Got S-Curve?

August 13, 2012

Early in my investment advisory career (as was the case with most of my HPWM colleagues), I was taught by the brokerage firm for which I worked that my clients would be best served if I employed a buy-and-hold approach. The logic being that markets rise more than they decline. And so, by outsourcing the heavy lifting (translation: thinking) to mutual funds and money managers, clients would ride the market's ups and downs. If markets appreciated, clients would do well. If markets did not rise, nor would client assets.
Problem was, the markets go through extended periods, like that in which we're currently mired, during which they don't go up. During which they remain in a trading range for an extended period of time. During these periods, investors will not lose serious money. Nor do they make money.
The brokerages continue to utilize and this flawed methodology because it allows advisers (who are more salesmen, these days) to aggressively market themselves to potential clients, instead of managing the investments for current clients. Mutual funds and money managers run the investments, which usually underperform their respective benchmarks, while the advisor/salesman spends most of his time preparing for seminars, cold calling and trolling for assets.
Clients, not realizing any better, pay 1% or more to some advisor/salesman who spends more time hunting for assets than managing investments.
Eventually, we woke up. Saw that the brokerage's fast-food approach to investment management was not effective. So, we left. Formed a truly objective, independent model.
Today, we employ many methods of analysis in the determination of forward-looking opportunities. One such method is the performance index-to-time ratio, known in certain circles as the S-Curve.
The S-Curve emerged some time ago as a mathematical framework utilized by a variety of fields including physics, biology and economics. It has been used to describe many complex processes, including the development of the embryo, the diffusion of viruses, and the utility gleaned by consumers as consumption opportunities increase.
The S-Curve illustrates the introduction, growth and maturation of various processes and innovations. This makes it useful to the realm of creative and industrial innovation, finance and economics.
For our purposes, the S-Curve illustrates the introduction, growth and maturation of technological innovations, products and services. What innovation can a company harness, package and market, and how can an investor profit by that process? If you can visualize potential outcomes prior to their development, you can be richly rewarded.
The early stages of innovation typically involve the infusion of resources like capital, labor, time and commodities. Small performance enhancements occur, as the innovation is improved and refined.
Soon, as knowledge accumulates, progress becomes more dynamic. Obstacles overcome. Eventually, the innovation reaches the point where it becomes ready for consumption. This is typically where exponential growth takes place as multiple levels of expertise (engineering, design, marketing, supply chain, management, etc.) collaborate on a go-to-market strategy that will maximize consumer adoption, revenue and profitability.
At this point, incremental infusions of effort, capital and resources can result in large performance gains. Eventually, a technological advancement will approach its physical limits. Further performance enhancements become difficult.
Manufacturing. Computers. Microprocessors. Aeronautics. Automobiles. The iPod. Each is indicative of this innovation development cycle. Each incurred a robust, flexible development framework during which an innovation(s) was introduced, developed, enhanced, and eventually matured. Often, one S-Curve can give way to another. Whereby one innovation matures, but gives birth to an entirely new lineage of advancement.
Today, look no further than the U.S. energy sector. It provides an excellent examples of the S-Curve at work. Innovations in oil and gas drilling and pumping techniques, known as Fracking, have initiated a dynamic technological surge related to U.S. natural gas technology, development and distribution.
Natural gas and all of its subsidiary products, service providers, developers and distributors represent one of the biggest innovations on the American industrial landscape. The energy and natural resources sector accounts for 15% of the market cap of the S&P 500. It was already a huge piece of our economy. Yet, we believe that size and value will be markedly higher in the years to come.
The global population has reached 6 billion, and continues to grow. Global energy consumption has gone parabolic, and will only increase in the years ahead. Especially as the middle classes in emerging markets like China, India, Brazil and South East Asia continue to grow.
This is where demographics and domestic opportunities collide. And the economic implications are far reaching. Energy producers see the opportunity. The investment community realizes the implications. And so develops a confluence of expertise, resources and energy focused on converting potential into reality.
These natural gas innovations may lead to a reindustrialization of America. Jobs. Energy independence. Complimentary technologies and entirely new industries will be born as the natural gas S-Curve evolves.
Coincidentally, many of the areas forecast to benefit by these industrial developments will be the very areas that need it most. The rust belt. The Midwest. The South. All may be the beneficiaries of this S-Curve in action (article here).
Analysts believe that this surge in U.S. natural gas innovation may create up to 3.6 million American jobs by 2020. Further, this S-Curve may add another 3% to U.S. gross domestic product. Already, we have seen $226 billion allocated towards spending plans on pipelines, storage, processing facilities and power plants, all slated for the next five years.
According to the U.S. Energy Information Administration, the U.S. imported 60% of its energy consumption in 2005. By 2035, that figure could be 36%, or less. What does the U.S. look like when it is not subservient to the oil tyrants of the middle east? To the energy cartels that offer nothing but black gold and political instability? Perhaps we no longer send so many of our young men abroad with guns and the best of intentions. Why do so when they can secure high-paying jobs in a booming energy sector at home?
The investment implications before us are dynamic. Our clients will continue to realize as much. We believe that this S-Curve, unfolding before our very eyes, could do for parts of the country what the tech boom once accomplished for Silicon Valley.
Peace. Prosperity. Jobs. Security. The future is bright, so long as the government does not screw it up. For investors who know how to follow the S-Curve, the road ahead is rife with opportunities.

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