Solutions Economic and Market Watch

Welcome to the Economic and Market Watch podcast. This is Antony Davies.

For the past several years, half or more of the gains in the S&P 500 have come from just seven AI related firms, Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. But investors are getting skittish. Are the Magnificent Seven priced on reasonable expectations or are we looking at an AI bubble?

While Wall Street sees financial bubbles as bad news, Main Street should welcome them. Bubbles are dangerous for investors. Early investors who pick the right firms can do very well. Later investors and those who back the wrong firms often do not. And when the correction inevitably comes, capital disappears, portfolios shrink, and optimism gives way to regret.

But that's not the whole story. In fact, it's not even the most interesting part.

Consider the automobile. At the turn of the twentieth century, dozens of car companies operated in the United States: Packard, Studebaker, Pierce-Arrow, Hudson, Nash, Overland, Maxwell, Duesenberg, and many others.

All but three failed or were absorbed -- but they didn't fail because the automobile was a bad idea.

The problem was that no one knew what an automobile was. Should it be powered by gasoline, electricity or steam? How many should it seat? Three wheels or four? One headlight or two? A retractable or fixed roof. How wide, how tall, how heavy, how fast, how durable?

Hundreds of thousands of design questions needed answers and the only way to get them was trial and error: Offer consumers different solutions and see which ones they preferred.

Entrepreneurs and consumers needed to dance.

Investors paid for the band in the hope that consumers would dance with the investors' favored entrepreneurs. Some investors made fortunes, others lost everything.

But the gains and losses were merely dollars moving from some pockets to other pockets. For the economy, the process of trial error discovery made all of our lives much better.

In the 1970s and 80s, firms like Tandy, Commodore, Atari and Texas Instruments competed to define the personal computer. Many disappeared, a handful endured. The shakeout was not a flaw. It was entrepreneurs offering ideas and consumers judging them.

Investors who sunk money into Apple, Microsoft and Intel made fortunes, But the big winners were the billions of people who could now afford home computers, smartphones and tablets -- devices that were science fiction just a decade earlier.

In the late 1990s, entrepreneurs and consumers danced again as internet companies attracted enormous investment with little revenue and less profit. Many companies collapsed when the dot-com bubble burst, but the capital they consumed built networks, data centers, and software that supported Amazon, Google, Uber and Lyft, PayPal and Venmo, Netflix, Salesforce, Zoom, and myriad social media companies that now serve billions of people in better and lower cost ways. Today's AI boom is the latest dance.

Capital is flowing rapidly into firms that promise transformative applications. Some promises will prove illusory, others too modest. Until consumers choose, we won't know which is which.

This is how discovery works. It's inefficient. It's costly. It's often painful. But it's the best way humans have devised for separating what works from what doesn't in an environment with millions of questions and billions of decision makers.

The AI boom will end the way previous booms ended. Firms will collapse. Investors will lose money. Talking heads will tell us they told us so.

But beneath that turbulence, the market is sorting through competing ideas, identifying which AI applications are valuable, which are not, and what is the best balance between what consumers want and what they can afford.

That process requires exactly what a financial bubble provides: abundant capital, widespread participation, and a hero's tolerance for risk.

And if history is any guide, the greatest payoff won't accrue to those who timed the bubble well. It will accrue to the rest of us long after the bubble has burst in the form of products and services that today we can't imagine and that tomorrow we won't do without.

This is Antony Davies for the Economic and Market Watch podcast.

Thank you for listening. Remember to download this week's Economic and Market Watch intelligence brief and dashboard, and send us email, economicresearch@nrucfc.cop.