1.15 with relatively few and isolated exceptions. This implies that the ratio of winners/losers and of 'up'-volume to 'down'-volume tended to remain much the same over a long period of time.

When winners stand to losers in a ratio of say 15-10, then the ratio of 'up'-volume to 'down' volume does not vary too far from the same 15-10 ratio. Similarly, when losers outpace winners 2-1, then the turnover of the winners also tends to be about twice as high as the turnover in the losers.

It is striking that the Trin of the period 1997-1999 shows only two occasion where the indicator rose above 1.15, to show a an oversold condition. Both happened during substantial sell-offs on Wall Street, in October 1997 and again in September 1998. On both occasions the trin was correct in signaling an oversold condition, as the market soon recovered from the sell-off and continued higher. Yet, there have been at least about 20 occasions when the Trin fell below 0.85 to indicate that Wall Street is overbought.

Then, in early to mid December 1999, the Trin for the first time reaches a value of 0.7, well below the previous lows and also substantially lower than the lower boundary of the typical range. At that time, the ratio of winners to losers was about 1200 to 1800. This gives a value of 1.5 for the first portion of the Trin calculation. For the final value to be 0.7, the turnover in the 1200 rising stocks has to be twice that of the 1800 stocks with declining prices. On average, therefore, the turnover in a 'popular' stock was three times that of a company that found itself in disfavour.

This, coupled to the fact that the Wall Street was in a bull trend over much of this period, shows that buyers were eagerly pursuing the 'hot' stocks of the day, driving prices and indices higher, while sellers of out-of favour second and third rank companies battled to find buyers and had to accept lower prices to close their positions.

In effect, the ratio of 1800 losers to 1200 winners in combination with a rising Dow Jones and S&P500 says it all: investors are disregarding and discarding the majority of stocks in order to aggressively pursue those that show strength. And this is taking place at a time when the economy is growing strongly, perhaps even starting to overheat.

Surely this is illogical – unless the growth in the economy is so lopsided that only parts of it are showing significant growth while the majority of the economy is in a decline. Since statistics do not support the latter view, the answer has to be that the market has become illogical. If not completely irrational. Why should an investor pursue a holding a company that is already at a 50 or 70 PE at the expense of making an investment in a company that is or also should be enjoying the fruits of a strong economy, but has a PE of only 20 or 25. Or perhaps 15?

Can it be because even at a PE of 15 these companies only provide a annual return of 7%. By "investing" in the S&P500 once could have made 20% during 1999; the Dow Jones delivered 25% while the Nasdaq Composite added 84% - surely investing in the leading companies in these indices makes much more sense that trying to pick a possible winner among the multitude of the non-performers Why give up an almost certain return of 20%, 25% or an oh so nice 84% to take a chance on one of the also ran listings on the NYSE that may earnings growth of say 20% or more, but then perhaps suffers a capital loss of as much as what it had earned?

Out of this reasoning follows the fact that well known and easily identified market leaders are being pursued strongly while the majority of stocks languish in the doldrums with prices in a sustained slide due to lack of interest In turn, this state of the market is evidence that decisions are being based more and more on short term capital gains, rather that medium to longer term value considerations.

In Part 2 this kind of situation where losers are scavenged to fuel the advance of the market leaders was discussed in support the view that investors are changing character to become traders – a characteristic that points towards a market bubble. At the same time, such apparent scavenging of losers to support winners offers indirect evidence that the amount of funds available for investment on Wall Street, even through the use of heavy gearing, is running up against a ceiling all the time. People seem to be finding it more difficult to justify or perhaps even to obtain new debt in order to keep on spending and to increase their exposure to the market. Some additional evidence to support this conjecture follows below.

Using expensive margin debt to fund purchases of stocks

A rising incidence of margin debt has two implications:

Traders have exhausted other forms of (cheaper) debt to be used for speculative positions on Wall Street. True investors are excluded from this statement; under most market conditions investors generally consider it far too risky to gear up on their investment positions. The premise of a debt ceiling is supported by the scavenging of losers, mentioned just above. The only easily available source of funds therefore is to use margin debt to fund new trading positions.

Secondly, for this practice to become more popular and widespread, traders/investors must have an ingrained optimism that the bull market is to continue long enough for them to show a substantial profit, despite the higher cost of their new positions in the market. These positions are most likely to be very speculative, with a short time horizon; it seems quite unlikely that anyone will borrow expensive funds to invest with a 3-5 year time horizon. Volatility over the near tem and uncertainty about the longer term is just too high to justify a commitment to geared investments for this length of time.

(Chart courtesy of www.yardeni.com)

Two aspects of this chart are of interest. The first is that in 3rd quarter 1987 the chart must have appeared much as it does now – with a spike rising steeply well beyond any previous high in the amount of margin debt. Starting in 1983, margin debt had risen an estimated 5 times higher than ever before; surely this must have been one contributing factor to events on 19th October when the Dow Jones fell by more than 25% in one day.

The second aspect is the very steep rise from about 1997, unbroken except during the brief 20% decline in the Dow in 1998. This period coincides with an already high personal debt to disposable income ratio, as shown in Part 1. Which implies people were even then turning more to expensive and risky forms of debt to fuel their speculative activities on Wall Street. Observe too that the steep increase settled into a top that now seems to have stabilised (at the end of September 1999), again at a time when Wall Street had hesitated in its upward trend. Yet perhaps also a sign that people are beginning to avoid further debt?

The reader could argue that the actual amount of margin debt is of little real significance. From the charts shown in Part 1 it is evident that total disposable income in the US has increased markedly and consistently over recent years. With more money in their pockets, American households can afford a much greater amount of margin debt in their pursuit of the maximum profit to be made on the equity markets.

(Chart courtesy of www.yardeni.com)

Perhaps at first glance a valid argument, but we have seen in Part 1 that the ratio of total personal debt to disposable income is at an all time high. Personal debt has been increasing at a much steeper rate than that of disposable income and, as the chart below shows, so has margin debt.

As a percentage of disposable income, margin debt is about 2.5 times higher than practically ever before, with only the 3rd quarter of 1987 creeping briefly to just above the 1% level.

Increased use of margin debt can be construed as, firstly, reduced ability of the trader to make other kinds of less costly loans to finance activities on Wall Street and, secondly as evidence of an increase in speculative purchases that will not be held for any significant length of time.

For these reasons, the sustained and steep rise in margin debt, in absolute and relative terms, are also seen as evidence for the presence of a Market Bubble on Wall Street, and of course even more so on Nasdaq.

Summary

Personal debt as a fraction of disposable income is at an all-time high. This does not imply that debt can not be increased further, but if the people behave as in the past, a peak in the ratio will be followed by a period during which debt remains fairly static. The increase in income then gradually reduces the pain of servicing a large amount of debt.

When this happens and the amount of debt remains fairly static, the recent sustained and quite steep increase in consumption expenditure, which must have been at least partly fueled by new debt, has to slow down. This undoubtedly will have a negative effect on the growth of company earnings.

Of course, this is not to say that the change will come this month or next. If optimism abounds, the American people may well feel that they can tolerate much more debt than what they now have to service.. Yet the trend cannot continue indefinitely. Sooner or later it has to stop. The "sooner" may well come into play if interest rates continue to increase over the near term.

Since the high PE ratio is defended on the grounds of continued high earnings growth, a slow down in the creation of new consumer debt and consequent reduction in earnings growth – or even in absolute earnings – may well make this claim ludicrous.

It was mentioned above that if investors are really rational, they would possible anticipate a slow down in earnings growth and act in time by keeping prices stable. Yet if the event happens before they had done so, there should be a mad scramble as investors try to lock in profit before the market goes into a correction. Human nature being what it is, the chances of rational behaviour in this market bubble are somewhat remote.

There is also strong evidence that the market has become the haven of traders; true investors, who rely on traditional valuations of stocks before they buy, have either taken profit to move to the sidelines – often regretting they have done so prematurely, but perhaps too scared to get back in – or they are anxiously watching the market to try and get out at the real top. And, of course, many investors are trapped in the majority of stocks that are under-performing the market by a wide margin and they too are looking for an opportunity to get out before the roof caves in.

It is said that the Internet is changing the whole traditional paradigm. Two comments will suffice. The first is that good profitability for the dot.coms will in most cases require a market share of perhaps as much as 30%, since margins are generally small. With 10 or 15 corporations competing in the same market it is of course impossible that they can all end up with 25% or 30 of that market. There will in due course be a sifting out of winners and losers – a process that will cost many optimistic investors a lot of money.

Secondly, it can be said that a dollar spent on the internet is a dollar not spent in the bricks and mortar shops along Main Street, to their loss. A dollar spent on the internet does not add to GDP and broad economic growth if it deprives someone else of income. A dollar spent on the internet adding to the earnings of a dot.com reduces the earnings reported by another corporation.

Over the longer term the ability of corporations to report sustained growth in earning depend on an increase in the total disposable income of all Americans. Now, if the dot.coms employed thousands and millions of people previously unemployed or attract millions of new employees by offering substantially higher salaries, then they would add substantial growth to income and to GDP. And perhaps then the high PE ratios on the S&P500 would be justified.

Unfortunately this is not the case. Dot.coms as a rule employ a minimal number of people given their vast market capitalisation. For example, it might not be too inaccurate to say that General Motors, with a market cap that is dwarfed by that of the dot.coms probably employ more people and create more true wealth than the lot of recent internet start-ups put together. A GM that is mostly out of favour with investors add more to disposable income and GDP – and indirectly to company earnings, the fuel behind the high PE ratio – than perhaps all of the internet.

Yes, American internet giants could attract income from foreign countries and can be expected to do so; thus avoiding the dilemma of riding on the impoverishment of other corporations as the internet e-trade blooms. The question then arises of how much could be extracted from foreign countries before their authorities either clamp down on the free outflow of funds or before they have their own internet sites that offer alternative choices. Or both.

The problem is that as of now it seems that in principle the internet will add relatively little new "wealth" to the economy, creating jobs and goods of substance. It will simply offer an alternative means of acquiring what the consumer needs and perhaps trigger some additional purchases that would otherwise not have been made, such as someone who never buys books placing an order at Amazon.com. However, given an already a low savings rate and near full employment, the fact remains that a dollar spent on the 'Net is a dollar not spent elsewhere; the overall net gain to the US economy and total company earnings from purchases made on the web is really very little. Neither the GDP nor total disposable income rises steeply as a consequence of the expansion e-trade on the internet, largely at the expense of more conventional retailers.

Therefore, in the end, the high valuations of the dot.coms will be found to have only increased the extent and duration of the market bubble and thus contributed to the magnitude of the collapse.

From the evidence presented here, it therefore seems certain that Wall Street is in a Market Bubble and has been so probably for the past two years at least. The question now is not so much when the Bubble will be pricked, but what will happen when it does.

What will happen then?

In effect this question really means, "How far will the Dow fall?". The nature of the answer will in effect determine how much remains of America's financial health. Perhaps the best place to look for the answer is in the PE ratio.

Over the longer term, under relatively stable economic conditions, which implies quite small variation in company earnings, the PE ratio tends to move between about 12 and about 16, or even 11 to 15. This implies that if the current steep rise in earnings should end, with earnings leveling off at current quite high levels, the PE ratio should return to that range. Let us use a value of 15, not to be too bloody in the calculations below.

Let us use A as the current value of the Dow Jones and B for the amount of earnings in the Dow stocks. Let the current PE ratio on the Dow be 30, about the same as the S&P500 and less than the PE of 40+ on the S&P400. So we currently have earnings/Dow value as B/A = 30, with the high PE justified by rapid growth in Y.

If earnings, in the form of B, no longer increases, but remain relatively constant, the PE on the Dow should return to its average value of 15. To do so the Dow Jones has to decline to a value A1, so that B/A1 = 15. With B assumed to be constant, it is easy to calculate that A1 = 0.5 x A, the original value of the Dow Jones.

For the PE to return to its average value if and when earnings level off, the Dow has to decline by half. It closed 1999 at almost 11500, which means that if earnings no longer improve, the Dow Jones has to return to a value below 6000 points. This would take it back to second half of 1996, just before Greenspan uttered his famous "irrational exuberance" phrase.

Such a large decline would not take place without some severe effects on investors. Practically all margin positions would have to be liquidated quite early on, or be made fully paid up – which is unlikely, as speculative traders seldom sit on losing positions that cost money all the time. That action alone would dump about 14 days of trading turnover on the market in a relatively short period of time, when demand might already be slackening. Under those conditions, the decline may then become a little disorderly.

But once the decline is well under way, another problem will arise. It has been mentioned on the web that as much as 40% if not more of American households have 50% or more of their financial assets in the form of investments on Wall Street. If one assumes that this statistic applies to the better off part of the US population and thus excludes the large working class that have seen minimal increases in their wages over the past few years, then a significant portion of total American private wealth lies invested on Wall Street.

Let the Dow halve and most well-off to comfortable American households find that their wealth has decreased by 25% – a more than just significant setback if one has borrowed heavily, using available assets as collateral. It seems likely that a good many of these households will suddenly find a messenger from the bank at their door, asking (demanding?) for some loans to be repaid as these are no longer adequately secured.

Under such circumstances, spending on luxuries and non-essentials have to be reduced. There are for some time no new TV's or computers or new entertainment centers or new cars. The boat might be sold and the move to the new – and suddenly quite expensive – house would be with the old furniture. There are no funds to outfit the house with brand new stuff. The contract to build an additional room onto the house is cancelled and so is the vacation in Aspen.

With decisions like these being made in almost half of America's households, companies suddenly find that their earnings retreat from the almost stellar levels they were anticipating and almost got to enjoy to the more mundane levels they were accustomed to before 1994. That would imply that earnings are reduced from B, the current level, by about half.

When that happens, with the Dow still at A1, the PE again rises to 30: we had B/A1 = 15, but if B is halved to B1, then B1/A1 is again equal to 30.

Which means that to maintain the PE ratio at its average of about 15, A1 must now decline by 50% to a value A2, so that B2/A2 = 15. With the 1999 closing value of 11500 points as the value of A, A2 would be about a quarter of that, or less than 3000 points. That would take the Dow back to what it used to be in 1991.

We saw that the first halving of the Dow reduced the wealth of almost half of US households by 25%, since more than half the wealth was invested on Wall Street. If the Dow returns to pre-1992 levels, then all of these households that had minimal or no investment in equities after the reaction to the panic in 1987, will find themselves poorer by as much as 50%.

All of the paper profits that made them appear so wealthy in 1999 would end up as mere paper, with no profit and in many cases even no investment left to contemplate.

Of course, if this should come to pass, company earnings will plummet even further as everyone is spending on nothing else except essentials. Layoffs will begin to rise and the total disposable income will reverse its steep trend of recent years to level off at best or even begin to decline. And if that should happen, it takes us back to Part 1 and the steeply rising ratio of debt to disposable income, which can now be expected to continue its increase.

For during this whole process very little if any personal debt would have been retired.

Also during this process other world markets would not remain on the sideline as mere spectators, but would become active participants by following the example set by Wall Street and even to improve on that performance by falling steeper and farther.

Conclusion

Not a pretty picture at all. Perhaps too simple in its explanation, as there are many other factors that could impinge on the process, perhaps to prevent it, to slow it down or even to reverse it once it has started. The exact degree of the effect of a slow-down in earnings growth is difficult to anticipate, because so many other factors would intrude. Yet the kind of the reaction cannot be too much different from what is described here – the situation has developed to such an extreme that the latitude of possible action has become very tightly constrained.

Once the point is reached where earnings level off, the process will almost be like a formal dance – step 2 follows naturally on step 1, and in turn is followed by the correct step 3.

Of course, if earnings across the board keep on growing at a steep rate to justify the high PE ratio, the whole of the above is just a piece of horror fiction, a nightmare. We'll wake up tomorrow, very relieved because what is described here will never happen.

Looking at that possibility just may warrant another part to this series, but that is not certain yet.

PS: It was brought to my attention that the fourth paragraph from the end in Part 2 contains a typo that is confusing: The word "now" that appears in the original should have been "no", as below:

"If no more funds can flow into the market and the losers have reached a level where the prices no longer have any downside potential, the mechanisms that feed the bubble have dried up. Then it is merely a matter of time before even a minor nudge causes the whole edifice to collapse upon itself."

Even worse, I made a total mess of the examples at the end of Part 2. Zero's were dropped off from some amount – a $200 should be $2000 and some $2000's should be $20 000. Hope I did not confuse readers too much. As I received only a few e-mails to inform me of my blunders, I also hope readers of Part 2 managed to hold out to the end so that they could become confused!

Best wishes to all readers for a peaceful and prosperous year 2000.

Part 1

Part 2

© 2000 Daan Joubert
All rights reserved
e-mail: daanj@mweb.co.za