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
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 thespending 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
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 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: