A long shadow hung over this week’s meeting of the US Federal Reserve (Fed). In September 1998, the US central bank made another important interest rate decision, also 16 years into a long bull market. It turned out to be more consequential than investors could have foreseen at the time, inadvertently kicking off one of the stock market’s most dramatic melt-ups.
Once in a generation or so, investors take leave of their senses. They are gripped by a mania. Greed overwhelms fear until the music stops and those emotions are dramatically reversed. For anyone who lives through such a period, this shapes their attitude to investing and, in extreme cases, such as the Great Depression, their entire world view.
My formative period in the markets was the dot.com bubble and bust in the years either side of the millennium. Early in my investing career, I witnessed behavioural excesses in both directions. They made me hyper-sensitive to signs of both irrational exuberance and extreme pessimism - and to the impact of central bank decisions on investor sentiment.
My apprenticeship was enhanced by the fact that I worked at the time with Jim Slater, a financier who bore the scars of a previous moment of madness in the early 1970s. Two generations ago, he briefly towered over the City of London before becoming a self-confessed ‘minus millionaire.’
He failed to read the runes first time round. But by the late 1990s he was better prepared. He rode the latter stages of the bubble but was wise enough to know when to stop. I remember a lunch in late 1999 when he told me he was no longer interested in publishing our investment newsletter: ‘there’s nothing left to buy’, he said.
My experience 25 years ago creates a risk - that, at the slightest whiff of over-optimism in the markets, I declare that this is 1999 all over again. So, if you’ve heard this one before, I apologise - but only a bit. History may not repeat itself, but it will rhyme.
In September 1998, the Fed cut interest rates despite the fact that US unemployment was low, at 4.5 per cent, and in the face of worries about rising inflation. It cut further in October and November before changing tack in 1999 as the US economy strengthened and the stock market soared on a wave of feverish speculation in internet-related shares.
The cuts were made in response to an unfolding emerging market currency crisis and the collapse of a giant hedge fund, Long Term Capital Management. Alan Greenspan, the chairman of the Fed at the time, justified the pre-emptive policy shift by saying: “It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress.”
Greenspan was widely praised for his actions at the time. Dubbed ‘the maestro’, he was credited with averting a financial calamity. An alternative reading of events is that he over-reacted to a run of the mill bout of market turbulence, poured fuel on an already smouldering investment fire, and set in motion an 18-month market melt-up that ended badly in March 2000, as the dot.com bubble imploded.
It doesn’t take a huge leap of imagination to see parallels between 1998 and now. The currency crisis and collapse of Long-Term Capital Management had triggered a rapid 15 per cent market correction after three years of strongly rising stock markets. The correction was similar to the market turbulence that accompanied the introduction of tariffs in April this year. The recovery in markets then was fuelled by investors rapidly buying into a ‘new paradigm’ market narrative - for the internet then, we can read AI and crypto today. The Fed cut rates when economic fundamentals pointed the other way.
Something else significant happened beneath the surface of markets in 1998 and 1999 that has worrying echoes today. Then, as now, there was a shift from a broad-based market rally based on sensible valuation measures to a speculative market in which the most volatile shares, often of unprofitable companies, led the charge. The Magnificent Seven-led bull market in 2023 and 2024 was, like its 1995-1998 predecessor, justified by superior earnings growth. Valuations, while high, were never excessive. Today’s market feels less moored, more akin to the early stages of the late 1990s euphoria.
A simple way of measuring the change in market sentiment that occurred in April this year is to compare the performance of three exchange traded funds - one tracking the market as a whole, one the most volatile shares in the market and one the most defensive.
If you had invested $100 in the S&P 500 in the week after Donald Trump unveiled his tariffs, you would have around $130 today. That’s a remarkable return in just five months. What’s more interesting, however, is that the same $100 in the Invesco S&P 500 High Beta ETF (the most volatile shares in the index) would be worth $160, while in the Invesco S&P 500 Low Volatility ETF (the defensive shares) it would have grown to just $107.
Delve deeper into the individual stocks capturing speculative investors’ attention and the point is made even more forcefully. $100 invested in April in Coinbase, a crypto exchange, is worth $215 today. The same amount in Roblox, a huge but unprofitable gaming platform, has risen to $270. Shares in Robinhood, an investing platform popular with day traders, have more than trebled in value since the spring.
I think we are in the early days of the final, frothy stage of a bull market which has been running for 16 years, not far short of the 18-year bull that ended in 2000. Which begs the question: how to invest at this most exciting but dangerous part of the cycle? It is a question I will return to shortly.
