What does the crystal ball say about 2010?
In remembrance of the 1 year anniversary of the Financial Meltdown, Forbes.com has included me in a list of bloggers asked to provide an economic forecast for 2010 and also to provide some insights as to what economic markers I use in my work. This is an interesting assignment for me: few who know me would consider me to be an economist and, indeed, such training was wholly absent from my many years of college, graduate and law school. This might actually be a good thing, however, because, as discussed in this recent Robert Lezner StreetTalk post, none of the so-called “experts”–even those at the highest levels of power and prestige (except perhaps Dr. Nouriel Roubini)–predicted the financial instability that would result from Wall Street’s increasing reliance on innovative, high yield financial instruments. Notwithstanding the vast reliance put on financial expertise, based on the results of the last couple of years, it now seems like financial predictions are akin to what William Goldman said about entertainment experts who are paid to forecast whether a movie will be a blockbuster: “Nobody knows anything.”
Since none of the highly compensated experts successfully predicted the performance of the financial markets in recent years, certainly my lack of expertise on the subject should not bar me from making an economic prediction for the upcoming year. (And, it will be fun to be on the record to see if my prognostications come to fruition.)
I am generally an optimist and hopeful about the future–and there is good reason to be because times of crisis in the US have historically resulted in remarkable innovations emanating from entrepreneurs and corporations. Unfortunately, I currently feel that we are destined for a significant and steep decline in the markets in the near future, perhaps early in 2010 after the enthusiasm of the Holiday Season wanes. Given the letdown of last year’s Holiday Season, my sense is that consumer confidence, which is currently on the rise, will provide some buoyancy–if merely because people want to be able to have fun and buy things this year after existing on Spartan budgets in the last 18 months or so.
Notwithstanding a possibly better Holiday Season this year, I believe we will experience a fall in the markets in early 2010 because it is clear that the same folks whose “expertise” facilitated and exacerbated the 2008 Financial Meltdown are still calling the shots. Moreover, there is no indication that they have seen the errors in their previous aggressive pursuit of quarter over quarter returns (and their resulting huge performance bonuses). What is going on now is the epitome of Albert Einstein’s definition of insanity: doing the same thing over again and expecting different results.
Whether my predicted early 2010 market decline comports to the “W-shaped recession” currently discussed by Dr. Roubini, I cannot say. (Although this week it was reported that some forecasters think that stocks have reached a high for the time being.) However, I am confident that until there exists a new management ethos on Wall Street, as well as the “pundit class,” we are destined to repeat the consternation of the last couple of years. The investor class, which now includes most of the U.S. middle class, also must be re-oriented to understand that continuous gains should signal a warning of problems, rather than something to be sought out in an investment vehicle.
The good news is that much opportunity for successful decision-making will exist for those who avoid the conventional wisdom espoused by recognized financial experts and pundits. Much as Warren Buffett has become renowned–and even reverred–by his strict adherence to a “value investing” strategy, I believe that those investment managers who look for typically unacknowledged signals about corporate performance will prove over time to consistently outperform those who rely on traditional financial data to predict market outcomes.
As someone who frequently evaluates the intellectual property (“IP”) rights of companies to assess whether my clients should make an innovation investment decision, I know that one of these typically unacknowledged (or at best incorrectly applied) signals of long-term corporate performance is IP quality. By “IP quality” I do not mean how many patents or trademarks a company holds, but, rather, how well a particular company’s IP protects its competitive advantage. Put simply, if a company “owns the market” in its particular area as a result of robust IP protection, that company can be predicted to be able to maintain its profit margins for a longer period of time than its competitors. All things being equal, such higher overall profit margins should result in greater overall investment returns.
The problem with using this form of data is that it requires finance experts to become familiar with the often arcane field of IP law and/or to reach out to IP experts, many of whom do not possess keen business skills. The difficulties associated with inputting IP decisions into existing investment models means that such data is often ignored or, if considered at all, it is not evaluated using a legally-trained eye and so is assessed in a manner that does not accurately reflect its true value (or lack thereof) in the marketplace as determined by its legal strength or lack thereof.
Of course, in recent years, many financial models have included IP as a data input. In reviewing many assessments over the years, however, I can say that no valuation that I have seen incorporates the legal substance of the underlying legal documents when conducting the valuation exercise. Rather, the valuation typically assumes the IP is strong and that no other company owns competitive IP. This is like assuming that there is no need to provide an objective inspection of a house and its surrounding neighborhood before lending several $100’s of thousands on a mortgage. (Ooops, never mind, we’ve seen THAT “movie” before.)
The key to successful use of IP data to identify promising long-term investment opportunities is to understand that IP has legal effects and, that to properly gauge its value, the legal meaning of the IP must be fleshed out by someone who understands the underlying legal aspects. In short, investment professionals who reach out to business-savvy IP professionals have an opportunity to make better decisions in the aggregate and to, possibly, outperform the market by identifying and acting on non-traditional forms of investment data.
I look forward to re-visiting my prediction of a market slide early next year. For the good of the country, I truly hope that I am wrong. I do know, however, when economic performance is pushed-down to the micro-level, those companies that protect their products and technology using a robust IP strategy will invariably outperform their competitors who do not. Those who recognize and utilize this signal in making investment decisions can hope that their market predictions will be better than those who ignore or improperly apply such data.
photo credit: Flickr/GarryKnight