Another month, another new investment trend.
You know what I am talking about.
We have had renewable energy, electric vehicles, and artificial intelligence (AI) before today.
These trends can pop up without warning, attract hordes of followers, and then just as suddenly fizzle out, leaving a barren landscape littered with dying businesses.
Flavour of the month ideas which cause a spike in interest before being revealed as fads.
As a consumer, you may be familiar with examples of such temporary popularity over the years; for example, the Roti Boy coffee bun, Tamagotchi pets in 1996 and the bubble tea craze that ended in 2002.
These fads come and go.
However, unlike consumer fads, investing your money requires due diligence.
Discerning whether a trend is the next big thing or the next big bust is key.
Trends that stood the test of time
Not all trends are fads.
Smartphones have taken the world by storm since the introduction of the iconic iPhone by Apple (NASDAQ: AAPL) back in 2007.
Back then, critics had panned the product as being too expensive to do well in the market.
Fast forward to today, and the number of smartphone users has grown significantly, more than tripling from 1.4 billion in 2013 to 5.2 billion this year, according to Statista.
Despite the criticism, the smartphone trend turned out to be real as major players such as Samsung Electronics (KRX: 005930) and Xiaomi (HKSE: 1810) joined the fray.
Another example would be digital ads.
In the past, newspapers and television used to be the dominant medium for advertisements.
However, the emergence of digital advertisements, backed by the rise of companies such as Meta Platforms (NASDAQ: META) and Google, upset the apple cart.
Casualties of the digital advertising wave include companies such as Singapore Press Holdings (SPH), which saw newspaper advertisement revenue fall off a cliff.
In just four years, SPH saw its newspaper ad revenue plunge from around S$400 million in fiscal 2017 to less than US$173 million in FY2022.
The third example would be e-commerce.
For context, US e-commerce sales stood at less than US$4.5 billion in the fourth quarter of 1999 but have soared more than 60-fold in 23 years to over US$272 billion in the fourth quarter of 2022.
For the whole of 2022, e-commerce sales in the US touched a trillion US dollars for the first time.
As you can see, there are opportunities for investors for trends that last.
The inherent uncertainty in nascent trends
Yet, a cynical investor may remark that the success of smartphones, digital ads, and e-commerce is only known in hindsight.
Critics would also point out that it is hard to know whether a current trend is sustainable or not.
This is a fair statement to make.
There are also trends that did not pan out.
An example would be the COVID-induced boost to digitalisation that benefitted a host of technology companies.
Shares of videoconferencing provider Zoom Video (NASDAQ: ZM) and e-signature specialist DocuSign (NASDAQ: DOCU) soared to the stratosphere as investors piled into this trend.
Prominent tech leaders in the industry projected that digitalisation will grow at a faster rate, post-pandemic.
Unfortunately, time has proven otherwise.
A sharp drop in demand resulted in this cohort of stocks getting sold down sharply across the board last year, leading to a 33% drop in the NASDAQ and a 19% drop in the S&P 500.
That is why it pays to be discerning as an investor.
The latest gaudy trend is generative AI, sparked by the release of large-language models such as ChatGPT by OpenAI.
As a result, any stock remotely related to generative AI has soared.
These include Meta Platforms, Alphabet (NASDAQ: GOOGL), Microsoft (NASDAQ: MSFT), and, of course, graphics processing unit manufacturer Nvidia (NASDAQ: NVDA), whose forward guidance has wildly exceeded all analyst expectations.
Similarly, Broadcom (NASDAQ: AVGO), Intel (NASDAQ: INTC) and Marvell Technology (NASDAQ: MRVL) have also seen their share prices surge in response to this sudden interest.
Whether this trend will last is anyone’s guess.
Hence, investors should be wary of extrapolating a popular trend into the future as stocks caught up in the hype can trade at bloated valuations.
Be wary of trends played up by the media
Another trend is the surge in airline and travel-related stocks due to pent-up demand for travel.
The idea sounds reasonable.
After being cooped up at home for almost three years, travellers are eager to take to the skies again.
But the key question you should ask is – how long will this trend last?
And what will the landscape look like should the trend shudder to an abrupt halt?
It has happened before.
One possibility is for the “high-base effect” to kick in, where comparable year-on-year numbers may no longer impress.
External events such as high inflation or an economic slowdown may also shrink consumer wallets and lead to lower spending on discretionary activities.
Travel spending may be a casualty here, as it has happened in the past.
Lessons you can learn
The examples above show that it is far from easy to tell if a trend can persist.
Even bubble tea, once written off after the bust in 2002, made a comeback in 2007 and 2009 with the entrance of Taiwanese brands Koi and Gong Cha, respectively.
These brands are still around today and are doing a roaring trade as millennials fork out money for the wide variety of colourful flavours and pearls.
Like bubble tea, generative AI could turn out to be a significant trend in the long term even if shares of the underlying companies suffer from over-optimism in the short run.
So, it is all right to extrapolate a trend if you have a basis for believing that it can continue.
But you need to be wary of valuations as over-optimism can push share prices into the stratosphere.
When reality does not match up with expectations, shares could be in for a sharp plunge.
Patience is needed to see if a trend can play out, so it is all right to be late to the game as you can then allocate your money to businesses with sturdier business models and more sane valuations.
Another method you can use is to size your position accordingly.
If you believe there is a risk that a trend could dissipate, then invest a small amount of money that you can afford to lose.
By doing so, you limit your financial exposure but can also capture significant upside should the trend play out well over the years.
Note: An earlier version of this article appeared in The Business Times.
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Disclosure: Royston Yang owns shares of Apple, Meta Platforms and Alphabet.