Thursday, March 7, 2013

New Highs for the Markets and New Lows for Investing


New Highs for the Markets and New Lows for Investing

Wall Street is celebrating the record high reached by the Dow Jones Industrial Average.  Indeed, the largest American companies are doing extremely well.  Profits and cash are piling up as the behemoths take advantage of low interest rates, global sales, and a continued emphasis on cost controls.  Should America be celebrating?

I’m sure that many investors are thrilled that their 401(K) balances have rebounded.  And, we can hope that the rebound in publicly traded stocks will slowly find its way into employment growth.  However, this near-term rebound is coming at a steep long-term price.  While we’re experiencing a financial resurgence now, we’re systematically killing the seeds for future growth, productivity, and well-being.

Lengthy Mutual Fund Meeting (1999)

While the formal sequester of government spending began only a week ago, we’ve been sequestering the funds meant to foster future development for the better part of a decade.  Historically, the private sector has played a significant role by funding venture capital and other forms of early-stage investing.   The government has also played a critical part by investing in basic research. Sadly, both these areas have lost serious amounts of investment capital, and thus our seed corn is being drawn down.

Let’s look at venture capital investing for a moment before turning to the much more serious problem in the public sector.  Over the past ten years, overall venture capital investments have increased by only 1.8% per year from $22.1 billion to $26.5 billion, and the number of deals financed by venture capital have only grown by 1.5% according to the National Venture Capital Association.  The tiny rate of increase masks an even more disturbing trend.  During the last decade, retail, industrial/energy, and consumer products have enjoyed double digit rates of growth.  Meanwhile, commitments to biotech, semiconductors, and networking investments have grown marginally or fallen.  True, the data can jump around from year-to-year, but the overall picture isn’t encouraging.  Investors are more and more interested in short-term results and are shifting away from higher reward and risk investing areas of venture capital.


Meanwhile, the dollars committed to basic research are dwindling.  Venture capitalists are likely to find fewer ideas worth pursuing for commercial development in the coming years if this trend persists.  Obviously, large companies still fund some basic research, but the days of Bell Labs and Xerox’s PARC Lab are long gone.  Endowments, like Howard Hughes Medical Institute, have stepped in to provide some increased funding for basic research, but their contributions are relatively small compared to government support. Before the sequester, spending on health care R&D had grown by only about 3.5% over the past decade to $35 billion and by only 2.6% in the past 5 years.

NIH research grants, the mainstay of basic research into disease, are a troubling case study.  According to USASpending.gov, contracts awarded by NIH have risen from $26.0 billion in 2003 to $26.6 billion last year. While there’s been a nominal increase of $600 million, after accounting for inflation, we’re investing a lot less in basic research.  I decided to drill down and see what’s happened at university and independent research labs over the past decade.  As you can see in the table below, there’s been a small increase in funding, but a decrease in the number of institutions receiving grants.  In real terms, spending has declined.  Obviously, sequestration is about to make these numbers look a lot worse.

I suppose if you are fifty or older, you might not care too much.  After all, much of basic research doesn’t result in commercial applications or therapeutic treatments for decades.  However, this lack of commitment to basic research is the legacy we’re leaving for our children and grandchildren.  The declining support from NIH will mean an immediate loss in research opportunities for some of the most talented people in the next generation and a diminution in fundamental inquiries that would otherwise lead to meaningful advancements later in this century.

If you’re interested in basic research in energy, the environment, or defense (DARPA), the trends over the past decade aren’t as bad as those in health research.  However, recent developments are equally dire.  The reduced appetite for venture capital, coupled with the lack of commitment to government-funded research, won’t make much of a difference in the next year or two.  But as time goes by, the damage will start to show up.  While many of us are loath to leave behind a massive debt, we’re creating another kind of deficit that is nearly impossible to fix.

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