The Next Game-Changing Trend

09/25/2009 10:12 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

What's it going to be? Economic recovery is by no means ensured, but there are intriguing investment possibilities out there—if they're able to emerge.

Sometimes the shortest distance to portfolio disaster is a straight line between two points.

This, I believe, is one of those times. If I've been clear about nothing else in the past few weeks, I hope I've been clear on how impossible it is to find a reliable, investible trend in the current market if you're looking more than a few months out.

Most investors, even if they're being very, very careful, are radically underestimating the difficulty of finding an investible trend right now. According to the conventional wisdom, there are two possible trends: Either the trend line points up from here into a sustained recovery that looks a whole lot like the economy and market before the financial crisis, or it points down into a second bottom that looks a whole lot like the recent financial crisis.

But it's not even that simple. There's another alternative: That we're still passing through a period of confusion without a trend. On the other side, and yet to emerge, is a new trend that won't look like either the pre-crisis or crisis economies.

I have a very strong suspicion that a year from now, things will look very different from both where we are now and where we once were. I can't give you all the details of that still-to-emerge trend, but I can block in some of that third alternative.

Does that sound like I'm about to make your investing life even more confusing? You bet. But the likelihood, history shows us, is that the way to make money after a crisis like this won't strongly resemble the way to make money before the crisis. Investors need to consider that now it really is time for something completely different.

No Trend to Befriend

We all like to draw trends. Give us two data points and we'll connect them with a straight line—and extrapolate that line until we run out of graph paper. I suspect it's embedded in our DNA from the days when the shortest distance to a meal was the straight throw of a rock. (These days, individuals with a strong genetic predisposition toward connecting data points become journalists or stock analysts or train men on the subway shuttle that runs between New York's Times Square and Grand Central Station.)

And much of the time, drawing a trend line and following it puts money in our pockets. I'm a big believer in the old investing saw "The trend is your friend." In fact, my book, The Jubak Picks, and the Jubak Picks 50 portfolio are built on the idea that most of the time, it's easier to make money in the stock market with the trend at your back than with the wind blowing in your face.

If you're paying attention, though, I bet you've noticed my careful caveats, "much of the time" and "most of the time." (For why "most of the time" investing even after a huge rally like this works, see this recent blog post. For what happens when it does not work, see this post.)

Right now, connecting the dots into a trend stands a good chance of getting an investor into trouble. The data are just too contradictory and too subject to divergent interpretations and too volatile from day to day. I can make a strong case for this rally to continue as the economy takes off in 2010 and for a double-dip recession as the economy sputters in 2010 and fails produce a sustainable recovery.

If the first trend is correct, you ought to be loading up on the kind of stocks I mentioned in my post "Time to start planning for the next rally."

If the second is correct, you ought to be selling into this rally to raise cash and be loading your portfolio with things such as gold that do well when everything hits the fan.

And if the third alternative I've mentioned is correct? Then both of those portfolios will be left in the dust and you'll be left playing catch-up to a group of stocks that aren't even on most investors' radar screens at the moment.

A Not-so-Straight Line: The IPO Pipeline

Like all exercises in trend drawing, my third alternative connects a few dots and then extrapolates them into a trend.

The dots for my third trend begin with the IPO of battery maker A123 Systems that I wrote about recently. And they include the rest of what amounts to a huge backlog of venture-capital-funded startups with the potential to transform the current economy or at least create entirely new subindustries.

|pagebreak|

Ever hear of any of these companies: SilverSpring Networks, NanoH2O, Juvaris BioTherapeutics, or AnoxKaldnes?

Unless you work at one of these companies or the venture capital funds that have invested in them, the odds are that these are completely unfamiliar. And why should we have heard of them? They're still private. We can't put a nickel into any of them. And until this week, it looked like companies such as these were going to stay private for quite some time yet.

After averaging 70 initial public offerings a year from 2004 to 2007, according to Renaissance Capital, venture capital-funded companies almost vanished from the market. If they were private, they stayed private. Raising money in the public markets has been that hard (next to impossible) and that expensive in 2008 and 2009.

The successful offering from A123 Systems on September 24 is a clear sign that the market has changed. (Successful is an understatement. The offering was red hot. It priced at $13.50 a share, massively above the original projections for a range of $8 to $9.50, and when it started trading, the stock opened at $17 a share.)

We won't see a lot of new companies with game-changing products come charging out of the gates immediately. Renaissance Capital calculates that most of the candidates for IPOs now in the pipeline come from private equity investors looking to unload stuff they bought in the boom. No more than 10% of the pipeline consists of class technology or health sciences companies.

But if they're not in the pipeline, they're circling the entrance. And some of these (but who can tell which ones?) are game changers that represent whole new industries.

There are smart grid companies such as SilverSpring Networks that will revolutionize the way power is delivered, stored, distributed, and priced.

There are cellulosic ethanol companies, such as Range Fuels and Iogen, that will turn ethanol from a cruel joke—where the world has to choose between eating or creating energy—into one where just about any kind of plant can be turned into ethanol.

There are lighting companies such as Lumenz that will push energy-conserving LED lighting down until it's actually affordable, rather than a novelty for Christmas trees.

There are chemical companies such as AnoxKaldnes that have figured out how to turn sewage sludge into plastics.

And water companies such as NanoH2O that use nanotechnology to engineer vastly more efficient systems for purifying water.

A Bet on Pent-up Creativity

These aren't small companies. Because they've been locked out of the IPO market for so long, and because much of this technology is hard to grow from the lab to the market, many of them have required $100 million or more in venture capital. Private investors that include Goldman Sachs Group and Royal Dutch Shell have invested $130 million in Iogen. SilverSpring Networks has required $170 million in private capital.

And these aren't small opportunities. Cisco Systems CEO John Chambers recently told investors and analysts that his company has identified at least 30 opportunities for new billion-dollar businesses that it will look to invest in (for Cisco, that means buying promising smaller companies) to fuel Cisco's growth. Chambers didn't give away the names of all the businesses that made Cisco salivate, but he did name smart grids.

One of the reasons that the future looks so dour even to the optimists in the United States is that, if you look around, you can't see the exciting new companies that have in past decades created whole industries and hundreds of thousands of jobs. That's understandable. The companies that might have generated that excitement have been bubbling away in private.

If you looked for the next Google or the next Amazon.com, the horizon was empty.

If you connect the dots into my third alternative trend, I think the landscape will look very different in, say, two years, and it will begin to look different as early as 2010.

|pagebreak|

Suddenly, as if out of nowhere, it will be possible to talk about the creativity of US business without getting laughed out of the room. It will be possible to talk about job creation and see where the jobs might come from. It will be possible to see the US not as a country in decline, but as a country that has come out of one of those periods of destruction that capitalism in our system regularly delivers and that has begun the creative part of the cycle.

Is this trend guaranteed? Does it have to happen? No way. If the economy goes back into a deep recession, in which fears that there is no bottom again run wild in investors' minds, these companies won't be able to go public and they won't be able to reach the scale that's required if they're going to have a meaningful impact on our economy.

If the financial markets tank or freeze or become terribly expensive, that will stunt these companies, and this trend won't gather significant force for years. Which one of these three trends will go from a few data points on paper to a real force defining our economy? I can't tell you. The uncertainties of the moment are real.

As an investor, I'm trying to spread my bets, hedging with this investment and that investment on this trend or that trend. That's not a satisfying strategy. And the returns from that kind of hedged bet on the future will certainly lag the returns that an investor would get from backing the one right trend with an entire portfolio. But at the moment, the odds of picking the wrong trend with that kind of all-or-nothing bet makes me go with a hedged compromise.

So how do you add a bet on this third alternative trend to your portfolio? Take advantage of Cisco Systems' interest in potential billion-dollar businesses. For more on why you should own Cisco shares, check out my recent blog post.

At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

Related Articles on MARKETS