Tuesday, January 13, 2009

Coming Out of Crisis

One of the better books on stocks is called “Triumph of the Optimists,” which tracks global markets throughout the past century. In fact, the title itself aptly describes the investment experience.

While the current crisis has thrust the Gloom & Doomers into the spotlight, their fame will be fleeting, as it always is. Bets against increased growth or productivity – the essence of economics – never turn out well.

The shamans of the current crisis will be forgotten, just as few people today can remember promoters of the 1990s tech bubble, or the 1970s technical analysis traders, the “Nifty Fifty” stocks of the 1960s, or the South Sea Bubble of the 1720s.

As Harvard economist John Kenneth Galbraith wrote, “the financial memory should be assumed to last, at a maximum, no more than twenty years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to come on the scene, impressed, as had been its predecessors, with its own innovative genius.”

From here, investors must assess where they are on the curve – ahead of it, with the pack, or bringing up the rear. I discuss this issue in a previous article that I wrote for the Expert Voices archive of the National Science Digital Library, at a cyclical peak in the agricultural commodities market.

As you can see, the bulk of profits from the commodities boom has already been made, by savvy investors like Warren Buffett and Jim Rogers, who were involved before anyone even knew that a secular shift in commodity prices was underway.

Furthermore, investors who've read a wide range of energy industry 10-Ks over the past few years know that substantial profits have been reinvested to expand capacity, in response to skyrocketing prices. The energy industry has had almost a full decade to adjust to the constrained world oil balance; and prices in excess of $100 per barrel gave an tremendous incentive to supply the market, while destroying global demand.

This is not to say that the bull market in crude oil is over, because I do not believe that it is. But the large number of new investors in the energy sector are by definition “with the pack,” not ahead of the curve.

In most cases, these investors are operating on outdated information that was generated many years ago, before the huge run-up in prices altered the capacity and oil balance picture. This will probably create greater volatility going forward, not the relatively steady double-digit annualized returns that accrued from oil over the past decade.

With 98% of stocks in the United States and Europe having delivered negative returns in 2008, there is no doubt that tremendous bargains currently prevail. But just as generals tend to fight the last war, the mass of investors will always look to reap the gains of the last bull market.

However, for those investors who are ahead of the curve, vast fortunes will emerge from the financial wreckage.

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This work by Nicholas E. Radice is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.