A brief history of booms and busts

Tim Carleton

Auscap Asset Management

Disruption. Change. Innovation. These are terms synonymous with the current investing landscape. The developments being witnessed across a number of fields are so potentially ground-breaking it is hard not to get excited at the prospect of major technological, healthcare, energy, environmental and productivity advances that might occur over the next few decades. 

Indeed the developments may end up exceeding all of our expectations and progress our lives in ways that are unimaginable today. As Amara’s Law suggests, we tend to overestimate the effect of a technology in the short run and underestimate its effect in the long run.

Cathie Wood, Chief Investment Officer of ARK Invest, has spoken of the five major platforms of innovation she believes to be currently at work. These are artificial intelligence, energy storage, robotics, genome sequencing and blockchain technology. Developments in these areas are truly exciting and each no doubt has huge potential application. 

It is easy to think that mankind has never seen such innovation before. The question is, are we in unchartered territory or have we seen this scale of disruption to traditional practices previously? And more importantly from an investment perspective, is investing in disruption likely to produce attractive returns for the average investor?

Carlota Perez notes in her 2002 book, Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages, that massive disruption has been a regular feature of capitalism over the last few hundred years of modern financial markets. There are many examples to choose from, and we briefly describe a few below. 

Canal Mania 

There was the Canal Mania in the United Kingdom of the 1780s and 1790s, during the first industrial revolution. It began with the success of the Bridgewater Canal in 1761, which lowered coal prices in Manchester by nearly two thirds within a year of its opening. The construction cost of the canal was recouped in just a few years, sparking the collective imagination of the possibilities for transporting other commodities and finished goods more cheaply than by a land-based route. 

This led to the start of a craze which saw 52 Acts pass Parliament over the next 15 years encouraging further canal building and offering exclusive tolling rights to the owners. This funded canal after canal, creating a situation where canals were being built in the 1790s that could never, and would never, be profitable. Some 3,900 miles of canals were eventually built in the UK and capital for canal building remained readily available until the Panic of 1797 which saw numerous canal businesses fail. 

Rail Mania 

Then there was the Rail Mania of the 1840s that resulted in more railways being built in England than could possibly be used. It started out as a good idea, with the opening of the Liverpool and Manchester Railway in 1830, the first modern inter-city railway used to transport passengers and cargo. Further railway development was encouraged by the Government which saw major efficiency benefits, resulting in 263 Acts of Parliament establishing new railway companies with routes totalling 9,500 miles. Railway companies were reportedly touted as foolproof ventures. At the peak of the mania railway companies were proposed that would have been difficult to construct and near impossible for locomotives to operate on. About one third of these railways were never built. 

In 1845 the Bank of England increased interest rates. The share prices of the railway companies stopped appreciating and investment capital became more difficult to obtain. This ultimately led to the Panic of 1847 and the collapse of most of the railway companies. 

A comparable railway building boom in the United States finished with its own Panic of 1873, which started with the collapse of a banking house, Jay Cooke and Company, over the development of the Northern Pacific Railway. By the end of the bust, 89 railroads and over 18,000 businesses had gone bankrupt. 

Steel Mania and the Roaring Twenties 

The Steel Mania of the 1880s and 1890s was driven by the 1857 development of the Bessemer converter, named after its inventor Henry Bessemer. This converter allowed the bulk production of steel at a cost that was previously unheard of. 

At one stage in 1875 the UK was responsible for 40% of global steel production. Further developments through the late 19th Century and early 20th Century led to the Roaring Twenties. Electrification prompted the large scale development and use of automobiles, telephones, radios, modern plumbing and electrical appliances, all of which changed life dramatically in the developed world. 

The introduction of mass production was punctuated by the development of the Model T Ford and the associated boom in the automotive industry. Beverly Rae Kimes estimates in her book Pioneers, Engineers and Scoundrels that at one stage there were as many as 2800 auto companies. 

The automotive industry powered the development of other industries such as infrastructure development, steel production, agriculture, tourism and car related sales, servicing and development activity. 

Radio became the first mass broadcasting medium. Charles Lindbergh completed the first solo nonstop transatlantic flight. Penicillin was discovered. It is hard to think of a period that experienced more disruption and innovation. Rapid economic growth and strong consumer demand for the array of new products that were being developed led to a booming stockmarket. 

This continued until the stockmarket collapse of 1929 and subsequent Depression. From the 2800-odd auto companies at the peak, by 1930 there were less than 50 still in operation.

The Dot-Com Boom 

The computer and internet revolution started in 1971 with the development of the first commercial microprocessor on a silicon chip and accelerated with the development of the internet and then the world wide web in 1994. 

Throughout the late 1990s, investors were hungry to invest in internet companies, fuelling speculation in technology stocks in what became known as the dot-com boom. 

The potential applications of the internet seemed almost unlimited. Most dot-com companies spent heavily on advertising to build market share and incurred net operating losses, making them vulnerable to funding availability from capital markets. Traditional metrics like price to earnings ratios were overlooked leading to a significant bubble by the turn of the century. 

When Federal Reserve Chairman Alan Greenspan raised interest rates in 2000, the bubble burst and over 50% of dot-com businesses were declared bankrupt by 2004.  

Relevance for investing today

All of the developments that fuelled these bubbles were transformational for society. And indeed we should be grateful that it is human nature to get excited about and pursue progress. This excitement has resulted in many bubbles, and most of them are written about negatively. This misses a crucial point. The bubbles led to an excess of capital being available for investment in areas of significant innovation, which helped to accelerate human progress. 

The outcome from investing in innovation however is often another story altogether. Those who invest early in successful pioneers can do very well. So too can those with the ability to successfully trade the waves of excitement. But for the majority of us, this is unlikely to be the case. 

History is littered with losses from investors who supplied the capital that created these bubbles. Most canal, railway, auto and dot-com companies went bankrupt, many remarkably quickly once they lost the ability to raise capital. 

We live in an environment where innovation in multiple fields is occurring at an incredible pace. Whether an attractive return will be generated on the significant capital being poured into the current technology boom remains to be seen. History might suggest on this front that the odds for general investors are not favourable, particularly at a time when it appears that we are moving into a rising interest rate environment.

One company that has been impacted by industry disruption over the last few decades is NZME, one of New Zealand’s largest traditional media organisations that has had nearly every part of its business model threatened by the digital age, with a decline in physical newspaper readership, the loss of classifieds revenue and challenges to the dominance of radio as the audio platform of choice. Yet the business has survived, is currently attracting record audience and we now think is in a position to thrive going forward. My colleague Will Mumford will discuss our investment thesis on NZME in our next wire.

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I am the Principal and Portfolio Manager of the Auscap Long Short Australian Equities Fund which targets solid absolute risk-adjusted returns, looking to invest in companies that generate strong cash flows and are trading at attractive prices. If you would like first access to my insights please hit the follow button below. 

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Principal and Portfolio Manager
Auscap Asset Management

Auscap manages the Auscap Long Short Australian Equities Fund and the Auscap Global Equities Fund which target solid absolute risk-adjusted returns, looking to invest in companies that generate strong cash flows and are trading at attractive prices.

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