Submitted by Brent Johnson of Santiago Capital.
Executive Summary
This report delves into the profound investment implications of innovation eras, specifically examining the 1920s and the 2000s.
These periods have significantly influenced economic growth, stock market behavior, and investment strategies. They demonstrate how genuine technological advancements can drive economic booms, yet also underscore the risks of speculative bubbles when investor expectations exceed realistic outcomes, leading to market volatility and economic challenges.
The 1920s marked a transformative era for the automobile industry, transitioning cars from luxury items to mass-market products. Henry Ford’s production innovations drastically reduced costs, making the Model T affordable for the average American family. The success of the Model T catalyzed economic growth in related sectors, including steel, rubber, and oil, due to the increased demand for raw materials. Major auto manufacturers like Ford, General Motors (GM), and Chrysler became industry titans. GM’s strategy of offering diverse models at different price points and Chrysler’s aggressive expansion through acquisitions and innovative engineering attracted significant investor interest.
However, the euphoria surrounding the auto industry led to speculative investments, not only in manufacturers but also in companies producing auto parts, tires, and infrastructure related to automobiles. Smaller, often financially unstable car manufacturers like Durant Motors and Marmon Motor Car Company attracted substantial investments, driven by the hope of finding the next big success. The practice of buying stocks on margin exacerbated the speculative bubble. This method allowed investors to purchase stocks with borrowed money, increasing both potential gains and risks. When stock prices declined, it triggered a wave of selling to cover margin calls, contributing to market instability.
By the late 1920s, production capacity outpaced consumer demand, leading to financial strain on smaller manufacturers. The realization that the extraordinary growth rates were unsustainable culminated in the stock market crash of 1929. The crash wiped out billions in wealth and precipitated the Great Depression, highlighting the fragile nature of speculative-driven markets.
The 2000s introduced the digital age, characterized by the proliferation of the internet, mobile technologies, and social media platforms. Companies like Nvidia, Apple, Google, Meta, Tesla, Microsoft, and Amazon, collectively known as the “Magnificent 7,” became central to market valuations. These companies drove significant technological innovation and societal disruption, leading to immense market concentration. At peak valuations, the three largest of these (Microsoft, Nvidia, and Apple) collectively represented around a third of US GDP, a concentration unparalleled since the 1920s.
Extreme valuations of today’s tech giants are driven by assumptions of continued exponential growth, invulnerability to competition, and resistance to future technological disruptions. These assumptions mirror the speculative optimism of the 1920s. The lessons from historical manias indicate that high
valuations based on overly optimistic projections often lead to speculative bubbles and market corrections.
Both the 1920s and the 2000s experienced rapid market adoption of new technologies, transforming daily life and driving economic growth. However, both periods also faced significant speculative excesses, leading to financial instability. Innovations in the 1920s, such as the automobile and household appliances, fundamentally changed how people lived and worked. Similarly, digital advancements in the 2000s, including smartphones and social media, redefined communication, media consumption, and social interactions.
The historical parallels between the 1920s and the 2000s provide valuable insights into the relationship between technological innovation and investor behavior. While technological advancements can drive substantial economic growth, they also tend to lead to speculative bubbles and financial instability.
These two eras also caused much bigger investor manias due to the multitude of simultaneous technological breakthroughs.
In isolation, each has had a profound impact on society and financial markets.
Collectively, even more so.
In both instances, the same common flawed thinking prevailed: There would be limited or no competition, the existing technology would not be surpassed, and estimations of future market saturation points were grossly exaggerated.
We know the 1920s ended very badly. Expectations of future investment returns were predicated on nonsensical forecasts, market share and no future disruption. While we don’t yet know the ending of our current boom, we believe it is helpful to understand the relationship between innovation and investment manias of the past
As new technological advancements continue to emerge, and tales of riches are presented, investors must remain vigilant about the risks that are sure to accompany these opportunities. The examples of past manias suggest the stretched valuations of tech giants today will eventually, and undoubtedly, also face challenges.
The report seeks to emphasize the dual nature of technological progress—driving economic growth while also posing risks of speculative bubbles. Investors should balance their enthusiasm for new technologies with realistic assessments of market dynamics and potential risks, drawing lessons from historical innovation eras to navigate the current landscape.
Background
Why are these two eras so important and unique in financial history? What makes them so distinctly different from other innovation manias?
How do technology revolutions lead to investment manias? Why do new inventions stir up animal spirits within investors? What makes them take leave of their senses, where genuine innovation breakthroughs lead them to suspend rational behavior?
These two eras are unique for the multitude of innovations that took place within them.
Most other innovation eras were centralized around a single innovation, whereas these two eras had many innovations colliding with each other all at once. As a result, these were turbo-charged.
Conversely, the Canal Mania of the early 19th century in Britain was driven by the enthusiasm for constructing canals to improve transportation and stimulate economic growth. The success of earlier canal projects, such as the Bridgewater Canal, fueled speculative investment in new canal schemes.
Promoters of canal projects issued shares and attracted significant investments, often based on exaggerated claims of profitability and future traffic. The bubble led to the construction of numerous canals, many of which were unprofitable due to overbuilding and competition. By the mid-1820s, the canal industry faced financial difficulties, and many investors suffered losses as canal stock prices fell and several projects failed.
The Railway Mania in Britain in the 1840s was one of the first major technology-driven investment bubbles. As railways began to revolutionize transportation, promising faster, more efficient movement of goods and people, investors poured money into railway companies. The promise of huge returns fueled speculative investments, driving up stock prices.
At its peak, Parliament authorized nearly 9,500 miles of railways – way beyond excess capacity. However, by 1846, the bubble burst, and investors lost fortunes as overvalued shares plummeted and numerous railway companies went bankrupt.
The introduction of steamships in the early 19th century transformed maritime transportation, leading to a surge in investment in steamship companies. The potential for faster and more efficient trans-oceanic travel attracted speculative investments in new steamship lines and related infrastructure. Companies were often promoted with grand claims about their capabilities and potential profits.
However, the overestimation of demand, competition, and technical difficulties led to a financial collapse in the steamship sector. Many companies failed, and stock prices plummeted, reflecting the overhyped expectations and eventual disillusionment with the steamship industry.
The development of the electric telegraph in the mid-19th century revolutionized communication by enabling near-instantaneous transmission of messages over long distances. The success of Samuel Morse’s telegraph system inspired a wave of investment in telegraph companies and related technologies.
Speculators were drawn to the rapid expansion of telegraph networks and the promise of lucrative returns from international communications. Companies such as the Atlantic Telegraph Company, which aimed to lay an undersea cable between Europe and North America, saw their stock prices soar. However, technical challenges and financial difficulties, including the failure of early transatlantic cables, led to a collapse in telegraph stock values and substantial investor losses.
In the early 20th century, the electric power industry saw rapid technological advances and widespread adoption. Companies that promised to deliver electricity to homes and businesses attracted massive investment. The advent of electric lighting, along with the development of electrical appliances, drove speculative enthusiasm. Accordingly, investors flocked to electric utility companies and electric equipment manufacturers.
However, the market soon became oversaturated with numerous competing companies, many of which were financially unstable. When the bubble burst, many electric companies failed, and investors faced substantial losses. This period highlighted the risks of overinvesting in emerging technologies without solid business fundamentals.
In each of these singular innovation examples, the same common the same flawed thinking prevailed:
- There would be limited or no competition
- The existing technology would not be surpassed
- Estimations of future market saturation points were grossly exaggerated.
What happens when many innovations happen at once?
If one singular innovation can lead to crazy investor behavior, what happens to investor behavior when many innovations occur at once?
In the case of 1929, it took 25 years for the Dow Jones Industrial Average to surpass the peak of 1929.
Let’s look at how today’s innovation euphoria compares to then.
Continue reading at the Macro Alchemist.
