Remembering a Year to Forget

The financial lessons from the year 1990 are all but forgotten. Today, the beginnings of the Nineties are a stark reminder that markets ebb and flow – and that the tide can actually recede.

Kevin Duffy

Deutsche Version

The last bear market is now ten years in the rearview mirror, which means investment professionals under the age of 30 have never experienced more than a mild correction. Prior to the 2008 meltdown, the 2000-2002 bursting of the technology bubble and the 1987 Crash satisfy the standard definition of a bear market in U.S. stocks, but 1990 gets overlooked for the pessimism generated, even though the S&P 500 fell less than 7%. For all but grizzled veterans, the lessons from that year are all but forgotten.

Kevin Duffy

Kevin Duffy is a battle-proven veteran in the risky business of short selling. He co-founded Bearing Asset Management in 2002. He and his partner were vocal critics of the 2007 credit bubble, successfully shorting many of its most aggressive players including Countrywide Financial and Bear Stearns. Prior to Bearing, Kevin co-founded Lighthouse Capital Management and served as Director of Research from 1988 to 1999. He chronicled the excesses of the Japan and technology bubbles of the late 1980s and the late 1990s. Kevin Duffy bought his first stock at the age of 13. He has a passion for Austrian economics and is the author of the popular Notable and Quotable blog.
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1990, for those with short memories, arrived before the Internet. Most of the information that paints a picture of that year is stored in microfilm in libraries and not available online or to algorithmic traders. In an age when quants increasingly dominate the investment landscape, this downturn might as well be dead and buried. With a bit of digging, however, a financial archeologist will discover that 1990 was a year of fear – in fact many fears.

The 1987 Crash was just three years away and still fresh on investors’ minds. The Resolution Trust Corporation (RTC) was in the middle of cleaning up a $160 billion mess caused by the failure of one-third of the nation’s savings and loans. The Japan bubble peaked a year earlier, but concerns about «America’s decline» and a lack of competitiveness had barely begun to fade. Would Japan’s unwind pull the rest of the world’s economies down with it?

Growth stocks, especially technology stocks, were abandoned. The takeover bubble peaked in 1989 when financing for the $6.75 billion United Airlines deal fell through. As the market for high yield bonds (a.k.a. «junk bonds») collapsed, chief financier Michael Milken was prosecuted by the feds and his firm Drexel Burnham put out of business. The so-called «Decade of Greed» seemed to be on trial, not Milken, yet he took the fall, fined $600 million and sentenced to ten years in jail and three years of community service.

Fears of the Japan Inc.

Heading into 1990, the greatest fear was Japan Inc. From politicians to management gurus, Japan’s brand of capitalism – cooperation between business and government – was deemed superior. America needed to emulate Japan, i.e. encourage more government intervention in the economy, or risk falling further behind.

October 29, 1990

October 29, 1990

«The United States,» Congresswoman Helen Bentley was quoted in a 1990 «Fortune» article as saying, «is rapidly becoming a colony of Japan.» Lester Thurow, MIT economist, «New York Times» columnist and frequent guest on business television, warned: «At the rate things are going, we are all going to wind up working for the Japanese.»

By the end of 1990, real estate prices in the Northeast and California were falling, big banks were bleeding red ink, and the U.S. was heading into recession while on the verge of the Gulf War. Brokerage firm profits reached a 16-year low (1974 being the worst bear market since the early 1930s).

Fears about debt, deficits, recession and even environmental Armageddon reflected the zeitgeist. Doomsayers were in vogue. One could peruse the business section of any bookstore (yes, they actually existed back then) and find titles such as Doug Casey’s «Crisis Investing: Opportunities and Profits in the Coming Great Depression» and Paul Erdman’s «What’s Next? How to Prepare Yourself for the Crash of ’89 and Profit in the 1990s». Ravi Batra’s «The Great Depression of 1990» was a long-running bestseller and staple of the doom-and-gloom crowd.

Amid all the negativity, even once-in-a-lifetime uplifting news – the fall of the Iron Curtain and the return of Eastern Europe to the free market – was seen in a glass-half-empty light, as more evidence that America’s glory days were behind it.

Dirt Cheap Tech Stocks

With American competitiveness in question, technology stocks were so cheap, some sold for little more than the cash on their balance sheets. The stocks of rapidly growing emerging tech leaders traded at prices a millennial portfolio manager can only dream of. The personal computing and networking industries were in their infancy.

Dell Computer, which went public in 1988, was growing sales at 36% and gross profit 45%, yet traded at just 11 times trailing earnings. Cisco Systems, which went public earlier that year, held a «formidable position» as «the clear leader of the $200 million to $400 million inter-networking market, according to market researchers,» reported «Investor’s Daily». For 1991, earnings were expected to grow 125% to 155% on a near-doubling of revenue. The stock traded at less than 19 times forward earnings and commanded a market cap of just $550 million (vs. today’s $239 billion).

Dell and Cisco would each go on to climb 100-fold from their public debuts in less than 8 years. According to a study of top-performing stocks from 1962-2014 by Chris Mayer in «100-Baggers», just eleven stocks accomplished this feat over a 52-year period. These huge winners are now obvious in hindsight, but at the time investors overlooked them as they were barraged with headlines like «Should You Work For the Japanese?» («Fortune») and «Where Are Computer Makers Thriving? Hint: It Starts With a ‹J›» («Business Week»).

How far removed is the financial world today from those dark days in 1990? A decade of zero interest rate policy has not only turned all traffic lights green, but many income statements red. Profitability and growth have become mutually exclusive terms. Apple sports a 25% operating margin, but revenues are declining as it surrenders market share in a saturated and competitive smartphone market. Meanwhile, newly public companies like Uber and Slack Technologies are growing revenues north of 40% while losses are counted in the billions.

There simply is no fear. U.S. equity fund managers hold record low cash levels and retail investors treat index funds like piggy banks. Favored strategies include buy-and-hold, buy the dip, and reach for yield.

According to Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management,

The U.S. today is about 55% of the global market cap, and its share of the global economy is 25%. The last time such a large gap existed was in the late 1980s, when the Japanese market was 45% of the global market cap and Japan's economy was about 15% of the world total.

Can a major top in U.S. equities be far off?

The year 1990 is a reminder that markets ebb and flow, and that the tide can actually recede. When the narrative becomes one-sided and the crowd convicted, don’t be surprised to see the opposite happen. As pioneer of modern contrarian theory Humphrey Neill said, «The public is often right during the trends, but wrong at both ends.»

With the unprecedented buildup of debt, Baby Boomers nearing retirement, and valuations at all-time highs this cycle, the next bear market could make 1990 look like a walk in the park.

Market Ebbs and Flows

Low 1990 High 2000 Low 2009 High 2019
Economic bogeyman Japan China
Financial disaster Money center banks Investment banks
Budget surplus / GDP -3.9% 1.4% -6.4% -4.7%
Public debt / GDP 56% 58% 77% 105%
Median Baby Boomer age 33 43 52 62
Equity fund cash 12.9% (Oct) 4.0% (Mar) 5.9% (Feb) 3.1% (May)
High yield bonds, yield 21% 10% 21% 6%
10-Year T-note, yield 8% 6% 3% 2%
Wilshire 5000 / GDP 50% 137% 57% 144%
Number of IPOs per week 1 9 0 6
% of IPOs with negative earnings 15% 80% 29% 80%