Three Types of Investors in a Bull Market: Innovators, Imitators and Idiots

 

Warren Buffet’s observation that there are three types of people in an economy—innovators, imitators and idiots, clearly reflects in the classic three phases, or legs, of a bull market.

 

Innovators See Opportunity in Bears

 

Since the start of 2009, we’ve seen Buffet’s “innovators” move, with markets up 30 per cent or more. Despite ubiquitous bad news, disastrous trailing indicators, and headlines announcing bankruptcies, bailouts and mayhem in the financial markets, innovators made their move early as usual, picking up stocks at bargain process from those who wanted to, or were forced to sell into a market characterized by fear.

 

The innovators again demonstrated their ability to see past the short term, and to filter the noise and to establish early positions in key growth sectors. For instance, even while venture capital funding in Clean Technology deals withered in the first half of the year, compared to the same period a year earlier, the Cleantech Index (CTIUS) rose from below 600 to nearly 1,000—close to a 40 per cent gain, a gain similar to gains on most stock markets, since early March.

 

A 30 to 40 per cent gain in six months on the stock market looks pretty good by historical standards. In 2003, the Dow rose from around 8,000 to 10,500 in 10 months, a gain closer to 25 per cent in the first leg of a new bull market, before consolidating for most of 2004.

 

Imitators Ride the Bull

 

Following its initial run, the Dow slipped sideways for much of 2004, before starting on a longer, more stable climb from 10,000 to 12,000 by mid 2006 or early 2007, the second leg of the bull lasting around 18 to 24 months, depending on how you read the Dow chart. Buffet’s “imitators” had arrived.

News was good, trailing indicators turned positive, corporate earnings began rising, inflation remained under control, in general most anybody could invest with confidence during this period, as very little evidence of risk appeared anywhere.

 

Idiots Take the Bull by the Tail

 

The final leg of the 2003-2007 bull market occurred as it often does, when the “idiots” piled in and drove stock prices up sharply and rapidly. By the summer of 2007 you could see the churn at the top. The Dow had moved from 8,000 in 2003 to 14,000 in 2007, with the last 2,000 points coming mainly in the first quarter of 2007. A rapid 20 per cent rise coming off a bottom could make sense, but after two solid legs up, it could only have been Buffet’s “idiots” who kept buying stocks aggressively, or insisted on holding.

 

Is Stock Market History Repeating Itself?

 

In 2009, we have already seen the first leg up—and a solid one it was. And we have begun to see consolidation, ahead of trailing indicators turning positive. This is largely what the imitators will wait for.

 

Lacking confidence and in many case resources to step in at the pit of a recession, where the real bargains can be found, imitators will appear on the scene once the potential for missing out on increasing corporate earnings and improving economic fundamentals, and the appearance widespread good news headlines, compels them to get back into stocks.

 

When this will happen can’t be predicted with much accuracy, perhaps 2010, perhaps 2011, but eventually the second leg of the bull market, likely lasting something around 24 months, will get underway.

 

Three Sectors that Can Turn Imitators into Innovators

 

Every bull market has its particular characteristics, and every investor has their own preferences. For those who watch trends and technologies, and for those imitators who want to get the kind of returns innovators get, three sectors ought to have great appeal—Cleantech, Nanotech, and Energy.

Beyond merely the scope of this bull market, these emerging markets look to have extraordinary growth potential, and are in many ways intertwined—economically and technically. Energy efficiency is a part of Cleantech, for instance. Solar panels or wind turbines used to reduce the carbon footprint of a production process amounts to both Energy and Cleantech. If the surface has been developed using nanocrystals, it may also be a Nano business.

Yet each of these sectors will foster initiatives that qualify as “pure play.” Nano-based electronics, for instance, look to be on the verge of taking computing to the next level, as the current threshold of miniaturization has already come into view. Still, most people know very little about these sectors—perhaps more about Energy and less about Nano. As small cap investors, they ought to learn.

 

Getting a First Leg Up on Emerging Markets

 

In a larger sense, each offers the opportunity for anybody to make Buffet’s “innovators” class, which is to say that each of these sectors offers such excellent longer term potential, and that gains to date represent only a tiny tick on what is widely expected to be a spectacular uptrend.

 

Of course, most imitators don’t feel comfortable making their move until they see bottom line results getting fatter—a little late by innovator standards. Taking the characteristics of a short term beginning of a bull market in stocks and extrapolating to an emerging sector, and in particular micro-cap stocks, it’s easy to see how an effort to understand Nanotechnology, or Cleantech can and will pay off.

 

In the context of the current bull market, it is clear that the innovators are in. It is not, however, clear that the pole positions have been established in Nanotech, Cleantech and Energy for the longer term. It is likely that the imitators will show up in the stock market pretty soon. For their sake, let’s hope they find their way, in some part, to these sectors.