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Investment Commentary: Lessons from the Tulip Bubble to Modern Market Dynamics

By Robert F. Taylor, CFA

The Tulip Bubble of the 17th century remains one of the most iconic and captivating episodes in economic history. It took place in the Netherlands, primarily in the early 1630s, and involved the speculation and subsequent collapse of tulip bulb prices.

Tulips gained immense popularity in the Netherlands during the Dutch Golden Age. Their vivid colors and unique shapes made them highly desirable among the affluent Dutch merchants and traders and as demand surged, so did the prices of these exotic flowers. At the height of the frenzy, a single tulip bulb could fetch the equivalent of several months’ salary for a skilled laborer.

The market dynamics were characterized by a classic case of “irrational exuberance,” with buyers purchasing bulbs not for their intrinsic value, but solely based on the expectation that prices would continue to rise indefinitely. As more and more people joined the craze, the fear of missing out intensified, driving prices even higher. This phenomenon is a prime example of herd mentality. Eventually the bubble burst, leading to a dramatic collapse in prices.Tulip Mania - Amsterdam Tulip Museum Price Graph

Source: Amsterdam Tulip Museum

Lessons from the Tulip Bubble continue to echo through time, finding resonance in the modern financial landscape. Pundits have drawn parallels to recent market dynamics, particularly within the tech sector. The following chart illustrates how the substantial gains of The Magnificent 7 (Microsoft, Apple, Alphabet, Amazon, Nvidia, and Tesla resemble the bubble patterns seen in previous decades, both in terms of their magnitude and duration.  However, we believe that in general, current prices reflect these companies’ fundamental value, rather than being rooted in speculation.

Source: Alpine Macro

While the Magnificent 7 price trends (light green above, second from right) layered with the Tulip chart might suggest that these stocks are exhibiting bubble-like characteristics, the majority of the group’s performance since 2019 has been driven by improving fundamentals rather than speculative valuation expansion. Since December 2019, the Magnificent 7 stocks have collectively achieved a 28% annualized return, of which approximately 27 percentage points (21 points of sales growth and 6 points of margin expansion) can be attributed to earnings growth. In contrast, only 1 percentage point of the return is derived from multiple expansion. Comparatively, earnings contributed just 13 percentage points to the S&P 500’s 17% annualized return over the same period. Simply put, the Magnificent 7 have collectively outgrown the rest of the index in recent years.

According to current bottom-up consensus estimates, the seven companies are expected to grow sales at a 12% compound annual growth rate (CAGR) through 2026. In contrast, the remaining 493 companies in the S&P 500 index are projected to achieve a significantly lower CAGR of 3% over the same period.

However, the Dot-com Bubble is a reminder that forecasts are just that – projections, not fact.  In March 2000, Microsoft, Cisco, General Electric, Intel, and ExxonMobil held the top positions as the largest S&P 500 companies, comprising 18% of the index. Consensus forecasts at the time anticipated this group would achieve a 16% CAGR in sales over the subsequent two years. Instead, the group significantly underperformed, achieving only 8% growth. Over the following 24 months the group lagged the S&P 500 by 21 percentage points.

The Magnificent 7 stocks now collectively trade at a forward price-to-earnings (P/E) ratio of 30x, in contrast to the index’s 20x and the remaining 493 S&P 500 companies’ 18x. Although this P/E ratio is higher than the average of the past decade, the current 63% premium falls notably short of the peak premium of 103% observed in 2021. Furthermore, when compared to their counterparts during the peak of the Dot-com Bubble, the Magnificent 7 stocks carry substantially lower valuations.

The Tulip Bubble of the 17th century stands as a timeless reminder of the consequences of irrational exuberance and herd mentality in financial markets. Despite concerns of bubble-like characteristics, the recent performance of the Magnificent 7 stocks has been largely underpinned by improved fundamentals.  Whether that continues to be the case will likely be determined by the group’s future revenue and earnings trajectory relative to the other stocks in the index.

Shannon Dermody

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