Focusing on hype cycles is key to investing in tech

Focusing on hype cycles is key to investing in tech

The hype cycle is a visual representation of the maturity, market perception and adoption of new technologies, first popularised by research firm Gartner.

Typically, the market will overestimate the short-term potential of any new technology and it will underestimate its longer-term potential.

These hype cycles have been observed consistently through time.

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Good examples include the 1999 to 2000 tech bubble, the 2013 to 2014 3D printing cycle and the 2017 to 2018 cryptocurrency cycle.  

These hype cycles create volatile movements, both up and down, in the underlying stocks exposed to these technologies.

Therefore it is vital to navigate these hype cycles to drive consistent long-term returns within technology equity portfolios.

One of the most talked about hype cycle is the tech bubble of 1999 to 2000, when market expectations for internet-changing commerce and our social lives saw expectations rise significantly.

It was only with broadband/3G, smartphones and Software as a Service (SaaS) solutions that we saw the real impact of how the internet would change our lives.

It is possible to show the clear difference between the hype of any given technology and its adoption, on the chart below.

Figure 1: Navigating the hype cycle

Source: Janus Henderson Investors

The green line represents the hype cycle curve andthe purple line representsthe rate of adoption of an innovation over time. The team analyses each new technology in the context of this hype cycle prior to making investment decisions.

Navigating the hype cycle: experience required

What makes these hype cycles so important? It is all about the pace of change, which is in part enabled by Moore’s Law, which has shown that technology typically becomes cheaper, faster and smaller every 12 to 18 months.

Rapid innovation enables legacy technologies to be quickly replaced by next-generation solutions, with major implications for legacy technology providers.

At the same time, they provide significant opportunities for next-generation players. It is the market’s expectations for these next-generation providers that typically become over-hyped, certainly in the short term.

The mismatch between hype and adoption provides both investment opportunities and risks.

Left and right split 

We typically split this hype cycle into two parts; the left hand side, where most of the volatility and risk lies and the right hand side, where adoption typically runs ahead of the hype.

3D printing technology is a perfect example of the left hand side of the hype cycle. Looking back to 2013/14, the soaring stock prices of both 3D Systems (DDD US) and Stratasys (SSYS US) implied there were expectations that 3D printing was going to fundamentally change manufacturing and that most households could potentially own a 3D printer.

While the stock prices rose rapidly, they also fell equally rapidly as it became clear that while this was a very interesting technology, in the short term it was most suited for prototyping and small batch manufacturing.

It would not fundamentally change manufacturing just yet.