HUMMONEY - Another Black Swan (Perspective)

-- By Greg Lewin 

The internet has always been a wonderful and dangerous two edged sword of information. Facts and opinions abound unfiltered and unchecked, more often than not of questionable value. But if you spend the time to verify and validate you can gain incredible insight. Over the past several months I have been following an intriguing series of observations which I would like to share which can potentially have important investment implications for investors worldwide.

In March 2010 I read an article in Le Monde, “Washington Considers a Decline of World Oil Production as of 2011.” In the article they interview Glen Sweetnam, who heads the publication of the Department of Energy’s annual International Energy Outlook. He describes what he identifies as a decline of liquid fuels production between 2011 and 2015 as the first stage of the “undulating plateau” pattern which will start when “maximum world oil production is reached.” Further in an April 2009 DOE round-table document entitled “Meeting the Growing Demand for Liquid Fuels,” the DOE had predicted that the decline of supply will be 2% per year starting in 2011, from 87 million barrels per day to just 80 Mbpd in 2015 as demand rises from the current 86Mbpd to 90Mbpd over the same period.

This is some pretty heady stuff so I thought it best to continue to see if we could find some more evidence. In April I found the following statement from the Energy Summary of the United States Department of Defense’s 2010 Joint Operating Environment Report: “By 2012 surplus oil production capacity could entirely disappear, and as early as 2015, the shortfall in output could reach nearly 10Mbpd.”

In February 2010 The UK Industry Taskforce on Peak Oil and Energy Security had issued a lengthy report entitled “The Oil Crunch: A Wake-Up Call for the UK Economy.” This is a group of private British companies whose interests span a wide range of business sectors. And the presentation of this data at the Royal Society included Richard Branson of Virgin Group. Amongst their conclusions was that the net flow rate data shows that the increases in extraction will be slowing down in 2011-2013 and dropping thereafter. So the drumbeat of credible sources continues to support similar conclusions.

Another voice chimed in July 2010, as reported in The Guardian, “Lloyd’s Adds Its Voice to Dire ‘Peak Oil’ Warnings.” In a report issued by Lloyd’s of London called “Sustainable Energy Security: Strategic Risks and Opportunities for Business,” they state, “Even before we reach peak oil we could witness an oil supply crunch because of increased Asian demand. Major new investment takes 10-15 years . . . and to date we have not seen the amount of new projects that would supply the projected increase in demand.”

And finally from Spiegel Online in September 2010, a study claimed by the online newspaper to have been confirmed by sources in government circles and not meant for publication produced by the Future Analysis department of the Bundeswehr Transformation Center, a think tank tasked with fixing a direction for the German military, points to peak oil occurring around the year 2010.

This subject is so very important because quite simply, energy makes the world go round. And given that alternatives are not remotely in position to absorb meaningful energy demand (and I recommend you look into this for yourself) this situation resolves itself in 1 of 2 ways: either meaningfully higher prices for not just energy but virtually everything you use in life that is transported, grown in the ground and manufactured, or demand falls meaningfully which means lower consumption, slower economies, poor job prospects and lower stock prices.  Now is the time for investors to think, verify and follow up because the first way to avoid the Black Swans is to identify and analyze them before they hit the pond.

---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.

HUMMONEY - Is Credit Worthy? (Perspective)

--- By Greg Lewin 

Credit: Belief or confidence in the truth about something.

People who lose confidence in the value of the US currency may choose to buy gold.

People who lose confidence in the political system may choose to not vote.

People who lose confidence in the economic system may choose to stop looking for a job.

And bankers who lose confidence in the health and welfare of businesses and entrepreneurs may choose not to grant credit.

In the most recently reported 3^rd quarter, the 18 biggest commercial banks in the U.S. earned almost $17 billion dollars, with almost half of those profits coming from drawing down loss reserves. It would seem logical that if a bank sensed that things were a little less risky they would then carry lower reserves against loss and therefore choose to lend more.  Yet everyone is perfectly aware that lending continues to be virtually nonexistent.

Corporate balance sheets are widely reported to have historically high levels of cash on their balance sheets generating almost no returns in our low interest rate world. Yet investment in capital, research and new employees continues to be very disappointing.

And the US Federal Reserve keeps flooding our economy with newly printed dollars in an effort to get interest rates close to zero in order to discourage savings and encourage spending, yet no one wants to spend.

Credit, belief, confidence.  As investors, if you really think about it, it’s almost all you really have! We rely on company managements to share with us their appraisals of the future, we look to our elected officials to make sound policy choices and we look to other investors to behave rationally. But when the messages are unclear and behavior seems not quite right we stop spending, we refuse to invest, lending shuts down and we might even chose to buy some gold.

Remember, as investors you must marry the fundamental prospects of that which you invest in with judgments of valuation of the assets or companies you are investing in. And the ultimate arbiter of the value of that asset or business is the after expense and after tax cash it can return to investors. In the vast set of circumstances it takes years to generate enough cash to produce attractive returns. And if its years it takes then it is confidence you need. So maybe we should wait for those who professionally dispense credit to exhibit a little confidence before we volunteer our own.

---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.

HUMMONEY - Golden Eggs and Such (Perspective)

- by Greg Lewin

I want to begin with some wisdom extracted from a recent essay written by Jeremy Grantham.

“In 1965, 3% of the US GDP that was made up of financial services was clearly sufficient to the task, the proof being that the decade was a strong candidate for the greatest economic decade of the 20^th century. We should be suspicious, therefore, of the benefits derived from the extra 4.5% of the pie that went to pay for financial services by 2007, as the financial services share of GDP expanded to a remarkable 7.5%.  This, in turn, should eventually reduce the growth rate of the non-financial sector, which it indeed did: from 3.5% a year before 1965, this growth rate slowed to 2.4% between 1980 and 2007, even before the crisis.”

Simply stated as the financial industry grew the rest of the economy shrunk. If you follow the growth of leverage throughout this period you realize financial innovation is simply an attractive moniker for piling on the debt. In my opinion, the age of financial innovation simply correlated with the age of financial compensation. I believe this is why the financial regulation bill recently passed in Washington is so misguided: over 2000 pages of policy when the only subject of any consequence is that of the permissible use of financial leverage by all financial institutions. Financial leverage compounds the magnitude of every risk taken and importantly compounds the potential reward. 

Unfortunately, the risk/reward equation does not grow proportionally, because along with leverage comes additional costs and limited timeframes. When you borrow you must repay on a given schedule.  But the greed gene always seems to dominate and although the prior equation suggests that leverage should be employed only in financial assets exposed to less risk, the financial industry seems to be willing to apportion leverage across all asset classes in the hope that diversification will lend some measure of protection on the path to increasing compensation.  While that has not turned out so well, regulation of financial leverage is still largely absent from financial re-regulation. 

This may be a consequence of the old relationship between those who have money, in this case Wall Street, and those who need money, politicians, and no one wants to mess with that incredible goose.

Until financial leverage is carefully regulated, financial risk will always supersede business risk. And it is business risk where jobs are created as opposed to financial risk where compensation is created. 

---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.

HUMMONEY - Preaching to the Choir (Perspective)

- by Greg Lewin

I have been told by some pretty fancy preachers that if you want somebody to get the message make sure you tell it to them 3 times. Now think how often you have heard, “If we hadn’t taken action our economy, financial system and our nation would have been in deep trouble”, or possibly, “Our swift action helped us avoid the next Great Depression.”  Well if the preachers are right your antennae should be way up because someone wants you to buy what they are selling.

Let’s look a little closer on how and why this speech making device was and continues to be used so regularly. If you were a strategic thinker, let alone a political strategic thinker, you would want to construct a game you couldn’t lose.  Now how might you swing such a slick maneuver? Let’s say there is a choice to be made between A or B. This would mathematically calculate that you have a 50:50 chance of success. To improve your odds you might engage in some sort of study to aid in making the best choice, but maybe you are insecure enough that research alone does not give you the edge you desire. Maybe, if you are a little crafty, you decide against more research and turn your attention toward actively depreciating the choice not taken. Now if you can accomplish this, think how the odds of success might change. If you actively kill the choice not taken, then if your choice is correct you win but if your choice fails it is no worse than the choice not taken, or at worst your failure is neutral. Now that is a much better game. So investing your energy in the non-choice can be a far better strategy, in certain fields of endeavor, than investing time and energy in the research driven choice. Sound familiar? So our government and assorted luminaries took action and selected massive financial warfare to combat this recession, as they simultaneously invested considerable time and effort in explaining the risks of inaction.

Even though you may now know the game they are playing, it still may be reasonable to ask, should you buy what they are selling? After a brief review of the outcomes I believe the answer is clear. Did they think that 1 ½ years following their initial important policy decisions we would still be burdened with record high unemployment, home foreclosures, personal bankruptcies, federal debt and Wall Street  profit, to name just a few unintended consequences?  With this tremendous record, do you think it deserving that we concede 20:20 vision to these policy makers regarding the consequences of the road not taken?

Whenever you engage in a game where someone else can’t lose that probably means you can’t win. As an investor it serves you well to repeatedly analyze your assumptions and carefully separate facts and opinion. Because in the investment game you only get credit for the decisions made and the only insurance against loss is to align yourself with an economic reality that validates your decision. Simply stated, we play in a world of win and lose and we use research to improve the ratio of risk to reward. All else is just preaching to the choir.

 ---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.

HUMMONEY SERIES: Money, More Money - Surviving the Investment Tsunami

October 19, 2010 at the Cornell Club