A speculative bubble is a period when stock prices rise to unsustainable levels, driven primarily by investor optimism. In retrospect, the late 1990s was one such period. Some experts also point to the late 1920s, just before the 1929 crash, and the years 1970 to 1972 and 1982 to 1987 as earlier examples.
When the bubble bursts, investors sell and prices drop dramatically. Stocks sometimes lose 50% or more of their value, and those that are hardest hit may remain depressed for years. Some never recover, and either go out of business or are absorbed by stronger companies. But past evidence demonstrates that stock prices overall eventually readjust to levels that are more in line with their actual value — and more in line with historical norms.
While a downward spiral that follows a period of euphoria may be unsettling, it may actually reward the patient, long-term investor who takes advantage of this opportunity to purchase high quality, undervalued stocks at discounted prices.
Tulip mania
The tulip bulb mania in 17th-century Holland is a particularly colorful example of a speculative bubble. The flowers — newly imported from Turkey — became an instant hit, and many people abandoned their customary livelihoods to cultivate tulips, which traded on exchanges at ever blossoming prices — one rare specimen sold for the equivalent of $150,000 by some accounts. When the craze wilted and prices plunged, many families were left penniless.
When the bubble bursts, investors sell and prices drop dramatically. Stocks sometimes lose 50% or more of their value, and those that are hardest hit may remain depressed for years. Some never recover, and either go out of business or are absorbed by stronger companies. But past evidence demonstrates that stock prices overall eventually readjust to levels that are more in line with their actual value — and more in line with historical norms.