Here We go Again
The recent disaster in Japan, partly an act of nature
partly a failure of man, has gotten us thinking again
about the nature of risk and subsequent financial
turmoil. Low probability, high impact events often
referred to as Black Swans, are individually unique. But
the probability of some sort of event with a major
financial impact is more likely than we are inclined to
believe. We tend to focus on a particular possibility
such as an earthquake in California rather than the
possibility of any number of low probability, high
impact events. As I look back over the last 25 years,
disasters have occurred with startling frequency:
1987 stock market crash
1989 Savings and Loan collapse
1991 Gulf War
1998 Asian debt crisis
2000 stock market bubble
2001 World Trade Center
2008 financial meltdown
In each of the above cases, financial markets
suffered a substantial decline. In time, however, the
system stabilized and prices rebounded to new highs
(with the exception of 2008, but we are close.) The
take-away for investors is that low probability, high
impact events happen with surprising regularity. We
should be less unsettled by them than we actually are.
Losses tend to be relatively short-term. Over time,
financial markets produce a return. My father, Philip,
was fond of saying that the end of the world happens
* * *
In light of the events in Japan, global stock markets
have been surprisingly resilient though Japan's has been
understandably weak. Short term, the tsunami will
probably be a drag on growth and corporate profits as
essential supplies of Japanese parts have been
disrupted. No question, wealth has been destroyed by the
disaster and Japan is poorer for it. But rebuilding
should act as a stimulus to global growth in the second
half of the year.
Of more concern to the US market is the ending in
June of quantitative easing by the Federal Reserve that
has kept US interest rates artificially low. What impact
will higher interest rates have? Inflation is a related
concern. We fear that gas at $4/gallon and escalating
food prices will act as a tax on consumers, too many of
whom remain unemployed.
Please see our disclosures on page 2 and on our
Member FINRA/SIPC We know clients have been watching
with concern developments in Washington as both ends of
the political spectrum debate the future of the
entitlement society we have constructed over the past 75
years. It is becoming increasingly clear to all that we
cannot afford future commitments made without
impoverishing the next generation. However, there are
sharp disagreements about what to do. This is sure to be
a long struggle but the fact that there is a genuine
debate is refreshing and fascinating to watch.
Surprisingly, the US stock market has been rising in the
face of this debate, climbing a wall of worry.
Expectations of strong corporate earnings seem to be
more important in the short term. The stock market has
almost doubled off its 2009 low. We remain concerned
that such momentum cannot be sustained.
* * *
The future of nuclear power has suffered a setback as
a disabled Japanese nuclear power plant leaks radiation.
Despite encouragement from President Obama, the cause of
nuclear power has likely been delayed substantially.
Re-engineering designs to enhance safety will be costly
and time consuming. It is uncertain whether investors
will require higher returns in order to finance nuclear
power, adding to costs. This development is creating
opportunity for natural gas as a bridge fuel between an
oil and coal powered economy and one powered by nuclear
and renewable energy.
Recent technological advances have opened up
tremendous domestic reserves of gas (and oil too) that
were previously uneconomic to develop. Daniel Yergen, an
industry expert, has estimated that these new reserves
could supply US demand for 100 years. Strategically,
developing domestic sources of energy is attractive. It
would make us less reliant on foreign sources. Gas is
particularly relevant in light of the numerous
rebellions in the Mid-East and North Africa. Gas is less
polluting than oil or coal. And, at current prices, it
is competitive with coal, historically the low cost
fuel, while supplying an equivalent unit of energy at
one third the cost of oil.
Investors should be aware of risks. Infrastructure
needs to be built to move gas to consumers. There are
obstacles to overcome pertaining to safety,
contamination of groundwater while drilling and disposal
of polluted wastewater. Finally, as resurgent supply
reaches the market perhaps overwhelming demand, natural
gas prices may remain depressed in the near to mid-term.
The future is bright but it will take time, making
natural gas an investment for the patient.
* * *
As an SEC registered investment adviser, we recently
updated our Form ADV Part 2 brochure to comply with new
rules. We have posted the new brochure on our website at
www. prherzig.com and will send hardcopies upon request.
We encourage clients to read the brochure, which
describes our business practices and code of ethics.
Please read our important notice
about these letters and the securities they mention.