Market booms and busts might be irrational, but we can understand why they happen – and what to do to mitigate the damage
Last year, Ross Gerber, a corporate investment manager, Tweeted a warning about Tesla. Gerber wanted investors to know that Tesla’s success would put other industries ‘at risk’. Which ones? Just oil, internal combustion engine automobiles, car dealers, railroads, auto parts, automobile services, and gas stations. ‘Did I forget some?’ he asked, implying yes, he did. Gerber included hashtags referencing Uber and Netflix as comparable ‘disruptors’. This is why, Gerber implied, there was so much ‘FUD’ (fear, uncertainty and doubt) in the media about Tesla. Gerber suggests a compelling storyline: the underdog hero, Tesla, is up against the evil incumbent forces that will play dirty to defeat it, but Tesla will overcome – just as Netflix and, presumptively, Uber have done.....MUCH MORE
The Tweet does not substantiate any of this. It doesn’t say why Tesla’s business case is like Netflix’s or Uber’s. It doesn’t say why all the purportedly threatened industries share the same interests here. It doesn’t have to – the human brain does that on its own without any help. As the US literary scholar Jonathan Gottschall has shown in his book The Storytelling Animal (2012), even the faintest sketch of a plotline is enough to prompt our minds to fill in the details. Gerber’s story outline is a familiar enough sketch of David taking on not just one but several Goliaths. It’s a good story outline. But it also ignores many important parts that do not fit with the plucky underdog narrative. It implies that all these alleged Goliaths have the same interest. It’s fiction, fantastically so.
The space between fiction and reality is where economic bubbles take shape. Froth fills that space. Gerber’s vaguely imagined world – one without oil companies, internal combustion engines, rail transportation, auto-service shops, parts makers, car dealers and gas stations – implies a radically different transportation infrastructure. But this future is just one of many possible ones, and storytellers have considered other potentially disruptive forces such as autonomous vehicles, new and different battery technology, or the micro-mobility revolution. How these potentialities play out, and Tesla’s role in them, is not just unknown but unknowable. As the late economic historian Nathan Rosenberg said to one of us: ‘The only thing certain about the future is that it is uncertain.’ Gerber’s Tesla story is fiction – and it is a fiction that relies on many unpredictable and uncontrollable convergent technological forces. To the extent that Tesla’s stock price reflects Gerber’s story, Tesla is a bubble.
As the Dutch Tulipmania of the 17th century and the South Sea Bubble of the 18th century attest, speculative bubbles have been with us since the early days of corporations and market capitalism. Instant mass communication, in the form of the radio, was an amazing invention of the 1920s. Almost 700 new radio stations – the United States’ entire current AM broadcast infrastructure – were established in 1922. But nobody had identified a successful business model for radio broadcast. That March, a small investor, Mrs W C B, sent a letter to the market columnist of the New-York Tribune seeking stock advice:
Question: I am a daily reader of your valued column in the Tribune, and your knowledge on investments has commended itself to me. The great impulse given to wireless telegraphy by the wireless concerts given daily at Newark and elsewhere suggest to me the advisability of making a modest investment in some wireless equipment stock that has potentialities. Could you name a few such stocks that I might invest in with reasonable assurance of large returns later on? What do you think of Radio common?Mrs W C B had constructed her ‘radio story’ (the term ‘radio’ had yet to completely displace earlier alternatives such as ‘wireless telegraphy’). She correctly understood that the new medium was a powerful means of communication – just as Gerber understands that electric motors are a powerful alternative to internal combustion engines. Mrs W C B’s mind connected the dots from wireless concerts to ‘reasonable assurance of large returns later on’ and manufacturers of ‘wireless equipment’. But this was only one possible future.
Investors were excited to get a piece of the technology that was broadcasting the Roaring 1920sIndeed, so uncertain was the radio business that the industry journal Radio Broadcast sponsored an essay competition in 1924 to answer the fundamental question: ‘Who is to pay for radio broadcasting and how?’ More than 800 essays were submitted seeking the $500 prize (more than $7,000 in today’s money). Each essay was its own narrative, a more or less sticky story that an entrepreneur could use to raise money. The US businessman David Sarnoff, who co-founded the Radio Corporation of America (RCA) in 1919, didn’t enter the contest. But he believed that RCA would be able to charge a subscription, just like the telephone company AT&T, despite the fact that it was impossible to know who was tuning in on a radio. There were many possible radio stories available to Mrs W C B, but she wanted to have her story about the future of radio endorsed by the Tribune’s columnist.
Radio common stock was in for quite a ride: in January 1926, RCA shares were trading for $43 on the New York Stock Exchange. Investors were excited to get a piece of the technology that was broadcasting the Roaring 1920s, and join hundreds of entrepreneurs hoping to profit when manufacturers began producing radio sets and related broadcast equipment. They invested in RCA along with the 18 radio-related IPOs that were floated between 1923 and 1926. Three years later, in September 1929, RCA shares cost a bit more, $568. Three years after that, RCA shares had lost 97 per cent of their value and were trading for a mere $15. RCA’s dividend-adjusted price did not recover to 1929 levels for decades. RCA stock – indeed the entire radio sector in 1929 – was not a good investment. If Mrs W C B followed the outline of her own investment thesis and invested in RCA in 1922, we certainly hope she had the good sense to sell well before 1929.
Often the opportunity for a bubble arrives on the back of a new technology. And some technologies make for fantastic stories – indeed, sci-fi is a whole fictional genre based on this premise. Bubbles form whenever a new story is not only told, but can also be sold. However, not every new story leads to a bubble. Sometimes stories can be told, but not sold.
When insulin was first isolated and announced as a treatment for diabetes (again, in 1922), the story was covered by newspapers around the world. Children in diabetic coma, only days from death, were ‘resurrected’ by insulin. Soon, they resumed their normal lives, and insulin was hailed as the ‘resurrection’ cure. This story has an incredible arc: the evil disease is conquered by modern medicine raising children from the dead. Investors might have loved to place a bet on the first miracle of modern medicine, but it was not to be. Eli Lilly and Company, the firm that contracted with the Canadian discoverers of insulin to isolate and distribute the hormone at scale, was privately held. There was no mechanism – no pure play stock – for investors to speculate in insulin. So there was no bubble....
Since this article was published Tesla stock has traded higher:
February 14 close $800.03
