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Today's Market WrapUp 01.27.2005 Mon Tue Wed Thu Fri Allison Archive
In the frenzy of daily life, investors frequently ignore the virtue of patience. Broad trend changes don’t occur overnight and don’t rotate every quarter. Don’t be mesmerized by the incessant “white noise” from Wall Street, the financial media, the Fed, hedge funds, cocktail parties, junk mail and taxi drivers. Ignore the day-to-day, minute-to-minute noise and focus out over the horizon. Major structural imbalances can be masked, papered-over by massive liquidity injections into the economy. But ever-larger injections never cured the drug addict, and they certainly won’t cure our economy. It may be a 24/7 world, but we need to pause in our whirling-dervish pace and think about the future, say 2010. Five years may seem like an eternity, but it will be here all too quickly. Assessing future trends allows for rational allocation in areas of great promise that may not be the momentum trader’s flavor of the month. Unquenchable Demand For OilAs you look to the future in an uncertain world, ask yourself some key questions. In five years will we have higher inflation than today? That’s always a tough question, but perhaps the succeeding questions will help shed some light. Will the price of oil be higher in five years? Given the volatile combination of war, political unrest, the arrival of peak oil, and massive demand growth from Asia, the odds of higher oil prices are pretty good. The more important, but unknowable, question is whether the price will be $60 per barrel or $160 per barrel. Looking out 15 to 20 years, the demand side could get frantic. Currently the U.S. uses 22 million barrels of oil per day for around 280 million people. Asia uses roughly 20 million barrels daily for 3.6 billion people (including India). Over the next twenty years, the rapidly growing East should easily exceed 40 million barrels per day. With the world pumping at capacity, one wonders where will all that new oil come from, and at what price? The world’s thirst for electrical power is also rejuvenating the nuclear power industry. China plans to build 20 new reactors over the next 10 years. India is planning multiple reactors as well. Where do you think the price of uranium will be in five years? The spot price already had a significant run in 2004, up 33%. The Tipping Point Moves CloserWill our debt problems (governmental, corporate and individual) be much improved in five years? Only a massive rebalancing (a severe recession) will slow down the debt spiral ($37 trillion in total debt) and force America to start saving. The odds of our total debt burden getting back to a sane level in five years are about the same as the U.S. personal savings rate, almost zero. As I mentioned in my article “The Debt Bomb,” our unparalleled level of debt will eventually reach a tipping point. This will lead to an unpleasant unwinding and much higher interest rates. Whether we reach this tipping point by 2010 remains to be seen, but the current imbalances cannot be sustained indefinitely. The odds favor a resolution sooner than five years. Resource WarsWill our geopolitical crises resolve themselves in five years? At the moment, our commitment in Iraq appears open-ended. Eventually the toll in American life and U.S. dollars will lead to our departure. Unfortunately, there are numerous other explosive hotspots (Iran, Syria, Saudi Arabia, North Korea, Israel, Pakistan, Russia, and Taiwan to name a few) that will not fade away by 2010. As the developing world more fully understands the consequences in controlling the earth’s shrinking natural resources, the conflicts will likely increase in intensity. Wars, cold or hot, are historically inflationary. Interest Rates on the MarchDo you believe interest rates will still be at 45-year lows in five years? It’s possible, but it seems unlikely as the Fed has already begun to push short rates higher. It’s reasonable to expect this era of rock-bottom rates will “revert to the mean” over the next five years, perhaps violently. If you are of the deflationist bent, then you believe that rates will be lower by 2010. I believe that the Fed will move heaven and earth to prevent this, and the budding inflation of 2005 will be robust by 2010, somewhat akin to the road between 1975 and 1980. History doesn’t always repeat, but sharply rising energy costs, a costly war and rising commodity prices do ring a familiar bell. Unfortunately, the volatile combination of debt, derivatives and terrorism makes the road to 2010 much riskier than it was 30 years ago. Inflation in the CakeThe future trend of inflation is clearly related to the other trends. To continue to fund our expanding debt structure, the government will continue to print money. Raising taxes is politically unacceptable and inflation is simply an indirect means of taxation. By the time the money works it’s way through the system, the average consumer is none the wiser. But consumers do notice their dollars don’t go as far as they did last year, or even six months ago. The full inflationary impact of excess money and credit has been partially offset by foreign intervention. As the declining dollar makes foreign purchases of U.S. bonds even more risky, don’t expect this level of intervention in five years. And don’t expect inflation to only be found in financial assets. Higher prices for goods and services are already “baked in the cake” and will show up on the retail level well before 2010. The Challenge of GlobalizationAs to our engine of growth, will the U.S. still be the world’s preeminent economic powerhouse in five years? As mentioned, five years goes by in a blink. The United States will still be the largest economy in the world, and it will still have a flexible and creative workforce. We may not see much difference in five years, but the longer-term trends are disturbing. Our workforce must begin to reinvent itself over the next 10 to 15 years or face the stark reality of lower standards of living. Globalization is taking hold at an astonishing pace and the playing field is leveling much faster than most Americans would believe. The following quote from the Daily Reckoning on the US/China relationship aptly states part of the problem in just 16 words. “They make, we take. They save, we spend. They lend, we borrow. They sell, we buy.” As you can guess, this is not a sustainable model, at least if you want to avoid economic suicide. If this pattern continues for the next twenty years, we will be considerably poorer and more dependent as a nation. We will also have a disillusioned, shrinking and angry middle class; historically a destabilizing situation. On a more cheery note, it is probable that the “reinventing process” will begin much sooner, and the U.S. will be able to become more competitive in world markets. The process will not be without painful employment dislocations, however.
The “lend and spend” domestic consumption party may still be winding down by 2010. For the sake of our long term health and stability, the sooner the party wraps up, the better. Many changes as a result of globalization will be hard to stop. Corporate America, to remain viable and competitive will continue to transfer its assets and capital offshore, mostly to Asia. Investors must begin to look at the global economy as a single market. Many geographic sectors will be growing more rapidly than America in the decades to come. Those sectors will benefit from younger populations, lower wages, improving education, and state-of-the-art production facilities (many built with American capital). The days of only investing in Fortress America are coming to an end. Lost in the HerdIt has been noted by many analysts that the “performance pressure” by the institutional community is even higher than 1999. Once the Fed injects liquidity into the system, the hedge funds must jump into the market, or their very jobs are at risk, P/E ratios be damned. With over 8,000 hedge funds in the U.S. (and new ones popping up daily), many fund managers have never met their clients. Loyalty, if it exists at all, is tied to each quarter’s results. This limits strategic thinking. Perform against the benchmark in 90 days or the money may walk. The herd instinct becomes overwhelming, as self-preservation is at stake. Herds have difficulty seeing the road ahead through all the dust they kick up, chasing a performance point or two. And mind the cliff, it’s out there in the dust somewhere. The Chinese, while totalitarian in governing style, have the perspective and patience of a 3,000 year-old culture. They think in terms of decades and centuries. Americans don’t need to think in centuries, but our investing horizon is often as limited as our attention span; months or even days. The Road AheadThe events ahead are impossible to predict precisely, but historic debt levels are not worked off in a few years, especially when the debt is accelerating. Eventually the rebalancing will begin and the problems that were masked by Fed money-printing and foreign central bank bond purchases will come to the fore. Historically, when inflation begins to rise and the dollar declines, traditional assets, bonds and stocks, perform poorly while commodities outperform. Inflation creates both pain and opportunity, and both will be found on the road to 2010. Major trends run in long cycles. The last two decades was a period where paper assets excelled as long term interest rates declined from 15% to 4%. But all cycles run their course, and new cycles take their place. Now that interest rates are beginning their climb back to historical norms, and the world is awash in liquidity and debt, this is no longer the time to embrace paper assets. The next great trend will be the transition from the dominance of paper assets to tangible assets; oil, natural gas, mining, timber, food and water. The paper asset cycle during the 80’s and 90’s created scant demand for oil or mineral exploration (given the low commodity prices), which has lead to supply imbalances in many metals (including silver) and no significant oil discoveries. Growing global demand, particularly in Asia, has been pushing commodity prices higher for over two years. Discovering and bringing new supply to market will take years of effort and huge amounts of capital. In the ensuing years, natural resources should more than hold their value in an inflationary, uncertain world.
The key now is to tune out the “white noise” and stop fighting the daily skirmishes of the last war. Look ahead, to the changes taking place on a global basis. No one knows what unexpected events will unfold during the next five years, such as 9/11, but emerging long-term trends are not likely to turn on a dime. Invest now for the changes to come. Tony Allison Copyright © 2005 All rights reserved.
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