CHAPTER 7
The Nasdaq Bubble Bursts in 2000

AN HISTORIC YEAR

The preceding chapter discussed how 1999 experienced a rising inflation threat from rising oil and industrial material prices. This pushed interest rates higher, which began to have a negative impact on those sectors of the stock market that tend to be “early peakers.” Interest rate-sensitive stocks are an example. Old economy stocks, which are sensitive to interest rate direction, had already started to weaken (which was reflected mainly in a falling NYSE Advance-Decline line). By contrast, new economy stocks shrugged off the threat of rising rates during the second half of 1999. Something happened at the start of year 2000, however, as a direct result of the dangerous intermarket trends that existed the previous year. The Fed had started raising short-term interest rates during the middle of 1999. By the first quarter of 2000, this tightening by the Fed had led to a condition known as an inverted yield curve.

INVERTED YIELD CURVE IMPLIES ECONOMIC WEAKNESS

An inverted yield curve, like the one that occurred near the start of 2000, is the graphical depiction of short-term interest rates that have risen above long-term rates. This usually occurs after a round of Fed tightening and, in the past, has been an early warning of economic weakness. The recessions of 1990, 1982, 1980, 1974, and 1970 were all preceded by inverted yield curves. In a normal yield curve, long-term rates are higher than short-term rates. When ...

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