The markets are a pretty good reflection of human affairs – the movement of money and the valuations of companies is generally controlled by the collective perceptions of the current and future states of society. They serve as a numerical diary written by the conscious and subconscious decisions of every person, and thus, imbedded in the erratic and seemingly Brownian fluctuations, we observe a manifestation of the Self.
Humans are generally forward thinking, and this concept flows as a direct link into the markets. Market participants can be likened to fortune tellers; each one predicts the future as a source of income. Many theories and models have been used to explain what the future will look like – from philosophical discussions, to the intersection of statistics and financial theory, to psychology. As such, the markets will reflect a combination of the current and the potential future states of society.
To understand the markets, a good starting point is its history – which is in fact quite fascinating. There has consistently been a delay between the fundamental state of the economy, and the time that it takes to surface into the markets. An example is the recent drop in oil prices, which is attributed to technological breakthroughs that made shale oil an economical energy source. Although the technology was available 3 years ago, by the time the fat lady sang, crude oil prices had dropped 50%. Entire nations were blind-sided, and they are still bleeding.
Similarly, because of internet start-ups like Pets.com, it took many years of irrational exuberance for the dot.com bubble, at the turn of the century, to pop. Pets.com was able to secure $300Mn in venture funding, even though they lost money on most of their sales. It was not a sustainable business model, which people only realized at the climax of the party. When the bloodbath ensued, over 5 trillion dollars in market value was destroyed within 2 years. And even more recently as most people know, in the past decade people were being given debt that didn’t deserve it. After a few short years of euphoria, the Great Recession began in 2008 with the death of Lehman Brothers, an institution that had weathered the two world wars. Bubbles kill.
The disconnect lies in the fact that humans are driven by short term thinking – within 2 years, and often shorter. If you agree that the markets are a reflection of the human psyche (adjusted for reality), then this fact becomes obvious when you look at the time horizon for Wall-Street – results are expected within 3 months.
The cash hoard that companies like Apple and Google are sitting on is a prime example– the numbers are literally unfathomable. For the two companies respectively, cash of $180Bn and $60Bn is easily visible on paper, and we see astronomical numbers like this thrown around constantly. However, commonality is not mutually exclusive from absurdity. Companies holding this much cash are doing it simply because of their lack of faith in succeeding with new opportunities.
The repercussion of short-term thinking is that the progress of technological innovation – the advent of super-computers, global networks, artificial intelligence, sustainable transport, and self-sustaining energy – will take longer than normal. Instead of investing in progress, companies will choose to earn a lower return and focus on shedding costs. Marginal improvement will be the focus of quarterly and annual results, and progress will slow down. The upcoming global recovery will be sluggish mainly because of the focus on marginal improvement, and the lack of propensity companies to “man up” and take risks. Institutional investors, hedge funds, corporations, have all lately been citing “economic uncertainty”, “customer behaviour”, and even “bad weather” as a cause of mediocre returns. This is grossly overstated – true progress for developed nations comes from innovation.
Innovation can either be linear or exponential, but the goal should always be the latter. There is no courage in the status-quo, and successful nations were not developed through conventional wisdom and complacency. The Western world has been defined by its revolutionaries – characterized in the moments that leaps of faith were taken into unchartered territories. When the internal combustion engine and steam turbines became feasible, we saw the birth of the industrial revolution. In the 20th century, electricity and cars changed the world, as did the advent of personal computers and the internet. What about today?
People will point towards the chart of exponentially improving innovation, but the promise of a better tomorrow is always a few years in the future – it never actually comes. If progress was truly exponential, companies would not be saving their cash for an apocalypse, cars wouldn’t be using the same energy source they did 50 years earlier, and it surely wouldn’t cost $4Bn dollars for pharmaceutical companies to bring drugs to the market.
There is however, a positive – a really good one. Although short-term thinking is innate in humans, it does not have to exist at the level of a collective society, and thus we can solve this problem of “sluggish growth”. In industries where people are encouraged to innovate with minimal restriction, specifically in the world of software and bits, progress has in fact been quite impressive. Moore’s law has held true, and the internet has become a significant part of society. In order to replicate this progress across all industries, there needs to be a shift in the incentives of investors, which requires a structural change across developed nations.
I believe that the solution lies in changing the roles and dynamics of governments and investors, and adding a third class of elite decision makers – experts. More on this soon.