The 4 Biggest Bubbles in Market History

November 16, 2021

There are times when the stock market seems perennially on the upswing. Investors are exuberant, businesses are growing, and times are good…at least until the market crashes.

Yup, we’re talking about market bubbles. And while they’re no one’s favorite topic, there are important lessons to be learned from market bubbles.

Here’s a look at the four biggest stock market bubbles in history and what you can learn from the mistakes of yesterday.

The Dutch Tulip Bubble

Perhaps one of the most famous asset bubbles of all time was tulip mania, a.k.a. the Dutch tulip market bubble and crash.

It was Holland in the early to mid-1600s, the latter half of the Dutch Golden Age. And unlike many market bubbles on this list, the center of the bubble was not money or real estate, but flowers. Tulips, to be exact. At the height of the bubble, the rarest tulip bulbs traded for as much as six times the average person’s salary, or about 10,000 guilders. For context, that’s roughly the cost of a mansion on the Amsterdam Grand Canal.

Why all the fuss over flowers?

Initially, tulips were status items purchased for two reasons: they were expensive and the sign of a properly affluent garden. Yet tulips were considered notoriously fragile, scarcely able to stay alive without skilled cultivation.

Then, in 1634, tulip mania swept through Holland. It got so extreme that people began using margin derivative contracts to buy more tulips than they could afford, assuming they would be able to repay their debts upon selling the bulbs for a profit. But then confidence crumbled, and in February 1637, prices plummeted. And because no one stopped to think that they were staking their fortune on a piece of greenery without intrinsic value, many dealers became impoverished overnight.

The South Sea Bubble

Another famous historical bubble is the South Sea Bubble of 1720, and this one presents even more valuable lessons for modern investors, as its causes were more complex than tulip mania.

Our story begins with the South Sea Company, founded in 1711 and promised an incredible boon by the British monarchy: a monopoly on all trade with Spanish colonies in South America. The company itself was devised in order to convert £10 million of government war debt into its own shares, and in exchange, the South Sea Company would receive government interest payments and, of course, the trade monopoly.

At the time, investors saw the success of the East India Company and anticipated another runaway success in the South Sea Company. They snapped up shares as soon as they were within reach (helped by tall tales of astonishing South Sea riches told by company directors).

It paid off for the company temporarily—their share prices surged more than eightfold. But by September 1720, the market collapsed, spiraling the British economy into a severe downturn.

The Roaring Twenties

In case you haven’t noticed a trend yet, stock market bubbles have a clear pattern: investor optimism, skyrocketing asset prices, and an inevitable crash. The Roaring Twenties is practically a textbook example of the stages of a market bubble in action.

The 1920s were heralded as a new era in economic fundamentals. From 1922 right up until the crash, the stock market value rose 219%. Investing in the stock market became the national pastime. Proponents pointed to a number of new policy changes, like the Federal Reserve and the Coolidge administration.

Then came Black Thursday, October 24, 1929, better known as the first day of the worst market crash in U.S. history.

In reality, the bubble was the result of the wildfire use of leverage (debt) by individuals and corporations. For those who didn’t have cash up front, they could borrow from their stockbroker “on the margin”, meaning they only had to put down 10% to 20% up front. Some banks even invested their depositors’ savings without telling them. Then it all started falling apart, and banks couldn’t even give depositors their own money.

The U.S. Housing Bubble

Sound like a familiar story? It should—it’s the basic story that drove the U.S. housing market bubble in the late 2000s, the key driving force behind the Great Recession of 2008, and the single largest economic downturn since the Great Depression.

House prices increased at a record pace from 1996 to 2006, yet the housing market soared. This was not because the average American earned more money, but because financial institutions relaxed many of their standards on who could qualify to borrow and offered subprime mortgages to borrowers with poor or nonexistent credit (in essence writing loans regardless of the ability to repay) saddling millions of Americans with homes they could never hope to afford. Worse, banks would quickly securitize the loan and pass the risk to someone else.

But eventually, homeowners started to default. Then mortgage-backed securities crumbled, and financial institutions started to fold. And when the bubble burst, homeowners lost more than $7 trillion of their housing wealth.

Learning from the Biggest Stock Market Bubbles

So, what can the biggest stock market bubbles in history teach investors today?

First, investor exuberance can lead to catastrophic consequences, especially if you don’t do your research or consider the full implications of what you’re investing in.

Second, pay careful attention to market indicators. Even if everyone is exuberant, careful investigation will often reveal irrationality. Look for those red flags.

Third, never invest everything in one area. If you put all your eggs in one basket and the basket drops (or rather, if you bet on the market one way and the market crumbles) your whole portfolio is at risk. Instead, mitigate risk by betting that the market could crumble either way, and spread your investments so that you have insulation regardless of which way the market folds.

Invest to Protect Your Financial Future

If you take nothing else away from the biggest stock market bubbles in history, remember this: you should always have strategies for insulation from utter financial disaster just in case the stock market were to crumble.

That’s where we can help. We’re on a mission to make blue-chip art investing accessible to ordinary investors so that you can insulate your portfolio against market volatility. So if you’re ready to learn more, fill out your membership application today.

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