What comes after the bubble could be electrifying

“Financial markets tend to be very good at spotting technological revolutions but have rarely proven able to anticipate their second-and-third-order effects,” Thomas wrote. “Bubbles deflate not because the technology disappoints, but because so much of its economics flow downstream to the companies that employ it and the new industries it spawns.”

He discussed the decades-long process of harnessing and deploying electricity from the 1880s to the 1920s. “The earnings and valuations of electric holding companies and equipment manufacturers both tripled; between 1925 and 1929, industry-wide annualized returns exceeded 50%.”

Those companies weren’t able to sidestep the . But what followed is notable.

“Electrified factories drove down manufacturers’ production costs and electrified homes stimulated demand for their products, like refrigerators, vacuums, and radios,” Thomas observed. “This is where far more of electrification’s economic value ultimately accrued, with 11% annualized returns on the stocks of durable goods manufacturers over a decade stretching through the depths of the Great Depression.”

Thomas noted that after the dotcom bubble burst in 2000, businesses leveraging the internet similarly outperformed in the wake of the market crash.

“These same phenomena repeated themselves in the internet boom of the late 1990s,” he wrote. “Real capex grew at a 24% annualized rate as investors focused on bandwidth, router architecture, and processing power bottlenecks. But the economic value of that IT and telecom hardware manifested downstream. Networked computing allowed manufacturers and retailers to exploit new sales channels, more precisely calibrate production and inventories to sales, and streamline logistics networks and supply chains.

“A technology doesn’t need to fizzle for its bubble to deflate,” Thomas continued. “Likewise, those inclined to focus on ‘irrationality’ or ‘market euphoria’ miss how bubbles seem a natural outgrowth of epochal shifts. If the market didn’t misjudge the importance of hardware bottlenecks and first-mover advantages, who’d be willing to fund the research and infrastructure that ultimately makes the technological revolution, and value downstream from it, possible?”

Read Thomas’ whole note .

As we’ve , history is riddled with examples of game-changing technologies leading to overinvestment followed by market corrections.

Unfortunately, when those corrections will happen and what they will look like.

But the bottom line is that investors should be mindful of the risk that the hot stocks most directly exposed to the AI capex boom are at risk of falling behind.

In fact, this .

On Wednesday, Deutsche Bank’s Jim Reid shared this chart of where the various AI-exposed stocks were trading relative to their all-time highs — as the S&P 500 itself was climbing to new heights.

“What’s striking about the [S&P 500’s] move back to the peak, though, is how much leadership has shifted over the past quarter,” Reid wrote.

By the way, this dynamic is a reminder that it’s possible for even as its leaders fall behind.