2011-11-04

2011 November 5

Reader Survey  &  The End of the World?

Here is the link to the Master Resource Report reader survey. The maximum capacity is 100 respondents so if you would like to let your thoughts be known don’t wait too long. None of the questions are mandatory so if you do not wish to answer that is fine. None of the questions ask any personal information. I will share the results in a few weeks. Thanks to everyone that takes the time to give me some feedback.

Now for something a little different.

Since I would be gone this week I asked Kevin to prepare a commentary that deviated from the usual look at peak oil and constrained natural capital usually covered by The Master Resource Report. We hope you find it both interesting and a little provocative.

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Seeing as the current topic du jour in the financial sphere seems to be to be the binary debate between complete economic collapse and the renewal of growth, I thought it would be interesting to make a few comments about historical perspective.

It’s the end of the world and the binary bet…

Rebellion in the Middle East, economic stagnation in the US economy, protesters cramming urban centers chanting for greater equality, Europe struggling under the weight of a sovereign debt crisis and a rising foreign nation set to surpass America on the global scene… Certainly the world must be ending, right?  A view of the Middle East during the 1960’s into the 1970’s yields a staggering number of coups, rebellions, and outright wars that saw the continual churning of the Arab political scene. Following the resolution of the Vietnam War and conclusion of large scale highway construction projects in the early 1970’s American real GDP growth began to fall into a malaise from which it seemed there was no end. In the late 1870’s after years of crushing deflation, abusive pay and employment practices foisted on the working class a massive nationwide series of strikes that was only put down after violent intervention of Federal and State Troops. In the years immediately following the end of the Second World War until the collapse of the fixed exchange rate Bretton Woods regime in the early 1970’s, Europe was in a chronic state of currency crisis leading countries like Great Britain and France to devalue their currencies five times (which essentially constitutes a sovereign default). During the early 1950’s Americans feared that the Soviet Union would eclipse the country on the international stage, by the 60’s economic fear had shifted to Germany’s rise from the post war ashes, and finally by the mid 80’s many feared that the Japanese were literally buying the county one golf course at a time.

So why, given past experience, does the market and the population in general expect a different reality? To understand this it is important to realize that the 1980’s and 1990’s were atypical, with the 90’s being exceptionally so. During this so called “great moderation” volatility in the economy dropped, asset markets boomed, and the great beast of inflation seemed defeated. Unfortunately, this recent history does not fit with anything seen before. So why should this be considered the norm? Since the relative tranquility of the 80’s and 90’s coincided with the formative savings years of many baby boomers and the culturally formative years of my generation, a false sense of history was created. With a median age of roughly 36.8 the vast majority of Americans truly did live in unusual times. Unusual in a constructive way, but nonetheless not informative in the scope of history. These decades of boom created a false narrative in our society from both an economic and cultural standpoint. Despite the many positives this modern day era of good feelings has created they also had the unfortunate side effect of removing from the minds of the public any form of historical perspective.

Perspective is something that has become sorely lacking in the modern world whether that is through our personal lives, government, or investing. The general population time horizons have shrunk as the baby boom (and it sometimes seems the country as a whole) approaches their preconceived notion of retirement. With politicians, perspective and foresight is limited as it has always been to the next election cycle, coupled with the public’s constant “what have you done for me lately” mentality. In the world of investing this loss of perspective is most damaging because its ripples are felt through the wallets of savers and more fundamentally through the funding mechanism of economy in general. The last ten years have not been kind to American equity investors as they have seen a total return on equities of 2.71% through Q3 of 2011 for the S&P 500 index (excluding dividends the average annual return was a 0.83%) leading many to declare the death of stocks.

For perspective it is important to recall that in the ten year period between 1968 & 1978 the S&P 500 Index including dividends had an annual return of 3.2% (excluding dividends the average annual return was a -0.77%). Compounding the poor performance of the stock market was the fact that interest rates sky rocketed along with inflation from 5.66% in 1968 to 7.94% in 1978 after hitting a decade peak of 10.51% in 1974 destroying wholesale many bond portfolios. With absolutely nowhere to hide, the average investor in the aforementioned decade fared much worse than his currently depressed counterpart.

Despite the calls on CNBC for more aggressive risk management involving complex and expensive hedging strategies one extremely boring theme continues to hold, own a solid well run business. There is nothing exciting about single digit returns, very little flare in quarterly or annual rebalancing to mitigate risk, and nothing flashy about solid dividend paying companies with defendable payout ratios, but therein lay the opportunity. With everyone trying to reinvent the wheel it seems that the world has forgotten that true wealth has never been built in any other way than owning and building solid businesses over the long run. The names that reverberate throughout history like Carnegie, Rockefeller, Gates, Buffet, and Vanderbilt built their fortunes on businesses constructed over the course of their lifetimes. The life of Cornelius Vanderbilt alone saw the War of 1812, the Mexican American War, the Civil War, countless financial panics, and long periods of dysfunctional government yet throughout he built an empire unrivaled in scope and value.

As I have made my way through the industry to the much greener pastures of independent money management the pitch on the street has changed. But despite the hype on television and on the internet, there is no one who can trade their way to riches. With every market cycle comes a new soothsayer whose correct insight becomes a career making calling card, but as any investor in John Paulson’s Advantage Plus Fund can attest to the fact that very often lightening does not strike twice. As I have said before, and will no doubt say again, there are no people who can consistently call market directions, for if it were possible they would in effect have a money machine and they, not Warren Buffett and Carlos Slim, would be the richest people in the world.

What will happen tomorrow I cannot say, but if we have truly come to the point where the best and most adaptive place to put your money is not a well run business, what you do with your money is irrelevant because the world is in fact truly coming to an end. Like any mildly sane person can decipher this is in fact a binary bet: heads you win, tails it doesn’t matter. And always remember when looking around our increasingly torrid world that those long term return numbers that came during turbulent times that in many ways eclipse the troubles of today. Maybe with a little bit of perspective we will all see that the fog is not so thick and that the sun may yet burn through someday.

** The S&P 500 Index is an unmanaged equity index.

Kevin J. Hansen

Ravenna Capital Management

If you would like to watch Kevin’s presentation at the 2010 ASPO-USA Conference in Washington DC it is available online.    Peak Oil: Investing Beyond Oil & Gas