Markets and the years ahead: The Investment Thesis

In times of turbulence, as in the first weeks of this year and possibly for a while to come, it may be a constructive and calming exercise for some to step back and reflect on the longer-term investment outlook. As markets rise and fall, sometimes violently, stock markets at least tend to generally rise, more or less in step with an economy that generally tends to do the same. But not all stocks and all investments rise or fall equally, and so it helps to have a thesis, I believe, as what may be a useful guide, to filter out and filter in, to work through its rationale and update as events may come to pass, and even trade around its edges as the short-term opportunity presents. This, then, is my thesis:

1. The conventionally perceived borders between industry categories — finance, retail, healthcare, transport, communication, real estate, and so on — are fading, as technology, and digital technology in particular, is infiltrating all of them to create a bridge of bits and data like a common language, both within the enterprise and externally in its interaction with customers, suppliers, and partners. It is a process that’s been playing out and seems unlikely to reverse; if anything, perhaps to gain momentum.
2. While such technology adoption and widespread adaptation may be uneven among sectors, companies, and customers, it is a universal thing that at a minimum suggests that technology itself — as a sector classification — is either too narrowly defined or else so broad as to be rendered senseless. By the same token, the conventional groupings of growth and value stocks — growth typically associated with technology, and value with everything else — are now similarly irrelevant.
3. The more indicative boundaries in the economy described are between vendors of products (defined to include services) and operators of networks, the latter including marketplaces, exchanges, platforms, messaging applications, artificial intelligence and other data collectives, blockchain, and other connected systems characterized by network topologies and effects. Sometimes networks offer products to their customers, and sometimes what may seem like a product is a network in the making. The demarkation of the two is not always obvious.
4. With that in mind, the challenge for the product vendor is that product requires continuous reinvention, upgrade, update or price reduction, because disruption always happens and is an ongoing threat, even if only as a threat. With the digital transformation of all things, disruption happens ever faster, competition among product offerings increases, and the result is commoditization. This breeds shrinking profit margins and, eventually, disappearance (sometimes by consolidation, but not always).
5. The networks, on the other hand, tend to be resilient. Consider the big telecommunication network of Ma Bell, the dominance of which, after almost a century, had to be controlled by regulation, and even then the resulting offspring have stayed dominant. Consider certain banking institutions (networks of borrowers, lenders, issuers, investors, etc.) that in many cases have survived as long or longer. While General Electric is a shadow of its former self and IBM continues to reinvent its business out of sheer necessity. The advantage of the network is its multitude of links, or in more technical terms its network effects.
6. But not all networks are alike, and not all network effects are positive (as sentiment, for instance, may drive social network engagement as well as disengagement). What’s more, with the emergence of digital networks in the form of apps, layered on hardware networks in the form of mobile devices (including electric vehicles), and hosted on cloud networks where the data is stored, the analysis is now much more complicated than before. It not only needs to factor in these many layers in the architecture, but also the multiplying network characteristics that are growing in complexity: centralized, decentralized, or distributed topology; single-, bi-, or multi-directional flows; single or multiple levels of the user offering; clustering that may or may not happen, or sometimes to excess via power law effects; the strength or weakness of the ties; the quantity and quality of engagement; the degrees of optionality driven by new use cases or directions; and network effects that may be based on users, data, or both.
7. It follows that not all networks are valued equally. But we are at a sufficiently late stage in the evolution of digital networks that there are ample cases to look to for comparison, analogy, backtesting, and other clues that we may find along the way, to form a decent enough view of the subject asset.
8. Financial markets, where these assets are priced and funded, are complex network systems also, and here as well a lot of the analysis requires a form of network understanding. In this case, the network is largely moved by sentiment, clustering among a series of financial classes, often interacting but with uneven strength or frequency, where the power law effects that can be found in any large multi-directional network may lead to influential concentrations that determine market flows, bordering on centralization.
9. Cryptocurrency in many ways embodies all that is discussed — not only as a digitally networked product with a networked use case and networked applications in all industry segments, but as a financial market that shapes the value of the currency and the underlying product itself. In one way of looking at it, cryptocurrency represents an equity interest in a network asset, where the price is a direct real-time reflection of the network’s growth and nature. Also, reflexively, vice versa.
10. In the environment described — technology-centric, highly disruptive, and often exponentially (rather than linearly) manifested — deflationary tendencies have grown with time and at a minimum serve to counterbalance inflationary waves that sometimes swing about. In a deflationary environment, cash gains in value and adds to that of the cash-rich cash-flowing enterprise. It is said, by some, that cryptocurrency is a hedge against inflation: Perhaps… but it’s too soon to tell… and it is just as likely, if not more, that as a form of cash, if you will, cryptocurrency hedges deflation.

My thesis, as you have by now surmised, is that network assets will (continue to) accrue the bulk of value in financial markets, and that the cash-rich or prospectively cash-rich variety will benefit most in the newly technified economy. The challenge is to evaluate these network assets properly — an exercise that is more intricate and fundamental than a discounted cash flow model or price-to-earnings ratio — which may be sound enough, but are at most a final output. Another is to not lose sight that this is just a thesis, only that, and not a law, and like such things are often prone to be, it may be incomplete, subject to wild market swings, or outright flawed. But it hasn’t been so far, and until then I doubt it will be.

Related reading:

Linear perception, exponential change and the new value

The mystery of new frontiers

Fractals and the market voice

The end of cycles (Part 1 & Part 2)

Networks 3.0: Defined by digital dimensions