The introduction of railways, cars or the internet to the general public marked a breakthrough in the economy. It now seems that the next such technology will not be cryptocurrencies, but artificial intelligence. However, the investments associated with it could lead to a speculative bubble. It is therefore worth taking a look at how revolutions in the financial markets have historically played out and how this relates to today's reality.
History of the 20th century car boom
In 1886, Carl Benz of Germany developed the first three-wheeled car powered by an internal combustion engine. At the same time, Gottlieb Daimler, Benz's competitor, also developed an internal combustion powered vehicle. The invention of the automobile marked the beginning of the rapid growth of the automotive industry. From 1900 to 1919, the number of motor vehicle companies grew from 100 to almost 2,000. The actual automotive boom, however, came in 1908, when Henry Ford introduced the mass production of the Model T. The revolution here was not only the mere existence of the car, but also the standardisation of belt production, which significantly reduced its costs through economies of scale.
Throughout this time, competitors were trying to catch up with Ford's assembly line advances by producing quality cars, while smaller companies were losing ground.It was hard to identify a winner in this technological race. And despite a product that was super-modern for the time, the number of American car companies had fallen to 98 by 1929. And by the 1930s, the number had fallen even further - to 44. Nevertheless, the number of cars produced was growing rapidly. It turned out that more efficient use of mass production and adaptation to the prevailing economic conditions displaced competition and gave rise to the so-called Big Three. At the time, a potential investment in GM, the leader in this big three, would prove to be a tough test for investors as the stock market crashed in 1929, known as 'Black Friday'.
Source: https://www.darrinqualman.com/global-automobile-production/
In August 1929, the average price-to-earnings (P/E) ratio on the New York Stock Exchange was 23 In just two months, it fell below 15 as a result of the sharp collapse in share prices. Investing before the collapse in GM shares would have only come out at zero after more than 15 years. This example shows that investing in even very fast-growing and promising companies, when buying them relatively expensively, may not necessarily prove profitable in the long term.
The DOT.COM bubble, or the story of the "new economy"
A similar situation occurred quite recently, when companies in the internet sector were booming. The ensuing crisis led to the collapse of the Nasdaq index, which rose five times in five years, peaking at 5048.62 points on 10 March 2000. 4 October 2002. However, it fell to 1139.90 points, a depreciation of 76 per cent. By the end of 2001, most internet companies had gone bankrupt, and share prices even at established tech giants such as Cisco, Intel and Oracle had fallen by more than 80 per cent. It took 15 years for the Nasdaq index to regain its peak, which finally happened in 2015.
Source: Tradingview
The so-called dotcom bubble was the result of a combination of speculative fashion-based investments and an abundance of funding from equity investors for start-ups, and the inability of dotcom companies to make a profit. Investors, particularly venture capital funds, poured money into internet start-ups in the 1990s, hoping that they would one day become profitable, regardless of the price they paid for the investment. At that time, terms such as 'new economics' began to emerge, which assumed that the previous approach to valuing businesses on the basis of the profits they generated was 'outdated'. The value of a company began to be determined, among other things, by the number of hits on the company's websites. Meanwhile, as Charlie Munger aptly points out, "We spend a lot of energy creating a new way of thinking, forgetting that the old one is good enough". The average price-to-earnings (P/E) ratio rose to 175 in March 2000. This means that an investment in the average company would take 175 years to pay off. Currently, the value of this ratio is around 20. As a result, even if we had invested in winning technology companies in 2000, we would have had to wait more than a decade to make a profit.
„Keep your eyes on the price”
It turns out that almost every time historically there has been a technology that has revolutionised reality, it has been over-invested in. Companies, aiming to be cutting-edge, spend huge amounts of money, regardless of the price they pay and the possibility of generating profits in the future. For this reason, we can increasingly hear from CEOs the phrase 'artificial intelligence' as a strategic expense for companies. It can also be expected that companies and projects based on this technology will start to emerge en masse. At this early stage, however, it seems impossible to pinpoint which ones will turn out to be the biggest winners. Sticking to the motto preached by Aswath Damodaran, one of New York University's top business valuation specialists: "Keep your eyes on the price", we can avoid mistakes. History shows that thinking that does not take price into account has always led to speculative bubbles that burst sooner or later.
Grzegorz Dróżdż, CAI, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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