Another day, another news title or conversation about COVID-19 and its’ aftershocks. Whether it is coming from the Fed Chair Jerome Powel, a small business owner, or you and me, it gets redundant. Many yearn for a degree of pre-COVID norms. Nevertheless, as we gradually adapt to the stubborn social standards spawned by the pandemic’s reaction, we cannot forget the opportunities it has created and behavioral expectations that will likely remain. This shift in the status quo and the consumer’s preferences accompanied by continued technological advancements have laid the groundwork for the “Age of the New Disruptor” in current industries.
Throughout history, disruptive industries stubbornly maintained their economic dominance. From the Steam Engine in the late 1700s and electricity in the early late 1800s to the computer in the mid-1970s, and the internet in the late-1990s, disruptive industries have historically risen to be the largest outperformers. A fundamental reason the S&P 500 Index and the overall market continue to trend higher (inflation, additional investors, investing simplicities, and organic growth aside).
If you look at a simple demand curve in a vacuum, innovation shifts that demand curve to the right, lowers costs, and lowers the price. In short, innovation is the economic invisible hand that controls the fundamental economics while increasing economic profits, as seen below. With this said, many disruptive products experience price inelasticity (or the proportionate change in price is less than the proportionate change in demand) as investors or consumers either do not know the fair value of the product/service or they believe that they are paying a premium for the favorable asymmetries’ innovation yields.
Economics of an Innovator
Source: Catalyst Capital Advisors LLC
D1= Demand curve before disruptor/innovator changes tastes/preferences
D2: Demand after disruptor/innovator changes tastes/preferences
S=MC: Supply equals marginal cost
Π1: Economic profit before disruptor/innovator
Π2: Economic profit after disruptor/innovator (yellow shaded and tan shaded combined)
AC1: Average total costs before disruptor/innovator
AC2: Average total costs after disruptor/innovator
Additionally, innovation is a synergistic unifier that connects industries and the global marketplace. The commonality between modern startups is that most bridge the gaps between two platforms or sectors. The best example of this is the Internet. In modern society, the internet is the platform or, to a degree, the adhesive agent that connects multiple and (a lot of the times) vastly different industries into one “innovation.” With this said, innovation remains a product of compounding, and many times a disruptive industry is born from the snowballing effect of multiple innovations that climax into a disruptor.
With this said, many companies and industries disguise themselves as disruptors but are only treading water to remain above the innovation upward sloping curve. As discussed by Harvard Business Review, many large conglomerates (i.e., Walmart, Home Depot, Verizon) find it difficult to innovate as they balance expectations, costs, operations, complacency, and economies of scale. However, it is important to note that many present-day conglomerates meet economic innovation expectations through internal advances that optimize their operations and create coordinating dynamics that achieve economies of scope and economies of scale. It is important to note that many of these “waning conglomerates” used to be innovators in their infancy, which enabled them to achieve market share. As seen through inorganic growth or mergers and acquisitions, large firms with strong management teams can identify early-stage growth companies that have the potential to gain market share, enabling these large conglomerates to continue to add value with third-party innovation – or, in other words, “treading water.”
What are some of the disruptive/innovative segments of the future?
Disruptive companies and industries have either littered market commentary or quietly improved modern society, clearing a path toward future developments. In part 1, we will discuss the tier 1 disruptors that consist of the mainstream innovations and most desirable growth segments. In part 2, we will discuss tier 2 disruptors that consist of the lesser-known innovations and technological advancements that, to a degree, are in an earlier stage of their development, adoption, and implementation.
The growth segments that have started to impact market synergies and functionality consist of blockchain technologies, non-traditional banking, alternative clean energy, and social investing.
Blockchain technology is a system of recording information that makes it difficult or impossible to change, hack, or cheat the system. Essentially it is a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Blockchain technology has been on a steady path toward setting a new standard. Blockchain has enabled cryptocurrencies to become mainstream, with institutions increasingly considering cryptocurrencies, especially Bitcoin, as a cash alternative. Companies have started to shift toward this mindset as well. Companies like MicroStrategy, Tesla, and Square started actively investing in Bitcoin in 2020 and 2021. This institutional curiosity, corporate investment initiative, and stable supply have led to the market’s long-term optimism. However, other blockchain-supported digital content has started to surface. An example of this digital content is the non-fungible token (NFTs). NFTs are digital files that cannot be replaced or exchanged with another identical one of the same values. This avenue of the blockchain is in its’ infancy, but it has exponential opportunities as the market grew from around $30 million in 2017 to approximately $340 million by Q4 2020 before NFT art went viral. Perhaps you heard about the recent $69 million purchase of one NFT). Blockchain technology continues to quiet critics exhibiting increasingly more potential as the technology improves, is accepted, and applied.
Non-traditional banking includes digital wallets’ everyday convenience and digital lender’s penetration into unsecured lending. For some color, digital wallets are a software-based system that securely stores users’ payment information and passwords for numerous payment methods and websites. Some of these digital wallets are supported by specific applications such as Venmo, CashApp, etc. Others are backed by specific devices such as the Apple Wallet, and the most recent versions are supported by the blockchain (i.e., Coinbase, Rainbow, etc.). Individuals, businesses, and institutions continue to adopt digital wallets as internet security increases and the blockchain safeguards become more mainstream. Digital Wallets create an easy avenue to transfer monies without the headache of wire transfers, withdrawing cash, or waiting on a check to pass. Digital wallets simplify currency exchanges amid a global economy.
On the other hand, digital lenders or financial service firms such as Square, PayPal, and Affirm are starting to siphon market share away from traditional banks. These non-traditional banking solutions have gradually started to creep into the unsecured lending market, which presents a large opportunity for alternative banking innovators. Regardless, as society becomes increasingly digitized amid the transitory purposes and the improved conveniences, the adoption of digital wallets and non-traditional banking solutions over the next 5 to 10 years continues to beat estimates.
Alternative Clean Energy
As discussed in “Opportunities in Clean Energy Alternatives: The Accord of “Green Hydrogen” to Combat Climate Change,” alternative energy (electrification, solar power) and a hydrogen economy remain highly coveted and desirable goals as recent technological advancements in “green hydrogen” persist. The high-flying companies of 2020, such as Tesla, NIO, SolarEdge, Blink Charging, etc., are just the first glance. However, as we continue to make technological improvements, growth companies will continue to multiply within this segment. The improved economics of this space (lowering costs) make alternative energy sources scalable.
Accommodative policy, international accords, and applicable social agendas to combat environmental concerns like climate change have fueled the push to clean energy and lower greenhouse gas emissions. This mindset will continue to fuel various subsectors and alternative commodity prices as the market recalibrates to adjust for the new infrastructure dynamics. Though investors are sometimes blinded by the obvious names described above, it remains imperative to not look past the underlying technologies that drive the segment as opportunities between alternative energy lines will continue to remain robust.
More generally, social investing appears here to stay. Whether it is an overarching ESG empowerment or the “revolt against the institution” (explained in “Did the Short Squeeze Game “Stop”?), the increased influence on markets from retail investors (spawned by technology apps like Robinhood and the accessibility of digital wallets) has changed modern investing dynamics. Technological advancements on trading platforms and the cultural dependence on social media increase accessibility to information, demystifying Wall Street and the “mystical complexities” associated with it. Retail investors, driven by the social lockdown from the pandemic, have increased their sophistication (or adapted to a new “get-rich-quick” fade) in day trading (significantly impacting markets). Regardless of individual opinions, this is behavioral finance in its purest form driven by investor sentiment. These behavioral shifts tend to be cognitive indicators for consumer preference and the adoption of innovations.
Disruptive innovation has remained a historical staple within our society. Whether from the steam engine to artificial intelligence, innovation is as contemporary as the associated technological advancements. However, disruptive innovation is not just high-growth companies that invent processes or accomplish unattainable feats. Rather, innovators are diverse. They can be the piecemeal approach to a problem or a layer of complexities that are difficult to decipher. Innovation is the basis of society and financial markets as people and investors seek to uncover the next social trend or socio-economic phenomenon. Investor’s education on innovation as the socio-economic and socio-financial aftershocks will likely affect equities and traditional and non-traditional fixed income as well as derivatives. Today’s “disruptors” discussed are the common or “mature” disruptors that have started to become mainstream. However, part 2 will highlight the disruptors that remain in the early stages or have less “curb appeal.” As we will discuss next time, this muddled curb appeal may mean ample opportunity created by “non-event arbitrage” and the “illegitimacy discount.”