What a difference a month made.

In early September of 2008 the stock market was perched on that wobbly mesa where it had been trading in a more or less sideways corridor for the better part of the summer. Rumors about the fall of Lehman Brothers, which had been making the rounds since back in the spring, were surfacing anew and giving renewed emphasis to the downward bias that had never truly gone away since the middle of 2007 when the burgeoning toxic soup of the credit markets finally spilled messily out of the container and into full public view. Then came the day of that fateful decision – when the same government that had rushed to the aid of Bear Stearns in March to prevent a St. Patrick’s Day Massacre took a pass on Lehman and unwittingly unleashed the Panic of ’08.

Even as the stock market was starting that fall into the abyss in the second half of September – and bear in mind the vertigo-inducing freefall of 3,000-plus points on the Dow Jones Industrial Average didn’t happen in one day but over about a month into the third week of October – even as it was all falling apart your ever-optimistic author continued to assert that the case for venture capital appeared compelling. All that money piling into Treasury bonds didn’t really want to be in Treasury bonds – it was risk-seeking capital in search of a destination.

In normal times there are a handful of alternative venues to serve as that destination: the market for publicly traded stocks, real property assets, stores of value like commodities, hedge funds, and the market for privately held equity such as leveraged buyouts, specialized partnerships in areas like oil & gas exploration, venture capital, and the relatively recent phenomenon of stock market platforms for very early-stage companies that still largely depend on private investment (more about these in a forthcoming Rita blog installment).

It is unusual for all of these risk asset classes to be nearly uniformly unappealing, all at the same time, but such was the case for all the asset classes cited above save for one: venture capital. The venture capital market has almost no correlation to either stock or property markets, does not rely on the price of oil or any other commodity, and is not dependent on robust, liquid markets for speculative-grade debt capital as with the LBO market. The VC time horizon is long, meaning investors should be more comfortable about riding out the present downturn. Looking at the numbers, the National Venture Capital Association and Thomson Reuters reported that investors in VC lost 1.6% for the 12 month period ended September 30 2008 – not much to get excited about to be sure, but still preferable to the -22% return for the S&P 500 over the same period, or the -13% showing for the HFRI Hedge Fund of Funds Index.

Essentially, the attraction VC would seem to offer to risk asset-seeking investors was that it has little to do directly with the most egregiously negative forces at work in the markets and the economy, but does in fact have a relationship to the most promising ones – including that in a potential recovery scenario the most likely viable engine for growth may come from technology-intensive sectors such as alternative energy, biotechnology and broadband 3.0 solutions like intelligent energy grids. In other words a recovery in the market could favor sectors that are heavily represented in VC portfolios – and these portfolios would thus find a bevy of willing buyers to provide a market for their future IPOs and other exit vehicles.

Not that there is any guarantee this scenario will actually play out, but then risk assets are called that for a reason – because there is uncertainty and variability among potential outcomes. Also, there is a history of spectacular growth stories emerging from moribund economic times – both Apple and Microsoft, after all, came into existence during the decade of malaise and stagflation otherwise known as the 1970s. If there actually is an optimistic case to make for our economic trajectory going forward it probably involves lots of groundbreaking technology leading the way (goodness only knows it doesn’t likely involve another debt-fueled consumer binge as the path to the Promised Land). Venture capitalists are some of the most terminally optimistic people in the world, and those who invest in their funds are prone to catch this infectious spirit.

So as I ruminated over these matters back in the fall of last year the luster of this asset class seemed to get brighter and brighter, or so I thought. And that brings us to the difference a month makes.

The difference in investor sentiment between the last week of September and the end of October was a difference in magnitude - the difference between wallets being open to the possibilities of risk-seeking assets and being padlocked shut to anything that did not bear the insignia “direct obligation of the United States Treasury”. In other words, risk-seeking capital generally speaking went on sabbatical. The results show. The Barclays US Treasury 7-10 year Bond Index returned 18% to investors for 2008 – and most of that stunning gain came from the deluge of risk capital dollars flowing in during the last three months of the year. That capital is still in hibernation – but at some point it is going to want to come out of the ho-hum world of Treasury bonds and back into something interesting.

In fact that is already happening to a certain extent. Technology indexes in the public stock markets are significantly higher than broader market averages, as I wrote about in a previous entry on the biotechnology sector. The Dow Jones Industrial Average is down more than 10% for the year to date, while the technology-weighted Nasdaq Composite is about flat. Growth-oriented technology stocks across the range of market capitalizations are outperforming so-called value stocks, mostly because the latter category is chock full of those banking and consumer-related names that are in the swamp along with other poorly-performing sectors like energy and industrial materials.

So the climate seems like it could be right again for VC. But over the past couple months I have started to wonder if that is really going to be the case. Not because the VC case isn’t compelling – I truly believe that it is – but rather because I believe the psychological scars from the last four months may last for some time to come and may alter the nature of the whole risk paradigm. Venture capital requires a greater degree of commitment than other investments – the time horizon is longer, the fund managers have to instill confidence (and many track records are looking rather sparse these days) and there are various and sundry legal, tax and other issues for prospective investors to countenance.

Are there alternative avenues for investors who want exposure to a particular breed of risk asset with low correlation to other investment markets that offer enticing prospects for growth at commensurate levels of risk? In our previous installment on this blog we looked at technology sector plays in the publicly traded marketplace – a good destination for more traditional investors who require the daily liquidity of traded equities. There is another vehicle, though, that provides a space somewhere between the very liquid public markets and the illiquid world of institutional world of venture capital. This is the market for listed early stage companies – and although it has been around for some time in one form or another the market has recently evolved. In forthcoming entries to this blog we will be looking at this market in more detail.

Flat is the new up: Biotech steady in a sea of collapsing sectors

The stock market remains a forbidding place to be these days. Coming on the heels of the worst year for US equities since 1931, the broader market indexes quickly tossed aside an embryonic rally over the New Year transition and reasserted the downward trend. Both the Dow Jones Industrial Average and the S&P 500 Index finished the month of January down more than 8% year-to-date, continuing last fall’s miserable performance as the economic data find new ways to disappoint investors with each passing day.

At times like this two sentiments can emerge. The bears – both those by natural temperament and by the pain of recent experience – will survey the bleak landscape and retreat back into their dens for the rest of the winter. The never-say-die optimists and the iconoclastic contrarians will go bargain hunting and value fishing. The bears’ sentiment is understandable – there is not a whole lot out there about which to get excited. Peace be with you.

For those ready to do some venturing down Wall Street’s mean streets, beware, for in the words of fearless voyagers in times past, there be monsters. However there would be many worse places to voyage than the biotech sector. In fact the Nasdaq Biotechnology Index finished the month of January just about flat, at -0.11% for the year to date, well ahead not only of the broader markets but also the broader healthcare sector: the S&P Global Healthcare Index returned -3.80% while the Dow Jones Select US Pharmaceutical Index was off -2.84% for the same period. The Nasdaq Composite Index, widely used as a broad gauge for the hodgepodge of technologies that make up the so-called “tech sector”, was down a bit over 6% at month end.

Risk as seen through the looking-glass

Biotech is unquestionably a highly risky investment sector, and intelligent investing in biotech companies requires a level of knowledge that relatively few possess in an adequate level of detail (and those who do possess it can be wrong as often as right). True enough, but “risk” in investment markets is not a static concept – it appears in different guises at different times. In more stable times, when equities are doing what they should be doing (i.e. outperforming bonds), biotech is considered to be significantly out there towards the edge of the risk spectrum, while traditional “blue chip” mature, large cap names constitute the core of prudent investment portfolios.

Right now, though, times are not stable and risk relationships in general are as upside down as the Red Queen in Alice in Wonderland. Both US and global equities have lagged every other liquid, publicly tradable investment category over the course of this decade through the end of 2008: bonds, commodity futures and real estate investment trusts (REITs) have all outgained equities over this period. I would argue that the riskiest place to be in the stock market is in anything that is highly correlated to…uh well, the broad stock market…and particularly the financial sector that has been the broader market’s primary engine of growth for more than a quarter century.

Low correlation: vive la difference

Cue in biotechnology. The Nasdaq Biotechnology Index currently exhibits a correlation of about 0.63 with the S&P 500 and 0.58 with the Dow Jones US Financial Services Index. A level of 1.0 indicates perfect positive correlation while 0.0 indicates no discernable correlation. The correlation coefficient is one of the most important indicators in portfolio management alongside mean return and dispersion around the mean (standard deviation) – it tells us the level of likelihood (or not) that very bad things will affect all assets the same way at the same time.

The comparatively weak correlation of biotech to the broader market is a function of a number of different factors. The Nasdaq Biotech Index is a potpourri of over 130 biotech stocks ranging from industry giants like Amgen (AMGN) and Celgene (CELG) to microcap offerings like Vanda Pharmaceuticals (VNDA) and CombinatorX (CRXX). Each of these stocks has its own unique value proposition – and those in many ways tend to have rather less to do with each other than is the case in many other industries – but as a group they are relatively less directly affected than other industry sectors by the two key interrelated economic forces responsible for the broader malaise: dysfunctional credit markets and the sharp retreat in consumer income and spending power. Naturally there is some correlation here, but health care spending decisions historically do not exhibit high demand elasticity; i.e., where prevailing economic trends exert high influence over the responsiveness of household or business spending to changes in price for any given product or service.

Save time: buy in bulk

Because business risk is such a determining variable in biotech – pipelines can take years to win approval for breakthrough drugs and technologies that in turn may or may not become commercial blockbusters – having one or two biotech stocks in a portfolio (even ones with proven products and revenue streams) is not a recommended strategy for the uninitiated. A better strategy is to take on exposure at the sector level, i.e. to profit (or not) from microeconomic trends in the biotech sector relative to the macroeconomy as a whole. This can be accomplished with one simple trade using the increasingly popular vehicle of exchange traded funds (ETFs).

For example one can obtain proxy exposure to the Nasdaq Biotechnology Index through an ETF operated by iShares, a fund management entity owned by Barclays Global Investors N.A. The ETF trades under a ticker (IBB) just like any stock, and buying shares will incur similar transaction fees, commissions, etc., just as with any other stock (actual fees and expenses will depend on the particulars of one’s own brokerage or financial advisory relationships). ETFs also generally do not come with some of the baggage of traditional mutual funds like front-end sales charges, redemption fees or confusing multiple share classes. IBB, which at present has 137 holdings across a range of sub-sectors from biomedical drugs to therapies, diagnostics and drug delivery systems, is constructed to mimic the trading patterns of the NBI index that it tracks (indexes themselves are not directly investable).

The weather outside is frightful, but…

The debt- and consumer-driven economic freefall will no doubt bottom out at some point, though a fairly dismal consensus seems to have formed around the idea that the economy will bounce along dully in that trough for awhile before something – and nobody seems to know exactly what – will start to revive animal spirits again. The worst may or may not be over for the stock market yet, and anyone venturing into these unhappy grounds would be well advised to proceed cautiously. Still, investing in equities is never without risk, and there are as many plausible cases to make that a true market bottom may not be that far away. What is going to power the growth when market strength does return? The best way to answer that question is probably with negatives: not the financial sector and not the consumer discretionary sector. Such growth as may happen in this next cycle is more likely to come from a sprinkling of tech sectors, and biotech has a better than average chance of being in that mix. To which end the type of broad sector exposure attainable through an ETF like IBB may be a very sensible play now.

“…we must also ensure that our hospitals are connected to each other through the internet. That is why the economic recovery plan I’m proposing will help modernize our health care system – and that won’t just save jobs, it will save lives. We will make sure that every doctor’s office and hospital in this country is using cutting edge technology and electronic medical records so that we can cut red tape, prevent medical mistakes, and help save billions of dollars each year.”
-President-elect Barack Obama, Weekly Address: The Economy December 6 2008

“…the way most large organizations actually process information…reveals a looking-glass world, where everything is in fact the opposite of what one might expect…a variegated patchwork of systems, containing 50 or more databases and hundreds of separate software programs installed over decades and interconnected by idiosyncratic, Byzantine and poorly documented customized processes.”
-Cynthia Rettig, “The Trouble with Enterprise Software” MIT Sloan Management Review Fall 2007

No, we are not trying to rain on the parade of hope that yesterday wended its way down Pennsylvania Avenue towards house number 1600. The US healthcare system is dysfunctional in so many ways, and the idea that healthcare technology should assert itself as a key plank in what is shaping up to be a multi-trillion dollar economic recovery effort is heartening indeed. A House Appropriations Committee draft currently making the rounds makes note of the figure $20 billion as planned Congressional spending on healthcare IT in connection with the larger economic stimulus package President Obama seeks to have on his desk by the Presidents’ Day holiday in February. That same document also details $2 billion for the Office of the National Coordinator for Health Information Technology. Observers are optimistic that something not too far from that $20 billion will emerge at the other end of the legislative sausage-making still to take place in the House and Senate.

Let a thousand flowers bloom – preferably in the form of innovative cooperation between the many public and private sector actors on the health care stage and preferably in the form of programs that will actually work. Electronic medical records (EMR) technology is undoubtedly something of which we need more – after all practically every corner of our $14.4 trillion GDP uses some form or other of technology to work better, and given the massive size of the healthcare industry it would be entirely sensible to bring medical records processing into the 21st century. Of course in so doing we are only bringing our own system closer to what is already standard practice elsewhere in the world – medical records in Denmark, for example, have long been 100% electronic, whereas by most estimates we are somewhere closer to 25% here.

Here’s the note of caution, though – we hope that “cutting edge technology” will turn out to be a phrase employed in a broad sense – grounded in the intent of a well thought-through strategy –rather than primarily in the more narrow-cast meaning of simply automating health records in hospitals and doctors’ offices. The driving problem we have is not the level technology per se, it is the high cost of waste and less than optimal administration of health services that result in our spending more per person for lower quality outcomes when compared with health systems in other countries. Technology can and should be seen as a potential enabler of lower administrative costs. But technology creates its own costs, and those unfamiliar with the tales of woe that permeate the landscape of system integration projects in large institutions would be well-advised to heed the lessons therein.

The purpose of citing Cynthia Rettig – whose Sloan MIT Review article caused a great deal of commotion and harrumphing among the corporate enterprise software set when it came out a little over a year ago – is that it neatly encapsulates the problems arising when, as all too often happens, we regard technology through the rose-colored lens of hope and deliverance from all ills rather than through the considerably more sober eyepiece of a posteriori knowledge – the history of ill-fated integrations of hundreds of thousands of lines of code on disparate, outdated platforms that collectively suck out any potential efficiencies gained from the technology itself. Technology is a tremendous enabler – it gives us power to accomplish much that would not be possible without it, but ultimately the gains we reap from technology in the form of enhanced productivity and task effectiveness derive from the intelligence of the strategies we devise and employ. There’s a lot of money out there in the public discourse, but the problems we as a country face in healthcare and overall public infrastructure demand that we leverage every dollar of it with intelligent thinking and effective execution.

So it seems a fairly good bet that quite a bit of funds are going to be made available in the very near future – but how are they going to be spent?

The Commonwealth Fund, noted in a report released on January 9 that technology-driven streamlining of administration and purchasing could actually reduce overall healthcare costs while at the same time providing healthcare insurance for uninsured Americans – in other words we accomplish two overriding goals of health care policy at the same time. The operative word there is “could” – for “could” to become “will” requires intelligence and care both in intent and in execution. In a recent article for Healthcare IT News Dr. Edgar Staren and Chad Eckes note that “[i]t is tempting for both administrative and clinical groups to view conversion from paper to electronic records as an information technology (IT) project. In fact, the optimal approach recognizes the integral role played by IT but recognizes such activity as an operations effort supported by IT and lead by Project Management. ”

One other voice may be helpful to add to the healthcare IT debate: that of the patient. In a recent New England Journal of Medicine article Dr. Abram Verghese issues a cautionary note:

The patient is still at the center, but more as an icon for another entity clothed in binary garments: the “iPatient”…the iPatient’s blood counts and emanations are tracked and trended like a Dow Jones index, and pop-up flags remind caregivers to feed or bleed. iPatients are handily discussed (or “card-flipped”) in the bunker, while the real patients keep the beds warm and ensure that the folders bearing their names stay alive on the computer.

All the technology in the world cannot substitute for the insights and judgments of experienced doctors at their patients’ bedsides, making those micro-level decisions that will add up in the aggregate to money well-spent or not as the case may be. What technology can do, though, is help to facilitate these decisions in a more effective manner throughout the system and leverage the administrative cost of providing the resulting health care services. As President Obama moves into the White House today we join our voices in the hope that this is where the road will lead.

Consumer spending, which accounts for $10.2 trillion of the $14.4 trillion US economy, is in decline for fairly understandable reasons. Household incomes, the ultimate barometer of budgets for discretionary purchases, have been flat for a very long time and in the past couple years have decidedly trended negative in real terms. Meanwhile consumer debt has reached historic highs thanks to the tireless efforts of financial institutions to figure out new ways for people to spend money that they don’t actually have. The asset side of most household balance sheets is dominated by housing values, and we all know how these have been doing. So these household balance sheets are short assets and long liabilities – not a happy confluence.

All these were facts well before September 2008 – but then came the credit crisis. The difference between August and October can be summed up thus: if you were someone with a good, though perhaps not stellar, credit score and you were thinking about buying a new car in August, by October your thoughts were far away from that as you couldn’t finance the purchase with a new car loan even if you wanted to. The data points in for durable good sales (like cars and other major items that typically require financing) in October and November are dismal and presage a truly terrible 4th quarter GDP. This turn of events, of course, has also driven a stake through whatever remained of the flagging fortunes of US car makers, who are now in the intensive care unit while the Economy Doctors hastily rig up a temporary life support device for a $15 billion injection.

Then came the news last week that jobs disappeared in November by the largest amount since 1974. Yep, the era of “Kung Fu Fighting” and regrettable wardrobe choices for the junior high class picture inexplicably continues to work its cloying influence on our present day Zeitgeist. But even that figure doesn’t properly reflect the magnitude of problems in the US employment environment. Here’s a sobering tale we came across the other week, from a Maureen Dowd op-ed piece in the New York Times. In her November 30 2008 column Dowd introduces Pasadena Now, an online newspaper whose founder pleasantly describes the newspaper business as a “one-way ticket to Bangalore [India]”. All of Pasadena Now’s content is developed and written by journalists in India (including Christmas tree-lighting ceremonies and other arcana local to the Pasadena scene), with the going rate being somewhere around $7.50 for every thousand words (that same thousand words would typically fetch between $200-800 when sourced locally).

The effects and the long-term implications of outsourcing could take up an entire discussion (and probably will resurface later on in this series of articles). But for now let’s return the discussion back to consumer spending. So all these bad trends are depressing the consumer, and so in order to “fix” the economy we have to inject our growth serum into some other part of the body to kick-start the process. But where? Well, the phrase on everyone’s lips these days is “government spending”, for the simple if not entirely correct reason that it seems like something we can just decide to do. We can enact spending-oriented policies and – presto – the economy will grow.

Stimulus math

But the math gets tricky. Say, for example, that consumer spending declines by 2% (that would be somewhere on the rather tame side of current consensus expectations). That would imply a $200 billion decrease to total GDP, going back to our numbers above. So all else being equal (ceteris paribus for the Latin aficionados among us) all we would have to do would be to ramp up government spending by $200 billion to break even – right? And haven’t we already done even more than that with all these bailout thingies that keep coming out every day?

Not really. We did in fact throw money at US consumers back in early 2008 – remember that? That was part of a government stimulus package to stimulate the economy including tax incentives for businesses and a grab-bag of other measures in addition to that $600 check that many of us received from the IRS this year. The government estimated the cost for the entire Economic Stimulus Act of 2008 to be $158 billion – not far from that $200 billion cited above but also clearly not enough to buttress the economy from the howling banshee of the credit meltdown that followed.

So then how much money is needed to fix the patient? Looking back, our whole perspective on money in the world of just two months ago seems rather quaint – remember the $700 billion stimulus package? That caused such a commotion back in late September, what with presidential campaigns being “suspended” and David Letterman blown off and Treasury Secretaries warning that failure to enact radical levels of spending within the next ten seconds would end the Holocene Epoch as we know it.

Of course other quaint little things – like daily swings in the Dow 500 points up or down – also managed to cause a stir back then but barely raise so much as an eyebrow now. Forget $700 billion – we’re into mid-to-upper thirteen figures now. Economists look at our environment and see a landscape so bleak that otherworldly numbers are the only ones that even hold out some faint promise of hope. $5 trillion is not surreal or outlandish – it’s just the ante.

The other thing that is not quite right in that example above is the assumption of ceteris paribus. An injection of $2 trillion or $5 trillion or whatever amount will certainly not result in a state of “all else being equal”. Money injected into the economy through one channel will stimulate others – and now we come to the centerpiece of the Obama team’s vision. Government spending – whether on infrastructure projects or new technologies or bailing out Detroit or Wall Street – should have a kick-start effect on both private business investment and consumer spending to a greater or lesser degree.

What’s the special sauce?

That “degree” really matters – and goes to the heart of what exactly the government decides to do. What’s next? In simplistic terms, if all of the stimulus spending is applied to bailing out Wall Street firms, and if those firms in turn dole out most of it on seven and eight figure bonuses for their employees, then the “kick-start effect” of the stimulus will be pretty dismal indeed. Likewise if it all goes into helping auto and other industrial manufacturers avoid bankruptcy and go right back to their failed strategies of the past then our economy isn’t going to get anywhere near that tipping point where stimulus turns into a self-fulfilling virtuous spiral of growth.

The problem with making choices like this is that none of them are glaringly obvious recipes for success. Investment in things that matter for the long term – education, public infrastructure, new healthcare or energy technologies – don’t always produce great results in the short term. On the other hand focusing the solution solely on new ways to put more dollars into American hands to go out and use at the mall today may provide a short-term bump with nothing to show for it after a couple years (this in fact could serve as an apt characterization for that whole illusory mid-decade growth spurt from 2003-07, with empty Neiman Marcus shopping bags and vacant Miami condos as evidentiary proof). A successful plan has to contain a bit of both – something that stimulates more jobs, spending and investment in the short-term but has a real payoff – greater productivity, new industry sectors etc. – in the long run.

Moreover whatever the government spends will likely be much more productively applied if leveraged by private sector investment. The incoming Obama administration wants to achieve energy independence in ten years, and active investment in alternative energy could be a viable way to get there, while creating jobs and other primary and secondary stimuli along the way. Much more viable indeed this objective will be if Silicon Valley and other entrepreneurial hot spots around the country get into the act and attract sizable volumes of private capital formation via venture capital and small-business lending. If there is one thing the US arguably does better than anywhere else in the world, it is to nurture the entrepreneurial spirit and support the animal spirits of innovation and commercialization of promising new technologies.

Will that be enough to slay the dragons of economic crisis that currently beset us? It is a narrow path through unfriendly terrain, but nonetheless it is a path. It’s the best shot we have. The incoming administration should grab it with both hands and do whatever it takes to lead the way with aggressive, forward-thinking policies that upend the status quo, dispel the formidable resistance of the entrenched powers with a vested interest in the status quo, and communicate directly and honestly to grass-roots efforts in communities, businesses and other institutions about the inevitable sacrifices in the immediate term and the rewards in the longer term. Now that would be change we could believe in.

Investment markets are deep pools in which the twin emotions of fear and greed reside. In observing several cycles of fear and greed that have played out over the past years we have noticed an interesting pattern. When markets are on an upwards roll, when bubble fever is pandemic and greed is the order of the day we often hear a chorus of Pollyanna cheerleaders pronouncing that “this time it’s different!” Presumably they mean that whatever “this time” is just happens to be the one thing that will change the world forever and so stock prices will never, ever come down. Such were the atmospherics that in the late 1990s allowed online pet food to be of such world-changing proportions so as fetch stratospheric price-to-sales multiples without a dime of profits as far as the eye could see.

When the bubble bursts and fear takes over we hear a different refrain, from seemingly more sober-minded types than the bubbleheads of the greed cycle: It’s not different this time. That is meant to be a reassurance to the folks whose equity portfolios have just been eviscerated. Yes, you are down 40% now, but the world isn’t going to end, people are still going to buy stuff, and there’s still a reason to stay invested in the market. Stocks do well over the long term, so just stay put – the sun will come out tomorrow, night is darkest before the dawn, light is at the end of the tunnel – comforting catch-phrases like so many cups of chamomile tea.

“It’s not different this time” is a useful thing to say insofar as, yes, we still have a functioning economy, the everyday humdrum of life continues for the vast majority of us and stocks do indeed tend to outperform bonds over the long term. But there is a tendency to take that notion one step further: “it’s not different this time” as shorthand for surmising that the market will shortly resume its inevitable upward course. For the vast majority of professionals toiling away in the salt mines of Wall Street or the City of London that is a perfectly reasonable assumption based on their own professional experience – they came into the profession sometime after the commencement of the Great Bull Market of 1982–2000. Despite a handful of well-known debacles like Black Monday in 1987 or the Icarus-like flameout of hedge fund Long Term Credit Management in 1998, for that entire 18 year period there was only one calendar year (1990) when the S&P 500 stock index showed a negative annual return. Brokers and money managers became accustomed to dips that were sometimes quite intense (over 20% on that one famous Monday in 1987) but nonetheless short-lived. This begat a confidence that gave rise to “it’s not different this time” with a whole supporting phraseology: “bump in the road”, “soft landing” and “time-out for the market” being a particular favorite for those with young children at home.

This confidence has been rather shaken up in the decade to date. Since 2000 we have already experienced three consecutive negative years for the S&P 500 (2000-2003) and barring some direct intercession from angelic hosts we are firmly on track for a fourth in 2008. Both the Dow Jones Industrial Average and the S&P 500 reached their 2000 highs in the past couple years, which technically is supposed to signify the affirmation of a bull market – but they have subsequently fallen way off those levels and so if the decade to 2007 was really a continuation of the ’82-00 bull market (which already by that time had achieved fame as the longest bull market of the 20th century) then it is sort of a bull market with an asterisk – a Barry Bonds bull market for the sports fans. The economy, which as we write has just formally tipped into negative territory with a -0.3% 3rd quarter GDP reading, shows very little in the way of positive signs of life. Real household income is in decline, consumer debt is at record levels and heading higher still, and the banking system is moribund. Structural problems such as these take more than just one or two business cycles to work themselves out, so we may be in for some more years of anemic economic and stock market performance. If so, then “it’s not different this time” will take on an entirely different meaning: not different than 1906-22, or 1929-54, or 1966-82 – those being the three macro bear markets of the past century.

So that’s the crisis at hand. What about the opportunity?

In any given macro economic cycle the overall markets, represented by broader indexes like the S&P 500 or the Nasdaq Composite, are usually driven by a small number of industry sectors that grow much faster than others and provide forward momentum to the economy. For most of the duration of the last bull market, the one that started in 1982, the twin engines of growth were the financial sector and consumer-related goods and services. Financial institutions as a sector comprised approximately 5% of the S&P 500 market capitalization in 1980; by 2007 that had grown to over 23%. In the consumer sector entire new sub-industries came into being, driven by the proliferation of choice (think of the 70-odd varieties of shower gels and exfoliants at the Body Shop), the micro-segmentation of consumer demographics (Prius-driving suburban 28-37 year-old female office professionals in the $85-110K salary range with a taste for gingerbread-spiced lattes), and the 24/7 availability of the consumer experience for customers and suppliers alike through the Internet.

In fact growth in the financial and consumer sectors was quite closely correlated – banks came up with new ways to give more consumers more credit to spend on more stuff, and the consumer goods and services supply chain rose to meet the challenge with lots of new stuff for them to spend their credit dollars on.

Those twin engines of growth are currently in a vertical downward spiral, and even when they regain their footing they are unlikely to be the engines of growth in the next economic cycle. In terms of the broad economy it is rather hard to predict which industry sector is going to be the next to accelerate from 5% to 25% of broader market capitalization. Here are two that offer better than even odds, though, in our opinion: innovative solutions in healthcare on the one hand and alternative energy on the other. Both presidential candidates have focused heavily on these two areas in their campaign platforms. If Barack Obama indeed becomes the 44th President on January 20th, 2009 then we have two clear mandates in this direction: effective universal healthcare and a pathway to energy independence within the next 10 years. That is not to say that either of these sectors will be profitable overnight. Biotechnology innovations leading to revolutionary healthcare solutions are risky, long-term efforts fraught with high probabilities for commercial failure at critical junctures along the discovery, trial and implementation phases. Alternative energy solutions may present themselves as scientifically viable but economic non-starters.

The opportunities in these two areas and their position in the klieg lights where business ventures and government policies intersect are likely to drive a renaissance in the venture capital market. In a world where many risk-based assets (publicly traded stocks, commodities, currencies, speculative-grade debt etc.) appear systematically unattractive on a risk-return basis, venture capital, though generally considered one of the riskiest asset markets, may look relatively attractive. VC tends to have a very low correlation with other financial assets, so for example if stock markets and real estate markets trend down over a long period investors will want to obtain exposure to assets that exhibit low correlation properties with them – and that enhances the appeal of VC. VC anticipates future, not present-day liquidity, so the idea of taking early stakes in companies with the potential to be leaders in exceptionally high growth markets will, in our opinion, drive private investor money into early stage opportunities in these sectors. There is a lot of investor cash sitting in US Treasury securities today, and that cash is ultimately looking for much higher potential returns. As the dust settles amid the aftershock tremors in global capital markets we will be paying close attention to this funds flow and the opportunities they may help unleash.