Investment Climate Oct. 2022: Bullish on Innovation

Market weakness persisted in the third quarter of 2022, with the broad equity indices ending September at or near their lows for the year. Inflation remains elevated, and the Federal Reserve raised the target range for the federal funds rate to 3% - 3.25% in its September meeting, with most observers expecting another 0.75% increase at the Fed's next meeting in early November.

Many investors sense that the Fed is absolutely willing to cause a recession as a way of reducing demand for goods and services, i.e., combating inflation by reducing demand instead of increasing supply through economic growth. In fact, Fed chair Jerome Powell has stated quite plainly that the Fed is committed to "taking forceful and rapid steps to moderate demand" in order to curb inflation, and has also declared that "reducing inflation is likely to require a sustained period of below-trend growth" (both statements from the press conference of September 21).

With statements like these, and with the generally anti-growth policies coming out of Washington DC, it is little wonder that the investment climate has been generally awful during the third quarter; although we note that our Growth Portfolio companies did perform slightly better than the overall market during the period. Year-to-date, however, it has been an extremely ugly environment and one in which we have seen excellent companies punished as much or even more than companies we consider to have inferior business prospects, which is actually typical of brutal selloffs in previous bear markets as well. When things are bad, the selling is indiscriminate. Then when sentiment turns positive again, it is the companies with better future business prospects which tend to rebound much more strongly than the overall market.

Historically, September has (on average, although not every year) been the worst month for stocks when compared to other months of the year, using data going back to the 1920s. This phenomenon is so widely known on Wall Street that it is sometimes dubbed "the September Effect." In addition, most bear-market bottoms have taken place in October, although once again this is an average, and does not constitute a rule that we would incorporate as a way of trying to time the market. While we would certainly be happy to see the current bear market turn around this October, we make it abundantly clear that we cannot forecast the next directional move in either the stock market or the economy, and that we are highly skeptical of anyone else who claims that they can do so (especially with enough consistency to predict its changes of direction year-in and year-out for decades at a time).

Rather than attempting to predict market and economic swings, and somehow time those reverses for long-term profit (a demonstrably fruitless endeavor), our decades of experience point to a much more rewarding target for investment capital: human innovation!

Whether the economic climate is good, bad, or indifferent, history shows that men and women will always innovate, and will always look for new and better ways to solve problems, do things better, and improve their environment, whether on a small scale or on a much larger scale. The word "innovation" contains the root sound nova which comes from Latin novus, meaning "new," and which is also related to the Greek word neos and the Sanskrit word navah, also meaning "new." Whether referring to a new way of treating refractory forms of cancer (such as those therapies that our Growth Portfolio company Compugen is pursuing), a new way of approaching fire alarms and school-entry locks (such as those offered by our Growth Portfolio company NAPCO Security Technologies), or even a new way of offering people a caffeinated beverage (such as those pioneered by our Growth Portfolio company Dutch Bros), innovation has the goal of improving lives in some way. And that concept is one that never goes out of season!

To be clear, it should go without saying that we can create a society (and an economy) that is either more conducive to innovation, or less conducive to it.

And it should also be fairly obvious to even the most casual observers of the economy over the past several years (and, some would argue, past couple of decades) that conditions for launching new companies and new innovations have not been ideal, and in many ways have been made worse by a variety of factors, ranging from tremendous increases in education costs and an explosion of student debt, to a venture capital and IPO landscape that is nothing short of dysfunctional (according to our observation), to Covid-response policies which in most cases were devastating to smaller businesses while favoring large incumbents.

And yet, despite these undeniable obstacles (and literally dozens or even hundreds of others that we could list, if we really wanted to write them all out), men and women will continue to innovate. It is what we do, and what we will always continue to do! If you look back at other periods of economic and market turmoil, including the 1970s and the 1930s, you can find numerous examples of innovations which came out of those difficult times, some of which are still powering valid business models to this day.

And so, during periods such as the one we are currently going through, we are not spending our time trying to guess when the market will turn around, or what the Fed's next move will be, or whether or not we are in a recession (and if so, exactly how long it will last). Instead, we are busy looking for innovation, finding businesses whose innovations are going to change the world for the better, and talking with the management teams of the innovative companies that we already own for our investors in our portfolios.

We are bullish on innovation and we would advise investors (and policymakers) never to bet against it!

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