Investing Under The Law Of Accelerating Returns
“This time it’s different—the most expensive words in investing.” So eminent investor Sir John Templeton has opined.
Foolhardy though it may be, I am about to assert exactly that, i.e., this time it is different. It is different because the entire world has reached a sort of tipping point whereby technological change is accelerating at a pace not seen before in human history. Globalization, fiber optic cables, the internet, the Cloud, social media, artificial intelligence, genomic breakthroughs, synthetic biology, 3D printing — the list goes on — it is all happening at once. New innovations are communicated globally and instantly. And private enterprise — ranging from the garage start up to the global corporation — is the main (though not the only) vector for this acceleration of technology. It seems clear that investors will want to ride the technology train.
"In Omega we have in the first place the principle we needed to explain both the persistent march of things towards greater consciousness."
-Pierre Teilhard de Chardin, The Phenomenon of Man, 1941. (Kindle Location 4960) Evergreen Books.
"…given the emergence of life, the emergence of a technology-creating species—and of technology— is inevitable. Technology is the continuation of evolution by other means, and is itself an evolutionary process. So it, too, speeds up."
-Kurzweil, Ray. The Age of Spiritual Machines: When Computers Exceed Human Intelligence, 2000
I am not arguing that the stock market must necessarily continuously rise. Any one factor on the laundry list of negatives — global problems like Ukraine, valuation bubbles, unfavorable advanced country demographics, tax hungry populist governments, negative income distribution fallouts, central bank profligacy, Obama — could send the market spiraling downward. But the acceleration of technology as compared to the past is something that is new and, barring some truly catastrophic set of events, in the long run more important than all these other factors.
As I have mentioned before in this blog, in 2001, in an increasingly well-known book called The Age of Spiritual Machines, futurologist Ray Kurzweil placed this acceleration of technology in the context of human evolution. The acceleration of technology has become the dominant factor in human evolution. Kurzweil made a number of forecasts including one regarding virtual reality (was he thinking of Oculus?) and another that has artificial intelligence entities replacing humans as the next phase of human evolution (you do not have to accept Kurzweil’s views on AI replacing humans to appreciate his entire historical thesis.) Kurzweil is actually just one of a number of futurologists forecasting an acceleration of technology. Above I quote French Jesuit Pere Teilhard de Chardin who in his 1941 book (that is when the book was submitted to his less than enthusiastic Jesuit superiors) talked about an Omega point which bears a lot of similarity to Kurzweil and other futurologists’ Singularity.
At any rate, Kurzweil posited something called the Law of Accelerating Returns which stated that technology was accelerating at an accelerating rate. Kurzweil’s “Law” is actually a forecast and is not based on some kind of rigorous mathematical proof. At its core, it is not really science. It is a belief, a belief based on a view of mankind’s history whereby evolution is taking the genus homo to ever higher levels of intelligence. I confess. I am a believer. I think Kurzweil’s Law is a pretty good description of what is happening today and one that I think investors should bet on.
Buy the Users of Technology – the Successful Global Enterprises
I have argued what follows in prior blogs but it is a central theme that needs repeating. So much of the new technology comes our way via new startups. Unfortunately, venture capitalists who are immersed in the technology and who have insider access to a company’s books have an informational advantage over the average public investor including many institutional investors. (The SEC’s witch hunt against insider trading only makes this situation worse.) Obviously well-heeled investors and institutions which have investment access to the better run venture funds are in a good position.
But all is not lost for public investors. The major successful global corporations are the users and therefore the beneficiaries of the crescendo of new technologies. Smart managements will embrace the new technologies. This is a major prop underlying the stock market as a whole, a prop as I shall discuss, offsetting the laundry list of negatives.
This point was brought home to me by two recent examples. The first was an ad from an advisory service called Investing Daily which claimed to have found seven robotic mining stocks that would make investors rich. It turned out when you clicked into the ad that the majority of these stocks were traditional Australian mining names, led by Rio Tinto (RIO) and BHP Billiton (BHP). Bait and switch? Maybe not. These Australian companies are becoming big users of industrial robots and driverless vehicles in their mining operations. Exactly in line with my thesis. (Of course in the unlikely event Chinese demand for Australian ore dropped to zero all the robots in the world would not help. But the accelerating technology does change the investment picture.)
A second example is a recent Fast Company article about GE and its CEO Jeff Immelt. GE makes lots of things but among them is a 220 ton locomotive called Evolution. What could be more nineteenth century than a monster locomotive? Well Evolution. According to the article, “it is in many respects a hurtling computer. Its array of sensors and data-collecting devices complements its bulky mass with a sleek, digital agility that will grow only more impressive and more significant with time.” The Industrial Internet Immelt calls it. The same story with GE’s jet engines and gas turbine power plants. According to Immelt, “the marriage of big data analysis and industrial engineering promised a nearly unimaginable range of improvements.”
The risk with all this of course is that the big global company you own will itself be disrupted by accelerating technology. As an extreme example, you do not want to own stock in the next Eastman Kodak which saw its decades old near monopoly on cameras annihilated by the digital camera. Great companies will have to constantly reinvent themselves in the face of accelerating technology. Thus the software king Oracle (ORCL) is now scrambling to get onto the Cloud. IBM (IBM), whose origins trace back to the 1880s, is in the midst of yet another reinvention as its hardware business has ebbed away to Asia. (While its traditional businesses downsize, IBM is throwing tons of cash into an AI project called Watson. Brilliant move? Quite possible.)
Another Strategy – Companies that Act Like Venture Capitalists
Another way to invest in tech in the public markets is to buy stocks of companies that are aggressively reinvesting their retained earnings in new tech ventures. Instead of getting dividends which are taxed, investors have company managements reinvest for them and hopefully reap capital gains in the future. The tech managements presumably know their businesses better than anyone else and in many cases have piles of cash to put to work. Google (GOOGL) is an example here. Investors get geniuses Larry Page and Sergey Brin to reinvest for them in things like Google Glass and driverless cars. In fact, in 2012 Google hired Kurzweil himself to develop an AI as powerful as a human. Facebook (FB), Softbank (9984:Tokyo), and Amazon (AMZN) are other obvious examples but many of the large tech firms to some extent engage in what could be called venture capital activity.
The problem with this is, if past research is any guide, companies’ venture capital efforts 1) are often stepchildren that are not allowed to compete with companies’ core businesses or 2) directed into activities outside core businesses where companies do not have a knowledge edge or 3) cannot help by their big corporate nature stifling budding entrepreneurship.
Robert J Gordon-Professor Buzzkill?
Not everybody shares Kurzweil’s views. In a widely discussed paper (“Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds”, NBER Working Paper No. 18315,August 2012), respected Northwestern professor Robert J Gordon wonders if the progress and innovation the US has seen over the last few hundred years are not one-off phenomena. Gordon is not a believer. Gordon goes on to classify US innovation spurts as belonging to three Industrial Revolutions, i.e., 1750-1830 (steam, railroads), 1870-1900 (electricity, internal combustion engine, running water, indoor toilets, communications, entertainment, chemicals, petroleum) and 1960-present (computers, the web, mobile phones). According to Gordon, this last Industrial Revolution has pretty well run down.
Besides not sharing his pessimistic view of the technological future, I find Gordon’s classification of US innovation progress into three Industrial Revolutions somewhat arbitrary. I see US innovation progress as a continuum, more in line with what one would expect from the law of accelerating returns.
But more importantly, Gordon goes on to argue that future economic growth:
”will be held back from the potential fruits of innovation by six ‘headwinds’ buffeting the U.S. economy, some of which are shared in common with other countries and others are uniquely American. Future growth in real GDP per capita will be slower than in any extended period since the late 19th century, and growth in real consumption per capita for the bottom 99 percent of the income distribution will be even slower than that. The headwinds include the end of the ‘demographic dividend;’ rising inequality; factor price equalization stemming from the interplay between globalization and the Internet; the twin educational problems of cost inflation in higher education and poor secondary student performance; the consequences of environmental regulations and taxes that will make growth harder to achieve than a century ago; and the overhang of consumer and government debt.”
Frankly, I share Professor Gordon’s views on the headwinds. Not only that, I would add a seventh related headwind which is America’s second anti-business President, Barack Obama (the first being Franklin Roosevelt). Obama has raised taxes, demonized businessmen, presided over a Federal takeover of the health care, mortgage finance and student loan industries, made the banking sector a target of a never ending fines and penalties, declared war on coal, wasted billions on unproductive and environmentally damaging green energy projects (how many birds have the windmills killed?), dumped all kinds of regulations on a wide swath of the economy and embraced an extremist anthropomorphic climate change view.
But headwinds or not, technological progress goes on and the acceleration process is likely to continue. Technological progress continued even in the dismal 1930s. In the face of macro/regulatory headwinds, companies may have reason to embrace new technologies even more enthusiastically. They will internalize the new technologies and, as with the locomotives, improve their own productivity even as they face adverse US macro and regulatory climates. Moreover the top US companies are global. The same headwinds are not found in all countries.
Stocks may still outperform in this environment. Corporate profits will maintain their current historically high percentage of GDP even as the headwinds cause the economy itself to underperform. Artificial intelligence in particular will infiltrate everywhere. Every company will become an artificial intelligence/robotics investment. And the biotech revolution will go forward on a global basis.
Parenthetically, as argued in prior blogs I do not share the view that the current stock market rally is simply the product of a slopping over of excess liquidity caused by the QE programs.
A Note on India
My strong endorsement of the new Modi government remains unchanged. Indian stocks have been correcting since the election. The Iraq driven spike in oil prices has not helped as India is dependent on foreign oil. It is fair to say that Modi is so far off to a so-so start which should not be surprising. Virtually all the needed structural reforms in India will set off riots as those adversely affected will protest. Modi is not superman.
Globalization, especially fiber optic cables, has unleashed the high tech Indian genius and plugged India into — to use a prescient Teilhard word — the “noosphere.” It has been estimated for example that IBM has more professionals working in India than in the US. The U.S. may no longer be the top city where technology professionals go to for business. As reported in the Wall Street Journal, four of the top five cities that technology professionals moved to last year were not in the U.S. but in India–Bangalore, Pune, Hyderabad and Chennai. Move over Silicon Valley. Indian high tech is part of the global acceleration of technology story. (Along with China, Israel, the UK, Japan, Switzerland, Scandinavia, Australia, Canada, etc., etc.)
Still, the Indian IT industry would do better if it had a bigger domestic market to serve. The world awaits the Modi reforms.