Talking the Walk With Burton Malkiel

In the new edition, I devote an entire new chapter to the Internet bubble, which has been undoubtedly the biggest bubble in market history. The speculative run-up in "New Economy" stocks pushed the market to extraordinary levels, which inflated expectations of market returns. By 2000, investors said they expected an annual rate of return of 15% to 25%.

The speculative mania also led many investors to sell out of their diversified broad-based portfolio and pour their money into tech stocks. The Internet was the latest new technology that promised to transform the economy, just as the railroads or the automobile had before. But the lesson we relearned is that transforming technologies often prove unprofitable for investors.

During the 1850s, railroad stocks increased to outrageous levels; in the collapse of 1857, many railroad companies went bankrupt. The same thing held for the auto industry, which went from 100 companies in the early days to three. The same thing has transpired with the Internet companies. Once the bubble burst, many companies vanished, and even the surviving "New Economy" stocks lost most of their value. All in all, more than $7 trillion of market value evaporated.

If the Internet mania marked the biggest speculative bubble in history, why hasn't the economic aftermath been the most devastating -- apart from the $7 trillion in market value erased? Is it early yet?

Professor Malkiel: No, it isn't early. There has been significant effect on the real economy. Business investment, especially for high-tech products, has fallen sharply, and the current sluggishness of the recovery is traceable in part from the over-investment during the bubble period.

How Even the Leading New Economy Stocks Ruined Investors
Stock	High 2000	Low 2001-2002	Percentage Decline
Amazon.com	75.25	5.51	98.7%
Cisco Systems	82	9.42	88.5
Corning	113.33	1.30	98.9
JDS Uniphase	297.34	1.64	99.4
Lucent Technologies	74.93	0.71	99.1
Nortel Networks	143.62	0.45	99.7
Priceline.com	165	1.37	99.2
Yahoo.com	238	8.45	96.4
Source: A Random Walk Down Wall Street, Eighth Edition

What made matters less painful this time is that our policy markers know a lot more about the way economies work than they did in the 1930s. [Federal Reserve Chairman] Alan Greenspan has aggressively lowered interest rates.

You note in the newest edition that the Internet mania seems at odds with the notion that the market is rational and efficient. How can a rational market spawn such a bubble?

Professor Malkiel: The market is usually rational, but it is made up of irrational participants who occasionally create anomalies.

Did the market go through a period of irrationality in 1998 and 1999? Yes, it did. The important thing we learn from the Internet bubble is that the market, as it has in every previous case of excessive speculation, corrects itself.