Tài chính doanh nghiệp - Lecture 23: Stock market booms and crashes

Lecture 23: Stock Market Booms and CrashesBrief History of Booms and CrashesFor hundreds of years, speculative markets have undergone dramatic ups and downs, that appear irrational to many observersTulipmania, 1630s, HollandMississippi Scheme, 1720, France, John Law’s Mississippi Company had monopoly of trading for province of Louisiana. South Sea Bubble 1720, England, South Sea Company had British monopoly on trade in South SeasUp-CrashesPopular view that markets rise slowly and crash suddenly is overblownJanuary 3, 2001, Nasdaq went up 14% in one day, following rate cutOctober 6, 1931, Dow went up 14.87% following President Hoover’s plan for economic recoveryBiggest 1-day crash October 19, 1987 Dow fell 22.6%, much larger than largest upcrash, but also twice as big as next largest downcrashMackay vs. GarberDavid Mackay, Extraordinary Popular Delusions and the Madness of Crowds, 1841, popularized these stories of bubblesPeter Garber, Famous First Bubbles, 2000, said Mackay’s bubble stories were not inconsistent with perfect investor rationalityEfficient Markets HypothesisStock market level is always unforecastable, not inconsistent with crashesVolatility may be forecastable, and in that sense crashes may be forecastableEfficient markets hypothesis denies the Mackay theory that something fundamentally irrational is going on in booms and crashesFundamental disagreement in the finance profession about how to model marketsIrrational ExuberanceThe Stock Market in Historical PerspectivePart 1: Structural FactorsPart 2: Cultural FactorsPart 3: Psychological FactorsPart 4: Attempts to Rationalize ExuberancePart 5: Tension between Efficient Markets Theory and Financial InnovationThe Next Few DecadesThe Stock Market in Historical PerspectiveS&P500 Jan 1871-Feb 2004S&P 500 Price/(10-Year Earnings)Jan 1881-Feb 2004Nikkei Index, Jan 1984-Feb 2004Germany Dax Nov. 1990 – Nov. 2003UK FTSE 100 April 1984-Nov. 2003France CAC 40March 1990- Nov. 2003P/E Predicts 10-Year ReturnsOne-Year Confidence, USAValuation Confidence, USAFaith in the Stock Market“The stock market is the best investment for long-term holders, who can just buy and hold through the ups and downs of the market.” 1996 1999 2000 2001-2 2002 2003 1. Strongly agree 69% 76% 63% 60% 46% 39% 2. Agree somewhat 25% 20% 34% 31% 40% 44% 3. Neutral 2% 2% 2% 3% 5% 8% 4. Disagree somewhat 2% 1% 1% 5% 8% 5% 5. Strongly disagree 1% 1% 0% 1% 2% 5% (Individual investors)Historical Intervals between Normal Years (Excluding War, Recession)1. 1871-18912. 1891-19133. 1913-19284. 1928-19505. 1950-19646. 1964-19727. 1972-19798. 1979-19889. 1988-1996Earnings, Productivity & ValuePart 1: Structural FactorsPrecipitating Factors: the Internet, the Baby Boom, and other eventsAmplification Mechanisms: Naturally Occurring Ponzi SchemesPrecipitating FactorsThe World Wide WebTriumphalismCulture Favoring Business SuccessRepublican Congress & Capital Gains TaxesBaby BoomMedia ExpansionOptimistic Analysts401(k) PlansRise of Mutual FundsDecline of InflationExpanding Volume of TradeRise of Gambling OpportunitiesVariations in Factors Since March 2000WWW: Dot-com bust weakened faith. Productivity numbers for 1990s revised down, strong productivity growth since thenTriumphalism: China 9% growth in 2003Republican Congress: Republican James Jeffords defection to Independent May 2001, Democratic Senate 51-49, back to Republican senate 51-48 Nov. 2002Optimistic Analysts: All major Wall Street firms have announced new guidelines, HSBC abolishes “hold” recommendation, “equal” buy and sell. Post-Enron reforms may reduce incentives for optimistic bias.Mutual funds: net new flow into stock mutual funds was $32 billion in 2001, compared to $309 billion in 2000, then back up to $69 billion in year ending February 2004 (all in first two months of 2004).Amplification MechanismsPrice-to-pricePrice-to-gdp-to-pricePrice-to-earnings-to-priceNaturally Occurring Ponzi SchemeAmplification Through ExpectationsPaineWebber/Gallup Poll: Expect 15.0% return on stock market over next 12 months in 1999.My polls of individual investors: Expect 4.6% increase in Dow over next twelve months in 1999.Part 2: Cultural FactorsThe News MediaNew Era Economic ThinkingNew Eras and Bubbles around the WorldLargest Recent One-Year Real Stock Price ChangesPhilippines 683.4% Dec. 1985-Dec. 1986Taiwan 400.1% Oct. 1986-Oct. 1987Venezuela 384.6% Jan. 1990-Jan.1991Peru 360.9% Aug. 1992-Aug. 1993Colombia 271.3% Jan 1991-Jan. 1992Jamaica 224.5% Apr. 1992-Apr. 1993Chile 199.8% Jan. 1979-Jan. 1980Italy 166.4% May 1985-May 1986Part 3: Psychological FactorsPsychological Anchors for the MarketHerd Behavior and EpidemicsProminent Psychological TheoriesAnchors: Kahneman & Tversky Wheel of Fortune experimentOverconfidence Attention AnomaliesPart 4: Attempts to Rationalize ExuberanceEfficient Markets, Random Walks, and BubblesInvestors’ Learning — and UnlearningPrice and Dividend Present ValueIrving Fisher 1929“It was only as the public came to realize, largely through the writing of Edgar Lawrence Smith, that stocks were to be preferred to bonds during a period of dollar depreciation, that the bull market began in good earnest to cause a proper valuation of common shares.”The Crash of 1929Complete absence of newsSmoot-Hawley Tariff not newsSequence of events led to bottom 1932The Crash of 1987Lawrence Harris, “The October 1987 S&P Stock Futures BasisFutures price too low to be explained by nontrading lags in indexQuestionnaire Survey Oct 1987Average time individuals heard of the crash, 1:56pm EDT (10:56am PDT) October 19, 1987Average individual spoke to 7.4 other individuals about stock market that day81.6% of individuals heard about the crash before 5pm Ranking of Importance of News StoriesThe 200-point drop of the Dow that morning 5.14 (on 1-7 scale)Drop in Dow October 14-16 4.54Treasury bond yields hit 10.5% 4.27Trade deficit figures 4.21Chemical bank raises prime rate 4.14Baker suggesting dollar should fall 4.04Psychology or Fundamentals?Which of the following better describes your theory about the declines: a theory about investor psychology or a theory about fundamentals such as profits or dividendsPsychology 67.5% individuals, 64.0% institutional1987: Investors Thought They Knew What Will Happen“Did you think at any point on October 19, 1987 that you had a pretty good idea when a rebound was to occur?” -Individuals 29.2% yes, Institutions 28.0% yesIf Yes, why? -gut feeling, intuition, market psychology, common sense, story telling The Nikkei Crash after 1989Nikkei peaked last day of 1989, nearly 40,000Has remained below half that sinceHigh expectations for Japanese economy in 1980sBubble Economics, Yukio Noguchi 1992Many reasons for slow growth in Japanese economy since then, but tend to be related to bubble situation in 1980sNikkei 1989 a model for Dow 2000?Samuelson’s DictumMarket Efficiency Theory Has Some MeritSamuelson’s Dictum: Some evidence of micro efficiency and macro inefficiencyPresent Value of Dividend Changes Plotted Against D/P RatioPart 5: Tension Between Efficient Markets Theory and Behavioral FinanceAggregate markets are not very efficientInvestors make many systematic mistakesAnd yet, financial markets matter very much for economic successAll successful economies have sophisticated financial institutionsConcluding ThoughtsThe Next Few DecadesThe most exciting prospect: the developing world catches upFinancial Markets will be everywhere, dominating people’s livesFinancial booms and crashes will be even bigger than beforeWorse things have happened in history!Dramatic Change in Finance, our EconomyExperience of last century suggests dramatic changes in the nextInformation technology unleashes a cascade of other changes in the economyOther technology transforms the world economy, creating opportunities and challengesRisk and Chance over CareersCentury-long personal outlookReflections on upheavals in last centuryStock market risk is compounded by individual career riskIllusion of invulnerabilityEcclesiastes IX 11 “I returned and saw under the sun that the race is not to the swift, nor the battle to the strong, neither yet bread to the wise, nor yet riches to men of understanding, nor yet favour to men of skill; but time and chance happeneth to them all.”Career RisksJoshua Angrist, Analysis of draft lottery, 1969. Low RSN lowered income decade later by 15%Over half of the cross-individual variance in incomes cannot be explained either by age, schooling, experience, parents income, parents occupation, or transitory component [Bowles et al. JEL Dec. 2001]A Risky WorldMedia focus on successLonger-run perspective: people in positions come and go by chanceCareers and economic success “come together” by the strangest coincidencesHuman Capital, Positioning, and MeaningMaintain an orientation towards history in the making, rather than to one’s own point in the life cycleMaintain human capital, strategically orientedMaintain humanity in an unforgiving business worldDon’t Sell your Textbook