The Innovation Wave and Secular Market Trends
This is the second of a series of articles dealing with the ideas of Harry Dent, which have been often used as a justification for the continuation of the secular bull market that began in 1982. This article discusses Dent's innovation wave, which creates a "new economy" which justifies high valuations on stocks of companies participating in the new economy. Dent relates the innovation waves with a demographic trend he calls the spending wave and with the generational concepts developed by Strauss and Howe. In Dent's formulation of his wave theory he holds that the secular bull market that began in 1982 won't end until the 2007-2010 period, when the spending wave peaks and when the current "growth boom" of the "information economy" peaks. I find Dent's synthesis fascinating and I believe it holds a lot of truth. However, I believe that Dent formulated his theory improperly. In a previous article I showed that, properly formulated, and allowing for a recession beginning this year, Dent's spending wave actually peaked around the year 2000, not 2007. In this article I show that Dent's concept of the innovation wave applied to both the present "information economy" and previous economies, is consistent with the secular bull market ending around 1999 and not 2007. Indeed, as I have mentioned in earlier articles, I believe it ended last year and a 10-20 year secular bear market has begun.
Harry Dent first described the innovation wave in his The Great Boom Ahead as a four-part economic cycle. Here I will describe this concept, extend it further back in time, and apply it to the question of future stock market trends.
The Product Innovation Cycle
All new products and technologies go through three stages of growth: an innovation phase, a growth phase and a maturity phase. It takes about the same time for a new technology or product to go from zero to 10% adoption (the innovation phase) as it does for it to go from 10% to 90% adoption (growth phase) and as it does from 90% to 100% (maturity phase). These three stages are shown graphically in what is called an S-curve.
The S-curve for the automobile is shown in Figure 1. Very few people in 1900 possessed automobiles; it was a toy for the rich. Between 1900 and 1914 the automobile went through its innovation phase, at the end of which Henry Ford introduced the assembly line. With the assembly line automobiles became affordable for the middle class and they moved into the mainstream. Between 1914 and 1928 the automobile went through its growth phase, during which the potential automobile market increased from 10% to 90% of urban families.
The Innovation Cycle for the Economy
Dent extends the S-curve concept to the entire economy. He notes that some periods are richer in entrepreneurial activity than others. One such period was the turn of the twentieth century. Figure 2 shows a graphical representation of when many of the common mass-market brand-name products like Gillette razors, Coca-Cola or Ford automobiles were introduced. Also shown are estimates of when many key inventions were commercialized (a lag of one decade was incorporated to represent the interval between invention and commercialization). Both the brand-name and invention data were combined into a composite innovation curve. This curve shows that the cluster of innovations that led to the development of our modern mass-market economy occurred during the 1890's through the 1910's.
Dent refers to periods like these as the innovation phase for an entire "new" economy. Initially, the new technologies operate on the margins of the old economy. Gradually, the new technologies/products are adopted by a small, but significant, fraction of the economy. At this point, the nascent economy enters its growth phase, during which the new technologies/products move into the mainstream. Thus far, the development of the new economy follows the same S-curve as does the development of an individual product or technology with an innovation period (0-10% adoption) followed by a growth boom (10-90% adoption).
The next phase of the developing economy is the shakeout. The shakeout occurs when many firms, attracted by the opportunities of the growth boom, encounter increased competition as the market becomes saturated, resulting in increased price competition and business failures. The shakeout is a period of deflation and depression. It is also a period of innovation, but of a different sort.
During the shakeout, new technologies and products are developed that complement and improve upon the original technologies. Of the many new-economy companies that existed at the end of the growth period, only a few successfully employ the new complementary technologies and products to win the competition and survive the shakeout. Following the shakeout, a new growth period begins, during which improved versions of otherwise mature products are sold. This period is called the maturity boom.
Another way of describing the maturity boom is the growth phase of the mature-type innovations. In this concept the shakeout is the overlap of the mature phase for the basic innovations and the innovation phase of the mature innovations. Figure 3 shows a diagram of this concept. The complete economic cycle is as follows: (1) innovation period; (2) growth boom; (3) shakeout; (4) maturity boom.
A good example of how a maturity boom innovation differs from a basic (growth boom) innovation is mainframe computers versus personal computers. When the mainframe computer was developed in the late 1940's and 1950's, they were thought of as engineering/business machines. Among the earliest computer languages were FORTRAN (FORmula TRANslation) for scientific/engineering applications and COBOL (COmmon Business Oriented Langauge) for business purposes. Early computers were well-suited for tasks similar to those that an earlier generation of mechanical devices (tabulators, adding machines etc.) had been invented to perform. These devices had been innovations around the turn of the century and had spawned such corporations as IBM, NCR and Burroughs. These business machine companies adopted mainframe computers as improved business machines. By doing so they prospered in the postwar maturity boom. When minicomputers arrived in the early 1960's they were seen as cheaper versions of main frames and used for much the same purpose. Thus, the minicomputer can be seen as merely an extension of the mainframe computer and not as a new basic innovation.
In contrast, when the microcomputer was first developed in the 1970's it was not seen as a smaller version of the minicomputer. The microcomputer was first commercialized as a consumer product: the personal computer or PC, and not as an improved business or engineering machine. After a while, it became clear that a PC was not a calculation device (although it can certainly be used as such), but rather a creative/thinking tool. People wrote documents, created art (both visual and audio), analyzed data, and played games. All these activities are creative rather than repetitive tasks. The applications for the PC are dramatically different from those of the mainframe or minicomputer. Rather than an improved way of doing a pre-existing function they introduced a new function and so constitute a new basic innovation and not a mature innovation.
By looking at the timing of important basic innovations we can obtain an idea of when each economic cycle began. Figure 4 shows the composite innovations from Figure 2 along with more invention data for earlier periods. Four periods of enhanced innovation can be identified, which are coincident with four major innovations. The first cluster is centered in the 1770's and is associated with the early textile manufacturing innovations that comprise the beginning of the Industrial Revolution. A second cluster, centered in the 1830's, is associated with the development of the railroad. The third cluster centered in the 1900's is associated with the development of the automobile and other mass-market consumer products. A fourth cluster of innovations in the 1970's and 1980's is associated with the internet and personal computer revolution. Like Dent's spending wave, the periods of heightened entrepreneurial activity designated by these clusters of innovations can be thought of as an innovation wave that periodically surges through the economy, beginning a new economic cycle. Table 1 lists the four economic cycles initiated by the four innovation waves:
Table 1. Innovations characterizing the four Dentian innovation waves for the U.S since the industrial revolution
|Innovation Wave||Example Basic Innovation||Example Maturity Innovation|
|Cotton/Textile (1762-1794)||Spinning Jenny (1764)||Clipper Ship (1834)|
|Railroad/Industrial (1831-1847)||B&O Railroad (1830)||Refrigerator Car (1872)|
|Mass Production (1882-1907)||Ford Motor (1903)||Automatic Transmission (1940)|
|Information (1961-1981)||Microprocessor (1972)||--|
These waves gave rise to new economies with the same name. For my book Stock Cycles I collected extensive data on each wave or new economy and applied S-curve analysis to each to determine their growth and maturity booms. Readers are referred to Stock Cycles for details on how these waves are constructed. The innovation waves or new economy cycles are shown in Table 2.
Table 2. Dates for Dentian Economic Cycles in the United States
|Economy||Innovation||Growth Boom||Shakeout||Maturity Boom|
|Agricultural / Commerce||--||--||--||-1809|
|Cotton / Textile||1762-1794||1794-1834||1834-1843||1843-1861|
|Railroad / Industrial||1831-1847||1847-1888||1888-1895||1895-1917|
Relation Between the Innovation Wave and Secular Trends in
the Stock Market
The growth boom for the information economy is still ongoing. Extrapolation of progress so far suggests that the growth boom would end around 2007. The growth boom for the mass market economy ended in 1937 and that for the railroad/industrial economy in 1888. Each of these growth booms were associated with a secular bull market that ended eight years earlier (in 1929 and 1881) as has been described previously. This correspondence suggests that the secular bull market associated with the information economy should have ended around 1999, which is consistent with the previously advanced idea that the secular bull market ended in 2000.
Dent did not do a detailed analysis of the spending wave for the economy. He used the single S-curve for the automobile industry to represent the mass-production economy. This specific S-curve shows the end of the automobile growth boom around 1929 and suggests that the end of the 1921-29 bull market corresponded with the end of the growth boom for the entire mass-production economy. Following this concept it is perfectly natural to associate the end of the present information growth boom in ~2007 with the end of a 1982-2007 secular bull market.
The more comprehensive analysis of the mass-production economy using many industries found in Stock Cycles shows that the growth boom did not end in 1929. That is, despite the Depression, the mass-market economy continued to roll out until 1937, eight years after the bull market ended. Similarly, the railroad/industrial economy growth boom continued after the stock peak in 1881. These two examples show that the information economy can continue its rollout without a continuation of the bull market. What this means is the commonly-held idea that the "new economy" justifies a continuation of the bull market to levels in excess of 30,000 on the Dow by 2007 or so is not supported by the historical record. Dent's idea that there is a new economy that won't be completely in place until around 2007 is perfectly compatible with the idea that the secular bull market ended in 2000.