Post-financial-crisis market returns are frequently referred to as “the most hated rally of all time,” with investors and pundits continuing to voice skepticism and fear as asset prices keep heading higher.
This trepidation is understandable in light of the panic-ridden market history of the past 20 years. Having lived through the Long Term Capital Management implosion, the Asian financial crisis, the technology bubble and 2007-08, many investors, reasonably enough, are looking over their shoulders for the next bout of random market misery.
Investors will be happy to know that, according to Carlota Perez of the London School of Economics, the past two decades of market upheaval aren’t random at all, but part of a 240-year cycle of technological boom and bust with a likely positive outcome that Prof. Perez calls “a new golden age.” It is a theory that also offers guidance for investors in individual high-flying technology stocks such as Netflix Inc.
In a well-received Nov. 17 lecture at the Peter L. Drucker Forum in Vienna (thankfully, transcribed by Forbes magazine), Prof. Perez explained that the developed-world economy is in the midst of the fifth major technological cycle since the Industrial Revolution began in 1771.
Each cycle proceeds in roughly the same stages: New technology is developed (often, as with the internet, through government and military spending), an investment bubble follows, the bubble bursts, then the technology is disseminated through the economy, raising productivity levels and aggregate wealth. This pattern is consistent through the Industrial Revolution, the steam-power and railway boom, the steel age in the late 19th century and the auto and mass production-related economic expansion in the early 20th century.
As for where we are now in the cycle, Prof. Perez said, “as in the 1930s, we have structural unemployment, low investment, growing inequality, a sense of hopelessness, risk-averse finance with trillions of dollars sitting on the sidelines, feeble growth, social unrest, recessions and talk of secular economic stagnation. Populist leaders find massive following precisely because of these issues.”
That sounds terrible, but the historical framework means that a turning point is on the near horizon when “control of investment shifts from finance to production.” Prof. Perez notes that this stage, when the benefits of new technology spread throughout the economy, is characterized by strong economic growth and widely dispersed prosperity.
There are important limitations to applying Prof. Perez’s template to individual market sectors or equities – the number of factors that can derail companies is far larger than for an aggregate economy. Nonetheless, the late-1990s technology bubble looks very much like a microcosm of the long-term boom-bust cycle, and current market stars such as Netflix and Tesla also show the same potential boom-and-bust attributes.
The internet and personal computing were the transformational technologies of the 1990s. Once the economic power of this combination became apparent, waves of investment assets were directed at stocks such as Nortel Networks and the U.S. market’s “Four Horsemen” – Microsoft, Cisco Systems, Intel and Dell.
In the end, the investment came in faster than the companies could convert it into profits, stocks reached insane valuation levels and the bubble imploded in early 2000. The big changes to our everyday lives – the iPhone, social media, Global Positioning System (which was available in 1990s, but not widely) – came after the tech bubble was long over. In other words, all of the elements of Prof. Perez’s framework were apparent in the last decade of the 20th century: The groundbreaking invention, the finance and investment bubble where, as she defines it, “the casino economy takes over,” then the implosion, and the subsequent, economically beneficial proliferation of the technology.
To the extent individual companies can follow Prof. Perez’s cyclical model, Netflix and Tesla might fit the bill. In both cases, it can be argued that the companies have developed a “better mousetrap” – a product with revolutionary potential. At the same time, the two companies are also staggering under huge debt loads and burning cash rapidly, possibly indicative of a previous “too much money too fast” finance bubble, and are not as profitable as investors would prefer.
Prof. Perez’s framework is an academic thesis, and these can often be hard to apply in the real world. On the plus side, it offers a historical perspective that allows for more informed predictions as to what developed-world economies, and markets, may look like over the next decade. But as with all wide-reaching theories there are ambiguities where important events – the economic influence of the Second World War on the model is a good example – can be interpreted in ways that don’t fit the overall template.
Quibbles aside, I find Prof. Perez’s work compelling, even if it’s not something that I’m going to blindly apply in my portfolio in the short term. It offers a well-grounded perspective indicating that the world isn’t ending and the next random market disaster may not be just around the corner. We’re just in a difficult part of a long-term historical cycle that, if accompanied by the right policy changes, will turn out positively for the majority of Canadians.
Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market online. Subscribe to Globe Unlimited at globeandmail.com/globeunlimited.
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