Back in 1999, at the peak of the dot.com bubble, I wrote an article
for Tocqueville Asset Management, the firm I had founded in 1985. It was
entitled “AOL, RCA and The Shape of History” (Tocqueville Asset Management, December 1999) and was inspired by the chart below, borrowed from that Thanksgiving’s issue of The New Yorker. It compared the 1920s bubble in the shares of RCA to the stock performance of AOL in the late 1990s:
As a preface, I quoted from a report prepared for RCA in 1929 by Owen
Young, then Chairman of General Electric, about radio in the 1920s: “[It]
has helped to create a vast new audience of a magnitude which was never
dreamed of… This audience, invisible but attentive, differs not only in
size but in kind from any audience the world has ever known. It is in
reality a linking-up of millions of homes.”
It was clear to me that radio — especially when combined with the
growth of automobile and air transport — revolutionized the perception
of space and time in the 1920s, just as the Internet and globalization
are doing today. It also reminded me of a piece of sage investment
wisdom: never invest in a company that promises to change the world. The
point is not that the most promising companies do not deserve their
reputation. Rather it is that, once a business’s prospects are widely
recognized, those prospects affect its stock price, often dramatically.
This makes the risk/reward ratios unacceptable.
The story of radio is instructive: it did change the world and
“disrupted” traditional news and advertising media. In the six years
between 1922 and 1928, sales of radio sets rose from $60 million to $843
million! RCA, as the largest manufacturer of radio sets and also the
leading broadcaster, saw its earnings grow from$2.5 million in 1925 to
$20 million in 1928; its stock price rose from $1.50 in 1921 to a high
of $549 in 1929. Yet few of radio’s early developers and participants
made lasting gains from this, as competition and industry changes eroded
the hoped-for profits.
As Mark Twain is reputed to have said: “History does not repeat
itself but it rhymes.” My own explanation of the shape of History is
illustrated in the following graph.
In this illustration, point B will display enough similarities with
point A so that economists with a good memory will experience a strong
sense of déjà vu. Yet, between these two periods, many structural
changes will have taken place – in societies, in world trade and in
technology, for example. As a result, point B will resemble point A, but it will also be different enough that precisely
forecasting what C will look like or when it will occur is all but
impossible. The only certainty (for me) is that there will be a point B.
Investors in RCA at the top of the 1929 speculative boom were right
about radio’s fundamentals: the number of households with radio sets
grew from 2.75 million in 1925 to 10.25 million in 1929 and, through the Great Depression,
to 27.5 million in 1939. But the investors were wrong about RCA’s stock
price. As we see in the chart below, included in a November 2002
follow-up paper, the fate of AOL’s stock following the 1990s dot.com
boom was not very different.
AOL was selected to illustrate what happened more generally to
internet stocks once the dot.com bubble burst. I hope the following
graph will awaken in our readers some memories of how history often
rhymes:
Source: Wall Street Journal Data Group
What triggered the current article was my watching the stock market
performance of many of the new industries, as illustrated by the
so-called FANG stocks (Facebook, Amazon, Netflix and Google) as well as
those of some other “disruptors.” The chart below of the performance of
the S&P 500 information technology index relative to the total
S&P 500 index gives some idea of the disparate performances of the
“disruptors” against the overall index. The ratio of the two is close to
the level it had reached at the top of the dot.com bubble, in 1999.
Source : FT Market Forces, JUNE 29 2020
Particularly striking is the fact that the technology and health care
sectors now represent 40% of the total capitalization of the S&P
500 index. Furthermore, the four companies in the so-called FANG index
account for 22% of the total capitalization of the 500 companies in the
S&P index. (Note: this index only counts 4 companies since both
shares classes of Google, which are listed separately, are included). If
we also included Apple and Microsoft, the so-called FAANGM would add up
to 25% of the capitalization of the S&P 500.
Source : BESPOKE 4/20/20
Needless to say, the weight of these new-era leaders in the leading
indexes has been a major factor in the behavior of the market as we
usually follow it. For example, the “narrow” FANG index has risen almost
62% year-to-date while the total S&P 500 index has gained only
4.8%. Furthermore, since the FANGs are included in the broad index, we can infer that the rest of the market has not gained much in this “great” recovery.
One of the most reliable signals of market excess is its narrowing
breadth – when the performance of a relatively narrow sample of
companies takes off, while the broad market fails to follow. The “Nifty
Fifties” in the 1970s were such a sample, which few of today’s investors
can remember first-hand. Major institutional investors had been
traumatized by the unexpected 1969-1970 recession on the heels of a long
and prosperous expansion that had led a number of reputable economists
to declare the economic cycle vanquished and recessions a thing of the
past. As a result, these institutional investors had concentrated their
portfolios on fifty or so companies of the highest quality. They had
potential to grow fast and were considered “recession resistant.” This
relatively small sample did temporarily outperform the economy and
especially the stock market, hence their nickname of the “Nifty Fifty.”
(They were also known as the “Vestal Virgins” because analysts could
find no fault in them.)
Something similar happened in the late 1990s with the dot.com
companies around the development of the Internet, an episode which many
younger investors remember, even if they have forgotten AOL and other
Internet pioneers.
Both of these episodes were initiated by smart and sophisticated
people, expert at articulating the case for the companies or the
industries they were promoting. The problem arose when a large crowd of
investors joined them, pushing up prices to unreasonable levels. In each
of these examples, a small sample gained a price advance against the
market at large, which is why the breadth of the market advance deserves
attention.
In my view, a similar fad has developed with the FANGs or FAANGMs
today. The details and the techno-socio-economic environment may differ,
but we should not forget that History usually does rhyme… eventually.
François Sicart – July 3rd 2020
https://www.sicartassociates.com/rca-nifty-fifty-aol-and-fangs/
