There have always been speculative bubbles
— periods when stock prices have risen to unsustainable levels
on investor optimism. The late 90s was one such period, as were
the bull markets of 1970 to 1972 and 1982 to 1987.
Usually, a period of very high stock prices
is followed by a period of depressed prices. Stocks become under valued — or fall lower in price than a company's prospects
would seem to warrant — when investors overreact to negative
news, such as a company profit warning, rising interest rates,
or political or economic upheaval at home or abroad.
Historical evidence demonstrates that stock
prices eventually readjust to levels that are more in line with
their actual value — and more in line with historical norms.
While the ups and downs can be unsettling, they may actually reward
the patient, long-term investor who takes advantage of the opportunity
to purchase high-quality, undervalued stocks at discounted prices.
Tulip Bulb Mania
Speculative bubbles have recurred throughout
history. Tulip Bulb Mania in 17th-century Holland is a particularly
colorful example. The flowers — newly imported from Turkey
— became an instant hit, and many people abandoned their
families and livelihoods to get in on the craze and cultivate
tulips in hundreds of different sizes, shapes, and colors. Tulip
bulbs traded on exchanges at ever blossoming prices — one
rare specimen sold for the equivalent of $150,000 by some accounts
— as people staked everything they owned to invest in the
bulbs. When the craze wound down and prices plunged, many families
were left penniless. Today a bag of tulip bulbs costs around $3.00.
Jeremy Siegel, The Wharton School 