Are We Seeing Early Warnings of a Dot-Com Bubble 2.0?

At the moment, nearly every investing advice platform is talking about one thing – Tesla’s (TSLA) recent and continuing stock bump following the unveiling of the Model 3 on March 31. As wary as I am of continuing the momentum of a story for its own sake, I think Tesla’s latest round of hype is worth talking about because it’s a good example of a broader pattern in the market that’s been emerging in the past several years.

As of the time of writing, Tesla’s market cap is neck and neck with GM’s, putting it at the top among U.S. automakers. This is where the similarities in their financials end, though – while GM consistently turns a steady profit, Tesla has yet to turn a positive net yearly income. Of course, this is no secret. So what’s the wind in Tesla’s wings if not actual cash? If a frequently-circulated remark by Piper Jaffray’s Alexander Potter is to be taken as a cue, for investors the decision to buy is about “optimism, freedom, defiance, and a host of other emotions that, in our view, other companies cannot replicate.”

Setting aside the issue of the wisdom of investing on that basis, it’s clear that the ongoing excitement surrounding Tesla comes from hopes that its research and development will lead at some point to a consistently saleable product. At the moment, anyone buying TSLA is clearly hoping that the Model 3, which begins selling in July, will turn around the Model S’s spotty record of interesting consumers as much as it does investors. This isn’t necessarily foolhardy – the Model 3 is an interesting product and there’s no certain reason it can’t be successful. The important point here isn’t whether the Model 3 will be Tesla’s breakthrough item, but that investors are willing to take their odds.

Since the investment market’s recovery from the recession a decade ago, investors have displayed a steadily growing appetite for risk, rushing to back tech companies with grabby and apparently promising goals for the future. This is in many ways reminiscent of the dot-com bubble of the turn of the millennium, when hordes of investors were caught up in an “irrational exuberance” (quoth Alan Greenspan) for tech companies on the basis of a belief that the internet was a source of incredible growth, and thus that unprofitable tech companies were always on the verge of being profitable. Now, as then, the potential of new technologies makes it difficult to gauge the valuation of companies exploring them, and investors become understandably, but dangerously, optimistic.

If there’s one thing Tesla has a lot of, it’s good press. To be sure, a lot of it is deserved – they’ve pioneered a lot of really incredible engineering. But it’s probable that some of the good press is part of a positive feedback loop, that we’re all suffering a bout of confirmation bias.

Contrast it with a company that’s had the opposite issue lately – Uber. Uber’s CEO Travis Kalanick has found himself in a whirlwind of controversy lately, mostly with good reason. But among this controversy has been an outcry against his role in Donald Trump’s economic advisory council. I don’t feel qualified to debate the politics of that matter but it’s worth pointing out that Kalanick was hardly the only high-profile industry leader on that council – it still includes Peter Thiel of PayPal, May Barra of General Motors, and indeed Tesla’s grand man Elon Musk.

So why wasn’t Musk’s involvement targeted for criticism, or even mentioned except in passing in most news coverage? Perhaps Musk’s narrative is simply too positive to interest readers in entertaining the idea that he’s done something negative. It took a pretty jarring sequence of bad press appearances to turn Kalanick into a bad guy. Perhaps if it was Elon Musk instead of Travis Kalanick who made churlish comments about women, Trump’s lineup of economic advisors would be different right now, and perhaps neither event has much bearing on whether Tesla’s engineers are about to sell a lot of cars and start making money.

It’s a well-known feature of human psychology that we interpret information according to our preexisting biases and are very resistant to switching narratives. Especially now, when most news is consumed via the internet and most online news is given to us according to our ad preferences, it’s very possible that it’s simply easier to continue believing in a person or product that makes us feel good than to actively seek out information to prove ourselves wrong.

When taking on the risk of an investment, confusing excitement or approval with actual financial confidence can get dangerous. A market bubble is specifically the result of collectively allowing ourselves to make such a confusion, and a market bubble eventually pops and leaves everyone inside with some painful hindsight. So if investors’ confidence in Tesla is to be taken as any kind of bellwether, it might be time to start building a portfolio around companies with some black on their income statements.

-Conor

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