Derivatives Theory: How to come up with successful Stock ideas
Nikolai Dmitrievich Kondratiev - Economic Cycles.
Welcome Austrian reader!
In today’s post I will be talking about a way to come up with Investing ideas, in relation to Investment Approach and facing early steps of Equity Analysis.
Here I was inspired by a Spanish manager called Carlos Val-Carreres, in order to be self-sufficient in regard to ideas’ generation.
Hope you enjoy it!
"An investment in knowledge pays the best interest."
— Benjamin Franklin
Introduction
Nikolai Kondratiev, a Russian economist, developed a theory known as Kondratiev Waves (or Kondratiev Cycles), which describes long-term economic cycles of boom and bust.
These cycles, often referred to as K-waves, typically last between 40 to 60 years, and Kondratiev believed that they are driven by major technological innovations that transform economies.
The Concept of Long Waves
Kondratiev observed that in capitalist economies, there are long cycles of economic growth followed by periods of decline.
These long waves are different from shorter economic cycles (Business cycle), which tend to last a few years and are often linked to fluctuations in supply and demand.
Phases of the Kondratiev Cycle
Each Kondratiev wave can be divided into four distinct phases:
1. Prosperity (Expansion)
This is a period of rapid economic growth, rising productivity, and increasing investment. It's often triggered by significant technological innovations or shifts, such as the Industrial Revolution or the advent of computers. Characteristics:
Rising economic output (GDP)
Technological innovation
High employment
Rising wages and living standards
Increased demand for goods and services
2. Stagnation (Plateau or Prosperity Peak)
Growth starts to slow down as the economy reaches a peak. The technological innovations that fueled the earlier growth are now fully integrated into the economy, and their impact starts to wane. Characteristics:
Slower economic growth
Investment levels still high, but returns diminishing
Technological improvements become more incremental
3. Recession (Decline or Contraction)
Economic activity begins to contract, marked by declining investment, unemployment, and economic instability. Technological innovations have been fully exploited, and the economy struggles to maintain its previous growth rates. Characteristics:
Shrinking GDP
Rising unemployment
Falling wages
Reduced consumer demand
Decreased investment
4. Depression (Trough)
The economy hits a low point. The old technology is no longer driving growth, and a major economic downturn occurs. However, this phase also often leads to new technological innovations, setting the stage for the next cycle. Characteristics:
Deep recession or depression
Massive unemployment
Falling prices (deflation)
Innovation stagnation
Prepares for a new technological breakthrough
“After the depression phase, the cycle starts over with new technological innovations that trigger a new wave of growth.”
Driving Forces: Technological Innovations
Kondratiev believed that major technological revolutions are the primary drivers of these long waves.
These innovations fundamentally reshape the structure of the economy, leading to periods of prosperity followed by inevitable downturns as the technologies mature and lose their economic impact.
Examples of Kondratiev Waves
Kondratiev identified several waves in economic history:
1st wave (Late 18th century - mid 19th century): Driven by the Industrial Revolution (steam engines, cotton production).
2nd wave (Mid 19th century - late 19th century): Railways, steel, and heavy machinery.
3rd wave (Late 19th century - early 20th century): Electrical engineering, chemicals, and automobiles.
4th wave (1940s - 1970s): Petrochemicals, automobiles, electronics.
5th wave (Late 20th century - early 21st century): Information technology, digital communication, and the internet.
Kondratiev’s Legacy and Modern Interpretations
While Kondratiev's theory was controversial in his time and remains debated, many modern economists and futurists see value in understanding economic cycles through the lens of technological waves.
The notion that technological revolutions lead to long-term economic patterns has been embraced by thinkers like Joseph Schumpeter, who extended Kondratiev’s ideas with his theory of creative destruction.
In recent times, some have argued that we are potentially entering a 6th Kondratiev wave, driven by green technologies, biotechnology, artificial intelligence, and renewable energy.
Limitations
Timing: Critics argue that the exact timing and duration of these cycles are difficult to predict with precision. Not every economic cycle fits neatly into Kondratiev's framework.
Causes: Kondratiev focused on technological innovation, but other factors like wars, financial crises, and political changes also significantly influence long-term economic patterns.
Complexity of Modern Economies: In today’s interconnected global economy, cycles may be influenced by a broader range of factors than in the past.
Derivatives theory
How to find opportunities
As explained, this is a general idea to be able to identify new patterns concerning new drives/technological innovation for the economy. Not always fitting the exact temporal frames he proposes.
However, the mental guide of focusing on the new inventions that will indeed change the world causing a productivity increment, is really useful. Being able to have the ability to generate new ideas in regard to structural tendencies and changes in the economy. For example:
“You can be an expert in IA now but in 20 years you will need to be onto the next wave in order to catch up with the new trends.”
Productivity: New Structural Patterns for Success
In today's fast-paced world, productivity gains often originate from significant structural changes driven by technological advancements.
We need to analyze those companies affected by structural changes, by their value chain. So that, we have to understand every process being affected and/or responsible for that structural change to happen.
But how should we approach these shifts effectively? Let’s break it down step by step:
1st Derivative: Navigating New Technologies and Changes
Rather than trying to predict which emerging technology or trend will be the ultimate winner, it's wiser to avoid early bets. It would have been so difficult to guess that Amazon was going to be the winner in early stages.The risks of chasing first derivatives are much higher, especially for generalist investors.
2nd Derivative: The Development of Change
Instead, focus on identifying the companies that will play a crucial role in making these structural changes possible.We could focus on companies that play the role of the enablers of transformation, the ones fueling growth and expansion.
3rd Derivative: The Beneficiaries
Here’s where our attention should be. This is where the true opportunities lie: the "good compounders" that will consistently benefit from these developments over time.
Example in Action
Think about e-commerce (1st derivative). It isn’t just about the platforms driving the change. If we are able to look further…:
“Logistics companies (2nd derivative) have grown exponentially, and with them, so has the production of packaging materials like carton (3rd derivative). This is where real, sustainable value emerges.”
By understanding the layers of structural shifts, we can better position ourselves for long-term success.
Conclusion
Navigating Economic Waves and Finding Opportunities
Kondratiev's theory of long-term economic cycles offers a powerful framework for understanding how technological innovations shape the global economy. While his concept of Kondratiev Waves may not always fit exact timeframes, the broader lesson is clear: those who can identify and adapt to emerging trends are best positioned for success.
Rather than attempting to predict which technology will dominate next, we should focus on the enablers, the companies and industries driving these structural changes. From logistics to renewable energy, these sectors are often where the real, sustainable value is created. By staying attuned to these evolving dynamics, we can unlock new opportunities, ride the waves of innovation, and ensure long-term productivity and growth.
As we stand on the brink of a potential 6th wave—driven by AI, green tech, and biotech—the key is not just to follow trends, but to anticipate the next shifts. The future belongs to those who can look beyond the obvious and prepare for the transformations yet to come.
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