Quarter three economic and investment update

Key stats

  • Pop the champagne*, Australia hit 25 years without a recession
  • Australian unemployment holds below 6% (5.7%) in a tough global environment. or another way of looking at it, we have 12 million employed people.
  • Inflation remains low at 1.0%.
  • Interest rates will remain lower for longer (current cash rate is 1.5%)
  • Services account for 58% of all industry output
  • Manufacturing accounts for 7%
  • Average dwelling price in Australia is $614,000
  • Economic growth is surprisingly resilient at 3.3%
  • Average weekly earnings in Australia are $1,161 with a savings ratio of 8%

*Note — we mean sparkling wine

This quarter we are taking a deep dive into the world of exponential growth, the industries displaying these characteristics, why we are uncomfortable accepting future exponential projections and finally, investment ideas worth considering.

An introduction to exponential’s

Exponential growth is the compounding effect of rates of change growing continuously over time.

Two million years of evolution have hard wired our brains to process information linearly not exponentially.
 
Calculating how long it takes to cross paths with a distant migrating herd or, figuring out when to plant and harvest crops are important brain functions that have allowed humanity to advance. Our evolution has ingrained in us a linear intuition, which has poorly prepared us to reason exponential’s trends, especially beyond a short term time frame. Our bias to think linearly makes longer term exponential outcomes often seem ‘counter-intuitive’.
 
Markets are not rationale, especially when market participants allow intuition to trump reason. This is certainly the case in some industries, which presents tremendous opportunities for investors. Industries currently in the grips of an exponential revolution are;

  1. Information technology
  2. Bio-technology
  3. Renewable energy technology

To appreciate why some industries and not others are undergoing exponential growth, the best place to start is Moore’s law.

Moore’s law

Moore’s law, named in 1965 after Gordon Moore, co-founder of Intel, was the prediction that the number of transistors within an integrated circuit would double every year and that this trend would continue for the foreseeable future. A doubling of transistors essentially doubles computing power. The trend has prevailed for forty years and there is no reason to suspect it will not continue.

Computational power doubling every year has unlocked a new world of opportunity in data and technology driven industries.

Energy

We are seeing vast improvement in both energy production and efficiency of energy consumption.

Solar

Solar power is growing exponentially. Consider this;

  • At present, 1% of global energy is produced by solar power. The cost of producing solar power is reducing at an exponential rate. Solar power’s contribution to global energy production has been doubling every two years. This has been occurring somewhat consistently for 30 years… Solar power is now more affordable, even when unsubsidised, than most fossil fuels (in sunny areas).
  • 1% does not sound like much, but 1% is seven doublings from 100%. This means that on current trends, in 14 years’ time, the global supply of energy could be solar!!!

Coal makes up to 14% of Australia’s exports. This solar revolution will have a particularly profound effect on Australia’s production of thermal coal.

Energy innovation

The university of Washington has developed passive Wi-Fi. This a variation on back-scattering (used in things like pay-pass). Passive Wi-Fi allows devices to feed off other signals to then power their own. It uses 1/10,000 the energy of typical Wi-Fi and Bluetooth sets, with greater range. In tomorrow’s smart home; security cameras, temperature sensors and smoke alarms should never need to have their batteries changed.

Snowgum Financial Services Pty Ltd view — We limit our investment portfolio exposures to oil/gas/coal producers. This is a long term imperative. It is easy to see who will lose from this trend and harder to predict which company will be the solar/efficient energy providing “winner”. Renewable energy Investment opportunities are more abundant overseas, making International investment an imperative.

Bio-technology

Bio-tech has recently joined the exponential industry growth trend. The catalyst for change has been an exponential reduction in the cost of genetic and cellular sequencing.

The first sequencing of the human genome cost $100 million in 2001, today a genome can be coded for a $100. To see just how far we have come, read this article in the MIT Tech review about the future of health care apps. Additionally, further reductions are expected.

Practical applications

Genetic sequencing of the human genes and cancer/viral/bacteria cell construction has unlocked a whole new area of study in ‘Immune Engineering’.

Consider this;

  • A young girl in a UK hospital was fighting Leukemia last year. In June 2015 she was out of T-cells and ahe had no options left. In desperation, a doctor sought permission to use genetically engineered white blood cells (T Cells). The cells, produced by Celletics, a bio-tech company based in New York, had four genetic changes, two of which were only recently possible via a new technique of genome editing. The doctor wanted the young girl to be a ‘special’ — to allow her to receive the enhanced white blood cells, without a clinical trial. The last recipients of the enhanced cells were mice. The choice was either take a risk or die. The young girl was administered the cells and made a full recovery. More info here
  • In the course of writing this quarterly report, the first baby was born to three parents via a series of procedures to overcome genetic defects. This child now has DNA from three people overcoming known genetic defects in the would be mother’s mitochondria. Not only are we solving genetic based defects, we are preventing them occurring in the first place.

The bio-tech revolution is really a data revolution. Once ‘decoded’, humans are essentially giant computers full of discrete, but interconnected applications, all of which have a data based source code (DNA). Once we know and understand this code, we can pinpoint exact areas of degradation or irregularity causing health issues and either replace these broken segments or inject targeted engineered immune responses to address anomalies.

As our capacity to manipulate data improves at an exponential rate, the world in 20 years’ time might be one that has cured most, if not all, the ‘mundane’ illnesses and ailments, leaving the ‘problem’ of aging as a final frontier.
 
Snowgum Financial Services Pty Ltd view — We look to explore portfolio exposures to a diverse range of biotech producers. As it is hard to predict which company will emerge as “winners”, diversification is key. Pharmaceutical companies not supporting R&D in genetic based treatment solutions may be left behind by more effective and targeted treatments. This is a highly volatile sector and piggy backing expertise from biotech specialist managers is a prudent approach. Investing in this industry requires a strong risk appetite.

Information technology

Data is big business. We categorise technology companies into two broad categories.

  1. Providers of Digital Ecosystems (DE); and
  2. Users of Digital Ecosystems via Information Innovation (II).

Information Innovation businesses use cleverly coded applications that provide a unique insight, service, network or productivity advantage. A Digital Ecosystem business provides the technology tools and infrastructure that support the army of coders building tomorrow.
 
Key Digital Ecosystem providers are IBM (makers of computers, AI and much more), Intel (makers of processors), Samsung and Apple (makers of hardware and software), Amazon (cloud services and various other tech-based logistics), Microsoft and Google (Software, cloud based services, App engines, data storage, AI and more…).

Providing a Digital Ecosystem is capital intensive. As such, barriers to entry are high. Modern Digital Ecosystem providers all began their journey first as an Information Innovator’s piggy backing existing Digital Ecosystems. Once an innovator becomes very successful that enough capital is generated to make the transition to being a provider of a digital ecosystem.
 
Information Innovation business, like Twitter, Facebook, UBER, AirBnB, Stripe etc. have much lower barriers to entry and are nowhere near as capital intensive. Because of this, they might have higher profit margins but are also at greater risk of becoming obsolete by the next great innovation.
 
Snowgum Financial Services Pty Ltd view — We incorporate portfolio exposures to a mixture of both II and DE providers. It is harder to predict which company will emerge as “winners” in the II space, but we can be more confident in DE providers like Alphabet, Amazon, Microsoft, IBM and Apple.

Exponential summary — where to next

A convergence between information technology and bio-technology is underway.

In the quest to build smarter computers, programmers are modelling advanced elements of human brain function to guide their research. Similarly, health care research is evolving to see the human body as a series of discrete applications (lungs/pancreas/brain etc.) all of which can be decoded and then treated like a computer application needing an update.
 
Although this parallel may seem nuanced at best, we strongly believe that a convergence is occurring and we are at the beginning of another exponentially growing industry (the crossover of bio/info tech). The profitable companies of tomorrow will be the ones that drive this trend.

Our biggest ‘shot in the dark’ predictions in the future is the lateral movement of key technology companies into the bio-tech space. The likes of technology players like IBM, Microsoft and particularly Alphabet (Google) could soon be key bio-tech players as the human body becomes the next computing frontier. Another expectation we have in the more immediate future is for Apple to disrupt the car industry, more info here.
 
As an Australian investor, there is cause to be worried. The cliché Australian portfolio, underpinned by banks and mining stocks, are companies within industries that may become relics of a fast moving digital evolution.
 
Should the industries discussed continue to match the rapid growth we have seen in the last thirty years, it may be that we are fast approaching a new era, marked by vastly expanded life expediencies and artificial intelligence which looks very different to today’s life. If this continues we may soon be drawing a line in the sand from which we say goodbye to the ‘industrial age’ (a rapid and turbulent era which fueled innovations) and enter a new age of technologically evolved humanity. The likelihood of there been a profound change in ‘era’s’ will be dependent on the development of artificial intelligence and the eventual occurrence of profoundly smarter computers than human’s. I.e. Computers a billion times smarter than us or an event called singularity.
 
Regarding your investment decisions, simply ignoring changes on our doorstep will likely well see your investment portfolio also become a relic of a different era.

Disclaimer

Any advice contained in this update is of a general nature only and does not take into account your circumstances or needs. You must decide if this information is suitable to your personal situation or seek advice. Prior to investing in any particular product, you should read the Product Disclosure Statement.

Snowgum Financial Services Pty Ltd (ACN 603 703 859 is a Corporate Authorised Representative (Corporate ASIC AR number 001001581 ) of Peter Vickers Insurance Brokers Pty Ltd (Australian Financial Services Licensee (AFSL) No 229302 & Credit Licensee (ACL) No 229302 ǀ ABN 68 074 294 081).

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Originally published at www.snowgumfs.com.

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