Engines That Move Markets (2nd Ed) Read online

  However, a striking feature of each chapter is the fact that while the patterns have not been identical in each case they have been very similar. First, a new invention is greeted with scepticism from incumbent technology and potential new investors. That scepticism is gradually replaced with enthusiasm, as businessmen come to appreciate the sales potential of the new technology. Soon, new entrants are flocking to the market, and venture capital funding is made available. Companies are started; almost all do well (in terms of share price) in the market on a tidal wave of enthusiasm. So far, so good; but as the technology begins to mature, a sense of realism sets in. Inevitably, for some, cash runs out. Companies begin to fold, only the strong survive and naive investors lose money in the huge rationalisation. Pessimism begins to pervade the marketplace and stock prices fall across the board. Eventually, the market stabilises.

  This same pattern occurred with the development of the railroads, electric light, oil, the telephone, the automobile, the radio, the semiconductor. After reading Sandy Nairn’s excellent book, you may well recognise the familiar pattern unfolding once more in today’s economy. This is not something to be frightened of. Technology may have changed the world – but it has not changed human nature. To survive and prosper now requires only the same fortitude and common sense as it did 200 years ago.

  john m. templeton, kt.

  August 2000

  introduction

  Making Sense of Technology Bubbles

  Purpose of the research

  This book had its origins as an in-depth study of the impact that the great technological inventions of the past 200 years, from the railways to the Internet, have had on financial markets and investors’ fortunes. The research was begun in 1999, just as the great stock market bubble of 1999–2000 was coming to a head, and it seemed that any company connected with the Internet could do no wrong.

  The original aim of the research was to satisfy my curiosity, as a professional investor, as to how and why new technologies can create such apparently irrational stock market bubbles. With hindsight we can see quite clearly now how the so-called TMT (technology-media-telecoms) bubble of 1999–2000 developed into the greatest of all stock market manias, just as many of us expected at the time. However, back then, living through it, it simply defied all notions of common sense or professional expertise.

  As Director of Global Equity Research at Templeton Investment Management at the time, it was my job to lead the analysis of stocks for a leading international fund management house. I lost count of how many times well-paid analysts from Wall Street sought to promote this or that dot-com company – with no sales and no prospects of earnings in the foreseeable future – with a view to influencing our staff and ultimately our portfolios. The underlying message was that whether we liked it or not these stocks were something we should be adding to our list of stock buys. For this edition of the book, nearly 20 years on, it is somehow fitting that I find myself back working at Templeton. The fundamental truths of investment remain unchanged, as does the need for investment discipline and rigour.

  Back in 1999 the problem was that I kept hearing: “This is the new economy, stupid. Don’t you know that things are different in the new economy?” As I scratched my head, trying to make sense of it all, this would often be followed up with the irritating phrase: “You just don’t get it, do you?” In other words: ‘It’s different this time.’ Well, I thought I did get it. My instinct was that the bubble was just that – an outbreak of collective insanity that was one day going to burst. There was no way that many of the companies being sold to investors could ever hope to make a profit, let alone justify the kind of market valuations that were placed on them at the time.

  True, I was not alone in this. Many investors held a similar view. Few of them, however, were fortunate enough to work in organisations which held to their discipline during a time when the pressure to invest and maintain short-term performance was intense. In this regard I was very fortunate – I worked in an organisation where the owners were themselves long-term investors, and as such were willing to support a position if it could be logically justified. Many professional investors were not in this position and found themselves exiting the industry, ironically just when the bubble was about to burst.

  One reason for that is that the incentives to participate in an emerging technology craze are so very powerful. Even in the most austere professional environment, any personal doubts about the sustainability of a high-profile momentum phenomenon tend to be swamped by the institutional imperative of grabbing a piece of the rich short-term pickings on offer. The investment business is dominated by corporations and partnerships whose internal processes are wired to echo St Augustine’s famous plea: “Lord, make me chaste – but not yet.”

  At the time, with the pressure to jump on the bandwagon so intense, I had to admit that I did not know all there was to know about the new technology. The nagging doubts that I might just be missing something remained. It set me wondering: what happened in the past when new technologies with similar transforming potential had arrived on the scene? How did investors and the media react at the time? Who ended up as winners and losers from those episodes? Maybe there were lessons to be learnt that could explain what was happening with the phenomenon I was living through.

  Questions raised

  The kinds of questions that I wanted to investigate were:

  Could and should the bubble mania of 1999–2000, and the way that it developed, have been foreseen?

  What lessons could today’s investors learn from the history of the railways, from the way that the radio and electric light developed, and other episodes of epoch-making technological change?

  Was it obvious at the time, for example, that a great company such as RCA would make as much money as it did, while its originally more successful parent Marconi produced much less impressive returns?

  What pointers from the past were relevant in deciding which (if any) of the pioneering companies of the Internet age – the likes of AOL, Amazon and Yahoo – were most likely to survive and prosper?

  Do investors in aggregate stand to make money from technological changes? If so, what are the characteristics of the most successful companies? And can investors predict the eventual winners with confidence?

  From a practical perspective, as the bubble started to burst spectacularly, it led me to wonder what pointers history provided as to how investors in this latest technology were likely to fare over the medium to longer term.

  Should I have been buying technology shares in preparation for an inevitable rebound – or continuing to avoid them like the plague?

  If the latter, for how long should I expect to wait until the sector became investable again?

  How well would the winners and losers from this latest technological breakthrough do for their shareholders?

  The scope of the research

  The ten historical episodes covered in detail in the research were:

  the railway boom in Britain, from the 1840s onwards

  the early railroad industry in the United States

  the development of the automobile industry

  the story of the discovery of electric light and its commercial exploitation

  the discovery and early development of crude oil

  the emergence of the telegraph business

  the early history of wireless, radio and TV

  IBM and the growth of the computer industry

  the PC battles of the 1980s

  the Internet and the dot-com bubble of the 1990s and beyond.

  Most of these episodes tended to be associated with just one or two successful companies – Western Union in the telegraph business, GE in lighting, Ford and GM in the automobile industry, IBM in computers, Microsoft in the software business. Yet the eventual success of these companies was far from a foregone conclusion. For every company that built an enduring market position, there were hundreds of others who tried to do the same thing – and failed.


  In many cases, reconstructing the economic and share price performance of the leading companies involved proved a full-time piece of research in itself. Simply finding and collecting the information was a task which absorbed a huge amount of time. I hope that readers find the graphs that show the earnings growth, return on capital and share price performance of some of the great technological pioneers of the past instructive. I tried to keep the analysis simple and such that comparisons could be made between different time periods and different industries. I did not spend a huge amount of time going into detailed valuation work, partly because of the space it would have absorbed, but mostly because the simple graphs were sufficient to tell the story on their own.

  New and updated material

  For this second revised edition I had an opportunity to revisit the events of 1999–2000 with the added benefit of a rearview mirror. It is pleasing to be able to report that most (but not every single one) of my contemporaneous thoughts on how the Internet bubble would play out were vindicated. ‘This time it’s different’ did not turn out to be any more true than before. Anyone with an understanding of previous technology episodes should have been able to navigate this mania successfully, although many investors and entrepreneurs did not.

  I have also taken the opportunity of this new edition to add some further analysis of how the Internet evolved in practice over the 15 years since the previous edition. As with railways and electricity, it turns out that the visionaries who predicted that the Internet would transform the social and economic landscape were right. We now truly live in a connected world, in which information travels seamlessly around the world, and the daily operations of myriad types of business have been made more efficient through adopting the networks and communication tools of the online world.

  And yet in the stock market, which embraced the arrival of technology, media and telecoms companies with such wild enthusiasm in the late 1990s, the story has been somewhat different. Only a handful of the companies which commanded lofty market capitalisations during the mania have come close to justifying their valuations. The great majority of market comets which lit up the sky back then simply crashed back to earth, many of them worthless. It took more than ten years for the quoted technology sector to regain its prior peak. The same was true for the Nasdaq index.

  In the last five years, however, we have seen a strong renaissance, with the US stock market being led to new highs by newly powerful global companies which have emerged as the biggest winners of the transformative technology investors were so excited about in 2000. Ironically, two of the biggest – Facebook and Google – barely existed at the time of the bubble, and few investors foresaw that search and social media would create two natural monopolies that dominate the world of digital advertising. In this respect, too, the Internet bubble echoes earlier technological episodes.

  I comment on these two companies and other sectors in more depth in chapters 10 and 11, both of which have been extensively revised to take account of recent developments. It is ironic that we are once again hearing the world ‘bubble’ on investors’ lips, referring to the strong performance and lofty valuations of new technology companies – not just Internet-related businesses, but those operating in other fields such as biotechnology, automation and transport. Do these new businesses, many still unquoted and capital-light, require a new way of thinking and new types of analysis?

  Living through the TMT bubble and further subsequent turns of the market cycle has stimulated me to consider further areas for research into this fascinating topic. One question in particular intrigues me: Is it possible to generate substantial value as a professional investor not by identifying and backing the winners of each technological revolution – which history shows is notoriously hard – but instead by identifying and betting against those companies which are bound to lose?

  The research that underpins this book strongly suggests that this could be a profitable and less risky approach. So many sectors of the economy look vulnerable to new and disruptive technology – retailing, financial services, automobiles, pharmaceuticals, to name but four. Are the coming phases of disruption so obvious that we can spot the failures in advance? This will be the subject of a series of sectoral studies – and in due course, I hope, the subject of my next book.

  Winston Churchill, the great wartime leader, is said to have commented that one should never let a good crisis go to waste. Although it was a difficult professional experience at the time, the stock market drama that led me to produce the first edition of this book has more than repaid the many hours of effort that went into it. The world moves on, however, and just as soon as one has absorbed the lessons of the last market hiatus, it is time to turn one’s attention to the next – the comforting difference being the hope that recent experience can be banked and turned to profitable use as the cycle turns.

  Timeless lessons

  The final chapter of the book outlines my general observations about the nature of technological change, its impact on financial markets and the roots of speculative mania. I use a simple model to formalise the interaction between a new technology and the markets, and assess the Internet bubble and what has happened since against that framework. I conclude with some further thoughts about the short-, medium- and longer-term impact of recent developments.

  I was fortunate in my early career in investment management to be able to spend time with Sir John Templeton, one of the greatest professional investors of the 20th century. A consistent theme from Sir John was that the study of past financial history can be a rich source of inspiration and guidance for investors. A historical perspective always underpinned his own impressive achievements as an investor. One of his famous quotes was that, “The four most expensive words in the English language are ‘This time it’s different’ ”. By definition, this means understanding what has gone before.

  As Mark Twain said, history does not repeat itself exactly, but it rhymes. This book is an attempt to capture some of the lines that many investors have had to relearn for themselves over the years. It is fair to say that professional investors are often just as blameworthy as private investors for their failings during times of speculative mania. It is never too late to relearn the important lessons of the past.

  dr sandy nairn

  Investment Partner, CEO, Edinburgh Partners

  Chairman, Templeton Global Equity Group

  April 2018

  chapter 1

  Making Tracks

  The Industrial Revolution,

  canals and railways

  “What could be more palpably absurd than the prospect held of locomotives travelling twice as fast as stagecoaches?”

  The Quarterly Review, March 1825

  “That any general system of conveying passengers would … go at a velocity exceeding ten miles per hour, or thereabouts, is extremely improbable.”

  Thomas Tredgold, British railway designer,

  Practical Treatise on Railroads and Carriages, 1835

  “Rail travel at high speed is not possible because the passengers, unable to breathe, would die of asphyxia.”¹

  Dr Dionysius Lardner (1793–1859), professor of natural philosophy

  and astronomy at University College, London

  Introduction

  The expansion of the rail network in both Europe and America in the middle years of the 19th century created great fortunes and wealth. Combined with the rise of industrialisation, it also dramatically shifted the balance of power within society. New financial dynasties were created. The distribution of wealth shifted from agrarian aristocrats to the new industrialists. Social habits were transformed. Although the term ‘new economy’ has become devalued by overuse in recent years, the arrival of the railway was a genuine example of a new technology that profoundly transformed society at the time. It therefore marks an obvious starting point for any student of technology investment to begin their investigation.

  Funding the Industrial Revolution

 
The Industrial Revolution was the driving force for the rapid economic development of Europe and the emergence of America during the 19th century. Goods once created slowly and laboriously by skilled craftsmen could be mass-produced. In a few short years, items once owned only by the very wealthy became available to the masses.

  Stage one was the invention of new machinery, driven by steam engines, producing ever larger quantities of goods at ever lower prices. Stage two was the rapid transformation of transport – first in Britain, then in Europe; and then, on a massive scale, in the US. Otherwise, how could these newly mass-produced goods be brought to market quickly and cheaply?