Most investors would agree that innovation promotes growth over the long-term. Such growth can translate into a stronger economy, stronger market growth, standard of living improvements or a combination of all three. The term ‘innovation’, however, is very difficult to define because it takes on a different meaning depending on who you speak with. Since I get the pleasure of interacting with our wealth partners and financial advisors daily, I often find it fascinating to hear clients’ varying interpretations of innovation amidst the current political and economic backdrop. In an overwhelming number of instances, innovation is hailed as a must-have, yet its impact is often misunderstood. Let me elaborate with an example.
It is no secret that renewable energy sources have been a tremendous driver of innovation over the past five years. Not only have we witnessed the creation of well-paying niche jobs that did not exist in the very recent past, but the asset prices of such companies (if they are publicly traded) have soared to euphoric levels. Such optimism has occurred with little investor regard to the fact that only a handful of them are generating a profit, but that is a topic for a different day. To one degree or another, we could all come to some form of agreement that such research and innovation in renewable energy makes sense and the economy is likely to benefit. Or is it? Contrarians would rightfully argue that such innovation is likely to harm the labor market over the coming years as the traditional jobs in the energy sector become obsolete. Such labor market downside could bleed into poor consumption and lapsed mortgage payments, which may then result in a prolonged economic slump. On the other hand, proponents of such innovation would argue that the net value add from higher paying jobs is more than enough to combat the short-term labor market downside. And so on. Both sides could objectively, and accurately, maintain an argument built on both data and hopeful conventional wisdom. The reality, however, is much easier to accept, or at least attempt to accept. If innovation stalls, we all lose. The scenario I described is just one example amidst a current transformation gripping the healthcare, technology, education, and energy industries, among others. From an economic standpoint, if innovation stalls, productivity is likely to stall and maybe even plummet. Wage growth may start to stagnate, which may likely promote deflation, causing equity prices to provide minimal long-term gains. None of these are things we want to experience over a prolonged period.
A quick Google search of the top innovations of the past 5, 20, and 100 years will provide a staggering glimpse of how life, business, and capital markets, have changed. Arguably for the better, but you can be the judge of that. The topics of innovation and research & development are critical to the DNA of the American economy and their impact is almost always misunderstood in the early stages of development. In the short-term, innovation will be marked by possible scenarios of job losses alongside the potential for wiping out entire companies. Once you add politicians to the mix, things can get a little complicated, but that is not of focus in this week’s commentary. The point I am trying to make is that innovation over the next 20 years will likely re-shape the way we currently experience healthcare, energy, transportation, and education, just to name a few sectors. History has shown us that our way of life, and the way we do business, tends to change following experiences like COVID-19. This time is probably no different, which means we must embrace forthcoming innovation with an understanding that it is likely designed for long-term growth, not short-term pain. In our view, this is a testament that we will see an overwhelming shift in how our businesses operate, not to mention the likelihood that the biggest companies today are not likely to be the biggest ones 20 years from now. We can factually prove this historically by tracking the shifting constituents of the Standard & Poor’s (S&P) 500.
The changes are also likely to be evident in the way investment portfolios are structured given that traditional valuation metrics may not suffice in today’s environment. I believe they will always remain relevant, to some degree, but the adaptation of the modern investment portfolio will need to consider the sentiment driven innovation factor to a higher degree than ever before. This became highly apparent in the recovery following the March 2020 COVID bear market and its impact is starting to generate permanent tracks. Forthcoming companies to publicly traded markets are likely to resemble such characteristics, which means portfolio structures must adapt in a way that allows us to participate in a changing world, yet without generating excessive risk in the process.
Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg.
All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations.
Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan.
Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.
Manufacturing data – Markit PMI – Bloomberg
Economic Policy Uncertainty data sourced from Bloomberg via The Baker, Bloom, and Davis Index.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changed in the aggregate market value of 500 stocks representing all major industries.