It's possible that we are on the verge of a new technological revolution. Economists such as MIT's Erik Brynjolfsson and the Brookings Institution's Martin Baily believe that technologies such as robots, 3D printing, the internet of things, genome sequencing and shale gas could transform western economies.
Such optimism, however, is absent from the stock market; the dividend yield on the All-Share index is actually slightly above its average of the past 30 years. This is a marked contrast to the last episode of techno-optimism: in the late 1990s, when hopes for a new digital economy drove share prices sharply higher.
Why the difference?
The answer might lie in something pointed out by Boyan Jovanovic of New York University and Peter Rousseau of Vanderbilt University. Companies, they say, embody the technologies that were new when they were formed and remain viable for as long as those technologies are useful. But it is very difficult for companies to transform themselves to exploit later technologies. They have 'core competences' which cannot easily be changed. You can't teach an old dog new tricks. For example IBM was great at making mainframe computers in the 1960s, but couldn't produce mass-market operating software for PCs: it took a new company, Microsoft, to do that. Microsoft, in turn, didn't produce a great search engine in the 1990s but a new company, Google, did. And Google didn't give us social media but newer companies such as Facebook and Twitter did.
Now, here's the thing. Put yourself in the shoes of an omniscient investor in the 1960s, who, amazingly, foresaw those developments. What shares could you have bought? The answer is: very few, because the companies that would exploit the new information technologies didn't exist back then. Even Intel was only floated on the stock market in 1971 and Microsoft and Oracle, the US's two biggest software companies today, only went public in 1986. Even rightful optimism about technical progress can't be embodied in share prices if those shares don't yet exist.
Today's techno-optimists might be in the same position as our hypothetical 1960s optimist. Maybe robotics, 3D printing and such like will transform the economy. But this means nothing for investors if the companies that will best harness those technologies don't yet exist.
In fact, things might be worse than this. Technical change, as Joseph Schumpeter famously said, is a process of creative destruction. New technologies can destroy companies that produce outdated goods or which use older, more expensive production processes; think of how the new generation of smartphones devastated the once-mighty Nokia, or how digital photography destroyed Polaroid and Kodak. In fact, Professor Jovanovic has shown that one reason why share prices fell in the 1970s was that investors rightly feared that the IT revolution would devalue the companies that existed at the time while being unable to invest in future successful companies such as Microsoft.
Today's equities face the same danger. Future technical progress - embodied in companies that don't yet exist, or barely do so - might destroy them.
In this light, two otherwise curious facts make sense.
One is that companies have built up massive piles of cash: Bank of England figures show that non-financial companies' sterling bank deposits have grown by more than 30 per cent since the end of 2010 despite negative real interest rates. There are several reasons for this, but one might be that companies lack the organisational capital to invest in new technologies but hope to take over some of the newer companies that will be able to do so.
The second puzzle is: why haven't shares benefited from the huge fall in real yields? Since the late 1990s, yields on index-linked gilts have fallen from over 3 per cent to minus 1 per cent. This should have given share prices a massive boost, simply because lower real interest rates mean that future dividends are discounted less heavily. So why hasn't this happened? One possibility is that the companies that will be paying big dividends in the future don't yet exist.
All this poses the question: what can investors do to exploit techno-optimism if existing shares don't embody it?
The natural thing to do is to invest in flotations of new companies that might exploit the new technologies. This, though, raises a dilemma. On the one hand, we know that newly floated companies are often overpriced, partly because their owners sell them at the best time and partly because investors tend to overpay for the small chance of huge returns. But on the other hand, history and psychology tell us that new technologies and new stocks can produce bubbles and massive returns: think of railways in the 1840s, radio stocks in the 1920s and tech stocks in the 1990s. These two facts can both be true of the same stock: Amazon, for example, fell from $85 to $6 between 2000 and 2002 but is now worth over $500.
Whether the techno-optimists are eventually proved right or not, there will be huge fortunes made and lost.
