A Look in the Mirror: Innovation and the Markets

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.

4 thoughts on “A Look in the Mirror: Innovation and the Markets

  1. Hey man, really exciting that you’ve begun to start blogging, particularly about finance and innovation (which are two very hot and central topics). It takes a lot of guts to write stuff and put it on a public display.

    Some comments:
    1) The biggest issue I had is that I felt like you provided relatively one-sided analysis when you cited certain examples that supported your arguments.

    i. I don’t think most people would agree that the drop in oil price is driven primarily by shale oil discoveries / fracking. I think most (at least Western media) would say that the price drop is driven by changes in Middle Eastern politics. Also even if you want to make the argument that the price drop resulted from fracking, I think it’s very logical that a price drop wouldn’t happen immediately, but would happen over time (reserves aren’t going to double immediately).

    ii. Secondly, on the point of Apple / Google holding cash. I think it’s also an over-simplification to attribute their large cash holdings to their “lack of faith in succeeding with new opportunities”. I would say they are one of the largest contributors to innovation in the world. Even if you want to apply a harsher lens of cynicism, most of the cash is held off-shore (well upwards of 80% for Apple) for strategic and tax purposes.

    2) You state that the disconnect between markets and reality is because humans are driven by short-term thinking and quarterly reports.

    i. This is a fair premise, but I think you’ve ignored a couple of key factors that most academics would bring up, i.e. markets are inefficient and imperfect because information does not disseminate perfectly, financiers focus on the short-term because of an inability to accurately predict the long-term

    3) You made certain generalizations, which I feel are very dangerous. I would either cite your facts or provide some buffer to the certainty of your claims. I think if you’re going to dabble in academic topics you need to do cite your claims in order to retain a level of credibility; otherwise this is just your own philosophical banter (which is fine, but I suspect your audience will take it less seriously)

    i. e.g. “Institutional investors, hedge funds, corporations, have all lately been citing…” Although I’m sure this is true for some and perhaps even many of these entities, do you really think that all of these bodies are ignoring the importance of innovation? I think it’s difficult to assume so.

    ii. e.g. “If progress was truly exponential, companies would not be saving their cash for…” Just feels like another broad generalization to me without any underlying fact.

    iii. e.g. “It surely wouldn’t cost $4B for pharmaceutical companies to bring drugs to the market.” I think this is also pretty bold; are you refuting the importance of R&D after having had praised innovation in previous paragraphs? You said Apple / Google were unwise for holding onto cash, but here you make it seem as though the alternative of investing lots of cash is also unwise.

    4) That being said, again I think it’s really cool how you’ve started writing. Keep it up!

    Liked by 2 people

  2. 1)
    i) What politics are you referring to? If you’re talking about Saudi refusing to act as a swing producer, i would say this is a DIRECT result of the new economics of shale
    ii) Google…maybe. Majority of their value is still derived from search engine cash flows, so give me specifics. Apple? Give me and example of meaningful innovation. You are talking about my exact point – clearly they believe (and are quite possibly right) that returns to capital are higher in cash/off-shore investments. Is this a good thing for innovation? No…
    2)
    i) Academics actively argue this though. It completely depends what you consider “news” and “information”. I believe that public knowledge gets disseminated fairly fast, its just interpretation that takes people a while to get used to.
    3)
    i) My point is that they simply fail to point out the true cause – a lack of innovation. I concede that most people understand the importance of innovation (although this changes wrt which economic period we’re in), but the issue is that we have not created an environment where innovation is best fostered.
    ii) Why?
    iii) I can concede this point – still, in terms of timeline? http://www.medicinenet.com/script/main/art.asp?articlekey=9877
    Not too educated on the pharmaceutical industry but this could be better.

    Like

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