Recent AP wire news flash 9-28-16 : OPEC countries neared agreement on a preliminary accord Wednesday to limit oil production, sending oil prices upward, despite lingering differences between regional rivals Saudi Arabia and Iran…Benchmark U.S. crude jumped $2.38, or 5.3 percent, to $47.05 a barrel in New York. Brent crude, the international standard, was up $2.72, or 5.9 percent, to $48.69 a barrel in London.
https://finance.yahoo.com/news/old-rivalries-seen-blocking-opec-093452256.html
Imagine a world economy that had a ceiling on the price of fuel and would not move higher unexpectedly. Technology has had a major impact on many items that we use in our lives. Energy powers modern life and is considered by markets to be one of the most important commodities. The powerful seismic and big data tech that has been applied to energy extraction in the US has begun to swing the balance of the world energy markets in powerful ways. Headlines like the one mentioned have scared the equity markets for many years, always fretting that we were on the precipice of a collapse of supply.
The persistent energy innovation in our modern industrial economy dating back to the heyday of Rockefeller seems to be entering a phase where technology is creating price stability and growing supplies as a result of massive US shale oil production capacity.
According to the WSJ, “Two Years Into Oil Slump, U.S. Shale Firms Are Ready to Pump More”.
Early in 2016, the market was in a darkly pessimistic mood about LOW oil prices and the impact that was going to have on the US energy industry. The Journal piece notes; “Few predicted that in the fall of 2014, when Saudi Arabia signaled that it wouldn’t curb its output to put a floor under crude prices. Oil pundits concluded that a brutal culling would force higher-cost players known as marginal producers—a group that includes shale drillers—out of the market.”
The early 2016 thesis was that slumping oil was going to unleash massive energy company failures, bankruptcies and loan/bond defaults that would create a downswing or even worse in the US and global economy. The prevailing psychology of investors is rooted in the belief that Oil Shocks were a fact of the modern world and the next crisis is always lurking around the corner. An early energy “crisis” occurred during the Civil War as demand greatly outran supply. In 1891 the Pennsylvania oilfields production began to decline and panic and rising prices followed. Decades of belief in “Peak Oil” and Malthusian pessimism about running out of energy have ruled the markets ever since. See the movie Mad Max for a less intellectual interpretation.
In the energy freak-outs and panics that have followed, technical innovations in pursuit of the massive economic rewards of energy have been grinding for more production. US shale oil production is now showing a break-even price range of between $40-$65 per barrel. The OPEC chokehold on the world economy is becoming toothless as whatever cutbacks are made to push up price, American production capacity stands ready to fill the void at a competitive price.
Oil security is only one piece of the newly stable energy landscape. Technological progress with wind is potentially getting a push from increased regulatory approvals in the US to provide more clean domestic energy in the coming decades. This story ties into the oil downturn as offshore drilling operators seek to diversify into wind farm engineering work.
Bloomberg notes; “With more U.S. offshore wind farms in the works, Gulf Island and its peers say the nascent industry offers a new source of revenue to weather the volatile oil market. Cheap crude has long been seen as a barrier to renewable energy. Now those low prices are helping the wind industry grow.”
This is a great example of when one market becomes impaired, innovative American companies find ways to redeploy and persevere.
In the midst of the cascade of negativity that has been this political season, it is refreshing to read about these positive economic developments and to ponder the consequences of a world with less petrodollars funding authoritarian regimes. This new reality will likely shape a new Middle East much more than any military action ever could.
The Study of Ignorance
In 1999 David Dunning and Justin Kruger of the Cornell University department of Psychology produced a fascinating study on intelligence and the struggle for people to grasp what they do not know. The Cornell University Website notes; “His research focuses primarily on the accuracy with which people view themselves and their peers. In his most widely-cited work, he showed that people tend to hold flattering opinions of themselves and their decisions that cannot be justified from objective evidence—a phenomenon that carries many implications for health, education, the workplace, and economic exchange.”
As Dunning describes it; “What’s curious is that, in many cases, incompetence does not leave people disoriented, perplexed, or cautious. Instead, the incompetent are often blessed with an inappropriate confidence, buoyed by something that feels like knowledge.”
Dunning continues, “This isn’t just an armchair theory. A whole battery of studies conducted by myself and others have confirmed that people who don’t know much about a given set of cognitive, technical, or social skills tend to grossly overestimate their prowess and performance, whether it’s grammar, emotional intelligence, logical reasoning, firearm care and safety, debating, or financial knowledge. College students who hand in exams that will earn them Ds and Fs tend to think their efforts will be worthy of far higher grades; low-performing chess players, bridge players, and medical students, and elderly people applying for a renewed driver’s license, similarly overestimate their competence by a long shot.”
This phenomenon has continued to be studied in the years that have passed since the original work on competence awareness. Strikingly, Professor Dunning states; “Occasionally, one can even see this tendency at work in the broad movements of history. Among its many causes, the 2008 financial meltdown was precipitated by the collapse of an epic housing bubble stoked by the machinations of financiers and the ignorance of consumers. And recent research suggests that many Americans’ financial ignorance is of the inappropriately confident variety. In 2012, the National Financial Capability Study, conducted by the Financial Industry Regulatory Authority (with the U.S. Treasury), asked roughly 25,000 respondents to rate their own financial knowledge, and then went on to measure their actual financial literacy.
The roughly 800 respondents who said they had filed bankruptcy within the previous two years performed fairly dismally on the test — in the 37th percentile, on average. But they rated their overall financial knowledge more, not less, positively than other respondents did. The difference was slight, but it was beyond a statistical doubt: 23 percent of the recently bankrupted respondents gave themselves the highest possible self-rating; among the rest, only 13 percent did so. Why the self-confidence? … bankrupted respondents were particularly allergic to saying “I don’t know.” Pointedly, when getting a question wrong, they were 67 percent more likely to endorse a falsehood than their peers were. Thus, with a head full of “knowledge,” they considered their financial literacy to be just fine.”
https://psmag.com/we-are-all-confident-idiots-56a60eb7febc#.px4ihwsz3
http://www.gq-magazine.co.uk/article/stupidity-for-dummies
This material on competence is powerful and revealing of a crucial social and psychological dynamic that provides a framework for understanding how repetitive mistakes are made by individuals and society.
The troubling dynamic of the arrogance of incompetence has much to teach us in many areas of our lives. Family, workplace, school, and financial realms of our existence are made better through awareness of the vast unknowable complexities that allude all of us. Einstein was a aware of this dynamic when he stated, “I prefer an attitude of humility corresponding to the weakness of our intellectual understanding of nature and of our own being.” T. S. Eliot pointed out, “Humility is the most difficult of all virtues to achieve; nothing dies harder than the desire to think well of self.”
There is a powerful mechanism of self-preservation and survival in our cognitive bias towards confidence and potential over-confidence. Great achievements, innovation, and every day noble endeavor, are fortified by our willingness to see ourselves as greater than seems possible or rational. The Dunning Kruger effect intersects with a cognitive bias (Overconfidence Bias) that allowed our distant ancestors to have the grandiose belief that there was life beyond the cave. Our great cities, medical facilities, electric cars, computer chips, solar panels and so many more, all stand on top of the overconfidence that allowed great achievement over the thousands of years of human evolution. These biases are embedded deeply in our subconscious. We must be continually mindful of our tendencies to overestimate our own individual abilities of understanding and rational decision-making in the face of complex, modern world decision-making.
What good investors need to constantly be mindful of is the freedom to say : I do not know. To take the humble path of the business owner that must face new uncertainty every time the sun rises. “Humilitarian” is a term that I want to introduce in our thinking; definition : an individual that seeks knowledge with constant recognition of the unfathomable complexity that must be accepted as a bulwark against over-confidence or arrogance of ever knowing but a fragment of what is actually happening or where the world is headed.
Stories illustrating overconfidence and lack of humility can be found on a daily basis in our mainstream financial press. It has been recently reported by the Wall Street Journal that former pro basketball player Christian Laettner has avoided bankruptcy and returned a portion of investor’s money in the face of multiple failing real estate projects. We might ask, “Why would someone’s success in college and professional basketball lend itself to expertise in real estate investing?” The rational / analytical answer in this case is that, the two activities do not seem to have much overlap.
It is not surprising that a mid-tier pro basketball player would find failure in the real estate business. He was most likely unaware and overconfident in his ability to navigate a completely foreign competitive landscape of commercial real estate. The odds of success for anyone starting out in the commercial real estate market are always going to be low as established competitors will be waiting in most markets. This would not even be a story if were not for the minor celebrity element. What is noteworthy is the willingness of investors to finance a neophyte athlete and the predictable failure that ensued.
http://www.wsj.com/articles/christian-laettner-reaches-deal-to-repay-investors-1474402851
There are numerous examples of personality driven nonsense that are successfully marketed. The target cohort is individuals that are drawn to the fame, name recognition or chance for a brush with “greatness”. These people are letting their guard down as they invest without looking much further than the name or face of the organization.
The travails of Thomas Marsico is a larger example of personality driven investment firms and the failure that they often produce. According to the recent WSJ reporting, assets at Marsico Capital Management have declined from over $100 billion to under $4 billion since 2008.
Tom Marsico was a high performing mutual fund manager for Janus Mutual Funds in the 1990s when he decided to leave and continue the process for his own firm. We have discussed the dynamics of individuals that get on a winning streak or series of judgements that seem to represent a certain type of genius, only to regress to the mean or break down below average. When the mystique is shaken, then money heads for the next hot idea, often leading to this type of cascade of declining assets as investors lose confidence and pull their money.
http://www.wsj.com/articles/denvers-stock-picking-star-wrestles-with-firms-debt-1474554004
These stories of failure are important lessons. The current hot idea can lead us to chase elusive “above average” performance at the expense of the steady and reliable systemic approach that the tortoise uses to beat the hare.
Sustainable portfolios are built on quality companies that meticulously refine platforms for sustainable profitability. There is a continuous drumbeat of failure along the way. As companies like Circuit City, Saturn Corporation, and Burger Chef fall by the wayside, Amazon, Tesla and Starbucks innovate and prosper. I hope that we are all alert enough to avoid investing in the next Minnie Pearls Chicken franchise (bankrupt in 1968).
The political season has been one that is fraught with many Dunning-Kruger “moments”. As much as supporters want to believe in the magic of “Feeling the Bern” or that an outsider celebrity can bring magical solutions to our political process, it is likely wishful (Dunning Kruger?) thinking. The complexity of our civic, legal and economic systems are daunting. It is highly unlikely that any one individual can storm in and master national leadership challenges. It is even less likely that the slogans of a presidential campaign will be relevant after Election Day.
These campaigns are voracious streams of political marketing that use any tactic that can be dreamed up to get people to show up and cast a vote left or right. Dire warnings, pandering to ideas like wall building isolationism, “debt free” university systems or never tampering with Social Security and Medicare can only lead to disappointment as the messy and slow reality of real world governance sets in after Election Day.
I avoid taking ideological positions and I yearn for a message of better government rather than left versus right. This election cycle, the dialog has been driven in a dangerous populist direction, leaving the market seemingly rooting for the status quo. I firmly believe that our capitalist democracy is resilient, whatever the outcome of 2016.
The notion that the world may be moving on from always fearing the next energy crisis does not mean that there are not going to be new threats to agonize about. The perpetual challenge is the fact that there is never a day for an investor to let their guard down and reflect on clarity in current time or the future. The great constant of uncertainty and surprise is the reality to we must always acknowledge. Awareness of our skills and humility in the face of our limitations comprise the highest form of investor and human IQ.
Talent is God given. Be humble. Fame is man-given. Be grateful. Conceit is self-given. Be careful.
John Wooden