On the verge of something important

Above is a chart from the Federal Reserve showing the US Gross Domestic Product (GDP) for the period April 1998 to April 2010 (the most recent data -- GDP data goes through multiple revision periods, so the latest data is always a few months old).

Many investors may be surprised to learn that during that period, the US GDP has grown from $10.19 trillion to $13.19 trillion -- an increase of $3 trillion or almost 30%! This increase, by the way, has not been due to inflation: the data uses "chained 2005 dollars." What is shown in the chart is an actual increase in the economic value of goods and services produced in the US over that time period.

In contrast, equity values have hardly grown at all. The S&P 500, for example, went from 1,108.15 to 1,178.10 over the same time frame (the first of April 1998 to the first of April 2010). That's an increase of only 6.31%. As of the market close yesterday, the S&P 500 was only 1,147.70, making the percentage of total increase since 1998 a mere 3.56%.

This data in and of itself suggests that broad equity values may catch up at some point to reflect the greater value that is present in the overall economy. However, we also feel strongly that investors should seek out the most innovative companies for capital investment, and that much of the economic growth will be driven by exponential technology advancement.

While the growth in the overall economy from ten trillion to thirteen trillion dollars of output value is significant, that growth is tiny compared to the growth in technological capability between 1998 and today. In particular, we are referring to the ability to send and receive massive amounts of data extremely rapidly -- and increasingly, wirelessly.

As the above statistics from Limelight Networks illustrate, the capabilities for sending information in the mid- to late-1990s were paltry in comparison to what we enjoy today, and those capabilities continue expanding at exponential rates.* Also, the cost for sending, receiving, or storing data has become more and more inexpensive. Incredible improvements have taken place in the amount of data that can be sent, the speed at which it can be sent, and the cost at which it can be sent.

Increasingly, these improvements include the mobility of what is sent as well. According to this Cisco Systems study of mobile data trends, AT&T reported that their mobile traffic has increased 5,000% over the past three years.*

This combination has already had a transformative impact, not only on our use of popular entertainment and information media as consumers, but also on business functions in a wide range of industries. As large as that impact has been in the past ten to fifteen years, we believe it is still in its infancy. The potential business applications for nearly free, nearly instant transmission of vast amounts of data, including video data, have not yet begun to be worked out in various industries around the world.

Again, the incredible technological advances we enjoy today, real advances which simply did not exist in 1998, have come to pass alongside virtually no net increase in the advance of the price of the market, measured by broad indexes such as the S&P 500. Much of this is due to wild market disruption induced in large part by erroneous "over-steering" by the Federal Reserve and government.

Although it is clear that this over-steering will continue, and that government interference can create obstacles to progress, we believe there are inexorable forces at work that will continue to drive these advances in ways that even government ineptitude cannot derail. For more on that subject, see our previous posts on the work of the great economist Joseph Schumpeter and our original post on "The Unstoppable Wave."

In fact, we believe that we could be on the verge of something very big, very positive, and very important. This is not a market prediction -- we have made it clear that we do not pretend to divine upcoming market moves -- but it is a business prediction.

In light of that, we believe investors should be certain to align their capital with companies that are positioning themselves to drive these business changes or to benefit from them.

* At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Limelight Networks (LLNW) or AT&T (T). At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by Cisco Systems (CSCO).

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For later posts on this same subject, see also: