The feverishly anti-business tone coming out of Washington, as well as the promise of greatly expanded government intrusion into industries from health care to energy, the prospect of significantly higher taxes in years ahead, and the threat of tremendously expanded government spending and budget deficits, has many investors wondering if we are heading for an economic re-run of the 1970s, or worse.

A new book out from demographic prognosticator Harry S. Dent, entitled The Great Depression Ahead, paints a grim picture of deflation, depression and economic decline in the US and advises readers to invest in China and India. In a recent interview about the book, Dent declared, "stocks have to go back to about 3800" (presumably he means 3800 on the Dow, which Dent uses for most of his predictions, such as his statement in 2004 that "we are still predicting a Dow as high as 38,000 to 40,000 by 2010" -- see The Next Great Bubble Boom by the same author).

Dire scenarios like Dent's are getting plenty of traction these days, and the economic mis-steps in government make it easy to fall into despair about the road ahead. However, as we have written before, even in times of excessive government intrusion and economic malaise, such as the 1970s in this country, there are well-run companies that are creating new fields of growth or taking advantage of major paradigm shifts, and investors would be wise to seek them out rather than just owning the "entire market" as often counseled by "wealth managers".

Those who believe, like Harry Dent, that economic prosperity is governed by blind cycles outside of human control miss the central role that innovation plays in economic progress. In his most recent book, Dent states: "The truth is that Newton was right in his theory of simple and clock-like cycles. [. . .] Our economy has peaked every forty years, like clockwork-- and commodity prices have peaked every thirty years. The early part of most decades starts off weak, even in boom times. Every four years the stock market tends to take a significant correction, and about every four months it often does so again on a more minor scale" (pages 3-4).

If Dent indeed holds this position, it would be interesting to ask him how his predictions could swing so wildly between his 2004 call for a Dow of 38,000 to 40,000 by 2010 and his 2009 interview calling for the Dow to drop to 3,800.

Noted Austrian economist Joseph Schumpeter held almost the opposite view from Dent's deterministic model. He held that free enterprise continues to create greater and greater progress, not by choice but by necessity. He wrote that the free operation of individuals and businesses within any given industry "incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one" -- that business in a capitalistic system "not only never is but never can be stationary."

This is an incredibly important truth for investors to understand, and it is why we are confident that innovation will be the engine that continues to drive prosperity, even in spite of the clumsy and unnecessary government intrusions which will probably be on the rise for the near future.

The scenarios of extreme pessimists, like Harry Dent (who were recently extreme optimists), generally ignore innovation altogether or predict that innovation has basically come to an end. In an interview just a month ago in the Minneapolis-St. Paul StarTribune, Mr. Dent ended by saying that innovation will not have much impact in the next couple of decades, because new innovation from here will just be incremental, not revolutionary.

He said "The iPhone's going to get better, broadband is going to get better, but you don't get the same impact from those improvements that you do from the adoptions of computers and cell phones." In other words, he sees only "sustaining innovation," not truly "disruptive innovation," in the terminology developed by Clayton Christensen. Harry Dent basically believes that innovation is tied to impersonal cycles just like everything else, and when the innovation cycle is on the way down, innovation will not make much impact.

This is as foolish as the apocryphal story of the Patent Office Commissioner who supposedly suggested to President McKinley that the US close the Patent Office in 1899, because "everything that could be invented had already been invented."

Not only do we not believe that innovation is bound up by multi-decade cycles as Dent argues, but we believe that the evidence shows that the pace of innovation increases over time. In fact, inventor and entrepreneur Ray Kurzweil, whom the Wall Street Journal calls "the restless genius" and Forbes magazine calls "the ultimate thinking machine," has observed that the pace of innovation increases not in a linear fashion but rather in an exponential fashion (see graph below).













In his 2005 book The Singularity is Near, Kurzweil says: "The future is widely misunderstood. Our forebears expected it to be pretty much like their present, which had been pretty much like their past. Exponential trends did exist one thousand years ago, but they were at that very early stage in which they were so flat and so slow that they looked like no trend at all. As a result, observers' expectations of an unchanged future were fulfilled. Today, we anticipate continuous technological progress and the social repercussions that follow. But the future will be far more surprising than most people realize, because few observers have truly internalized the implications of the fact that the rate of change itself is accelerating" (pages 10-11).

In fact, there are many innovations that are going to be quite revolutionary in the years ahead, and we have discussed some of them in previous posts such as this one and this one.

We have often stated that we do not make predictions about the next move of the overall market, and we don't suggest that investors try to time economic cycles. We do believe that the prospect of less economic freedom should give investors cause for concern, but we also believe that there will be innovation that will drive growth, and that investors who put forth the effort to seek it out have cause for continued optimism.