Al Root

The electric-vehicle revolution looked unstoppable. It turned out to be another stock-market bubble based on a classic "big market delusion," or BMD.

Investors can avoid catching another case of the BMDs if they remember a couple of key points.

On Tuesday, Research Affiliates published an EV report looking back on the past few years. "With the auto industry going electric, investors saw a once-in-a-century opportunity and poured billions into EV start-ups, driving the sector's market capitalization up 900% from 2020 to 2021," wrote co-authors Rob Arnott, Research Affiliates founder, and Bradford Cornell, finance professor at UCLA.

The market value for EV start-ups not named Tesla went from roughly $75 billion in September 2020 to a peak of more than $400 billion in November 2021. By then, the likes of Fisker, Lordstown Motors, Canoo, Nikola, and others were valued at roughly twice what the market paid for the traditional Detroit Three auto makers: General Motors, Ford Motor, and Chrysler parent Stellantis.

Today, Fisker, Lordstown, Canoo, Nikola, and others have gone bankrupt. The non-Tesla start-ups, which still include Rivian Automotive, NIO, Lucid Group, and others, are worth about $80 billion, or three-quarters the value of the Detroit Three.

Then there is Tesla. Its market value hit $1 trillion in October 2021, up from about $400 billion a year earlier. It fell back below that 13-digit mark in early 2022 and didn't retake the trillion-dollar level until late 2024, after the Nov. 5 presidential election.

"When the dust settles, only a few players will remain," added Research Affiliates. "The lesson, as always, is simple but seldom learned: The bigger the narrative, the greater the risk of overpaying for it."

The EV episode is another example of what Arnott calls a "big market delusion," or BMD, in which investors assume a new, fast-growing technology will overtake incumbents and any start-up with access to capital can be a spectacular winner.

The BMD is key to forming a stock-market bubble, and it is based partly on underlying truth. EVs are greener than traditional cars, cheaper to operate and maintain, and falling battery costs could eventually make them cheaper to purchase than a gasoline-powered vehicle. What's not to love?

One of the problems is that everyone can't win. "Speculative bubbles throughout history follow this rubric," adds Arnott, citing 19th century railroads, early 20th century car companies, mid-20th century airlines as well as the telegraph, radio, and television. They all "ended in several financial panics [cycling] through the same stages: fevered expansion, inflated valuations, and painful consolidation."

Investors, for the most part, aren't complete fools. They know all won't win. Sometimes the strategy is to buy a basket of start-ups and hope the gains from the winners overwhelm the losses from the failures.

That might not be the way to bet. Holding a market capitalization weighted basket of EV start-ups, including Tesla and China's BYD, has yielded gains roughly on par with the S&P 500 since late 2019. The volatility, however, has been incredible. What's more, Tesla is responsible for almost all the gains and any missteps in portfolio construction or timing amounted to disaster.

Tesla might be a special case. It appears to be going from bubble to bubble, shifting from EVs to artificial intelligence. These days, Tesla investors are optimistic about the potential for AI computing to unlock trillions in value.

That's the hope anyway. "Musk is a genius," Arnott tells Barron's, but that doesn't mean all AI expectations will yield long-term investment gains.

Arnott points out that Nvidia shares trade for more than 10 times estimated 2025 sales. Sun Microsystems CEO Scott McNealy called that level ridiculous when his company traded there amid the Dot.com boom.

One lesson from Arnott is that price always matters. The higher the starting price, the worse the performance of an EV stock. Another lesson is that investors should weight stocks by fundamentals, such as sales, and not by market capitalization. In the case of EVs, this automatically gave investors bigger positions in BYD and Tesla while minimizing exposure to the likes of Nikola.

Arnott doesn't see an easy fix to the market's penchant for bubbles. "There is no law against stupid," he says "Otherwise we'd all be in trouble."

Write to Al Root at allen.root@dowjones.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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March 11, 2025 10:50 ET (14:50 GMT)

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