21st Century Economics

This report was originally created in July 1999 but is as relevant today as it was then. In fact, most of what it predicted has happened and the opportunities for profits (or not taking large losses) have increased.

What happens to our air is critical to our economy.
If it changes, even slightly, we will feel the financial, health and food effects of it. As a global megatrend, it has far reaching implications on the financial well being of every nation on earth but especially the US. For that reason, it is important to understand the forces at work here.

Life as we know it is possible on Earth because of a natural greenhouse effect that keeps our planet about 60o F warmer than it otherwise would be. Water vapor, carbon dioxide (CO2 ), and other trace gases, such as methane and nitrous oxide, trap solar heat and slow its loss by re-radiation back to space. With industrialization and population growth, greenhouse gas emissions from human activities have consistently increased. These steady additions have begun to tip a delicate balance, significantly increasing the amount of greenhouse gases in the atmosphere, and enhancing their insulating effect.

A wide variety of activities contribute to greenhouse gas emissions.
Burning of coal, oil, and natural gas releases about 6 billion tons of carbon into the atmosphere each year worldwide. Burning and logging of forests contributes another 1-2 billion tons annually by reducing the storage of carbon by trees. The result is that the atmospheric level of CO2, the most important human-derived greenhouse gas, has increased 30 percent, fro m 280 to 360 parts per million (ppm) since 1860. Over the same time period, agricultural and industrial practices have also substantially increased the levels of other potent greenhouse gases — methane concentrations have doubled and nitrous oxide levels have risen by about 15 percent. These gases have atmospheric lifetimes ranging from decades to centuries; today’s emissions will be affecting the climate well into the 21st century.

The overall emissions of greenhouse gases are growing at about 1 percent per year. For millennia, there has been a clear correlation between CO2 levels and the global temperature record. Fluctuations of CO2 and temperature have roughly mirrored each other over the last 160,000 years. The current level of CO2 is already far higher than it has been at any point during this period. If current emissions trends continue over the next century, concentrations will rise to levels not seen on the planet for 50 million years.

Which countries account for the largest proportions of CO2 emissions?
In 1995, 73 percent of the total CO2 emissions from human activities came from the developed countries. The United States is the largest single source, accounting for 22 percent of the total, with carbon emissions per person now exceeding 5 tons per year. Over the next few decades, 90 percent of the world’s population growth will take place in the developing countries, some of which are also undergoing rapid economic development. Per capita energy use in the developing countries, which is currently only 1/10 to 1/20 of the U.S. level, will also increase. If current trends continue, the developing countries will account for more than half of total global CO2 emissions by 2035. China, which is currently the second largest source, is expected to have displaced the United States as the largest emitter by 2015.

Opportunities for Profit

These reports on the megatrend of global warming and ocean rise are not so much meant to present immediate investment opportunities as to alert you to an inevitable trend that will eventually affect all of us. This is not speculation but scientific fact. Unfortunately, it is not in our nature to react ro respond to events that unfold very slowly. Our government and that of many other nations will never put global warming above more immediate issues related to current economic growth and prosperity. For that reason, there will be virtually no preventive measures and no preparation for the eventual effects.

Because there are a few scientists that do understand the coming event and can foresee the impact it will have on society and our economy, they must be silenced so as to not upset the rest of us in our ignorant bliss. To that end, the government will frequently offer up studies that contradict those of established scientists so that the public will remain confused and non-responsive to the warnings. This also allows the government to push off any response until it actually begins to affect our economy - i.e., take money out of the pockets of corporate America - THEN we will address the issues and begin to prepare. Unfortunately, that will be very late in the process and little will be able to be done without major upheavals and deep changes that affect many people.

If a stock is being bought and sold in a thin market the volatility will be large. A thin market is when there are few bids to buy and few offers to sell. This can exist if there is a high demand for the stock but a limited supply of shares. The few trades that do occur in a thin market can affect prices significantly. Institutional investors tend to avoid thin markets because when they buy and sell large blocks of stock, they can significantly affect the stock’s price. They may also find it difficult to get into and out of a position.

If you were to plot beta of a stock over time, you might see changes as the volume of shares in a typical trade fluctuates.

A change from a low beta to a high beta can mean that a thin market has developed for this investment. If the company is buying back its stock or there is a developing takeover in which a buyer is trying to buy up all the shares, the market for this stock will become “thin” and the volatility will increase.

Depending on why this is happening, it can trigger a buy signal for a wise investor.

A change from a high beta to a low beta can indicate that the stock is not seen as being very popular or that is has resolved a major internal problem that has reduced its susceptibility to outside influences. For instance, if an airline is buying fuel on the commodity market, its costs and market position can fluctuate with the price of oil and be influenced by competition with other fuel users - trucks, utilities, heating, manufacturing, etc. This could result in a high beta.

The reason is believed to be overconfidence in a bull market that is encouraging investors to chase the latest shining star. Even when they miss, the bull market imposes a small penalty but that small penalty is adding up. Net returns are lower than if the investor had just stayed with some basic index fund for the duration and not traded so actively.

There is another source of loss that is a direct result of this increased trading. Each time a trade is made, a taxable event occurs. If you gained, it is taxed and if you loss, you are pressured to create an gain so you can take the loss.

For instance: If you sell at a $10,000 loss in the first quarter of the year, you cannot claim that loss (except under special circumstances) unless you have a gain of that amount some time during the year. If your normal dividends do not amount to $10,000, then you have to sell something to create a gain so you can deduct the loss. Now you have another taxable event.

Or you are just creating extra taxes because of the frequent trades you make in day trading or chasing the numbers. The end result is that you are paying taxes on each transaction that lowers your overall gain.

One other way that you might be gaining in these taxable events is by investing in a mutual fund that has an active manager that believes in a high turnover rate. This creates capital gains that may be distributed to the investors.

An alternative is to invest in a few index funds that do little trading. You could also trade in tax exempt bonds and other investments and move your money into a tax-exempt money fund between trades. If it is in a bank, it continues to earn taxable income.

Finally, whatever you do, try to hold your investments that show a profit for at least one year so you can take advantage of the 20% long-term capital gains tax rate. If you don’t the capital gains can be so high as to offset your profits on the trade.

Many people that have read anything about the stock market know that dollar cost averaging is the best way to invest and that the buy and hold strategy for extended periods has proven to be most consistently sound investment method of all. Despite the views of hundreds of investment gurus that spout about the virtues of timing, demographics, contrarian and other sector investment methods - none have proven to be as reliable as simply buying good solid stocks and waiting.

In recent years, the tech boom market has skewed this view by so much that many are beginning to doubt it. The short term success of Internet stocks or other sectors have made people lose sight of the norms and history of the market. If we accept the concepts of “regression to the mean” as described in other articles on this service, we must view the history of the market to get some insights to where the future lies.

Despite the 25% to 50% returns of many funds and stocks in this bull market, the average return over the life of the stock market is between 4.7% and 6.3% depending on how far back you go and what numbers you use.

Let’s be conservative and say it is 6%. That means that by the rule of regression to the mean, the current bull market cannot continue for much longer without swinging the other way to maintain the historical mean. Even if we allow for a massive change in the mean, it almost certainly will not swing from 6% for the average from 1897 to 1997 to some much higher number over the next decade.

The problem is that many people are thinking and planning for their retirements based on these high returns. I have seen many “retirement guides” that use 12% and 15% as the return on your retirements investment and then they always show you the “magic of compound interest” to convince you to reinvest your earnings. Figures in the millions are often quoted if you being saving when you are young. But is this realistic? Can you expect 12 to 15% returns over your investment careers while you save for retirement? The answer will surprise you.

No one in our entire history has ever been able to do it!

Let’s look at why. Suppose we look back at the average growth of the S&P 500 over the past 15 years (this is called the15 year annualized growth). As of the end of 1997, looking back to 1982, we have had about a 15% growth. But this number is very misleading because it happened for only a very short period of time. That number was only 10% if we look back from 1995 and it was only 8% in 1991. If we go back to 1985 and look back to 1970, the average is below 5% average growth.

Remember, we are averaging the total growth for a full 15 year period. That almost totally obscures such minor adjustments as the 500 point drop in 1987 and other “corrections” and it reflects only the major trends of the economy that have some degree of duration such as recessions, wars, demographics, etc.

In fact, the longest period of time that we have ever been able to sustain a 15% return for a 15 year annualized growth was for a two month period in 1997. The average 15 year annualized growth for the stock market since 1887 is just over 4%.

This means that those lucky few that invested during a short 2 months in 1982 and that left their money in the market until 1997, saw a 15% return on their investment. If they had invested any earlier or later than that, the return would have been much lower and it was never higher at any time in history for a 15 year annualized growth figure.

Even if we drop it back and look at an average of 10%, we find that there have only been a total of 17 years since 1887 that we have experienced a 10% growth annualized over 15 years. Contrast that with 16 years in which we had 5% or less for a 15 year annualized growth.

If we believe the concept of regression to the mean or if we believe that history gives us some insights into the future, then we have to conclude that no one should be planning on getting 15% return on their money for periods longer than a few months - a few years at best - but certainly not for the life of an investor from early working age until retirement.
You would do better to figure your retirement investments based on a 5% to 6% return over the life of your investment (3 to 4 decades).

Unfortunately, this will have a significant sticker shock to most investors. Those “retirement guides” that use 12% and 15% as the return on your retirements investment and then show you the “magic of compound interest” use figures like this:

You invest $10,000 at age 20 and get 15% average returns for the next 40 years, you will have $3,887,006 for an early retirement at age 60. Sounds great but it has never happened in all of history and is not likely to happen in the future.

More likely is this: You invest $10,000 at age 20 and get 8% average returns (if you are lucky) for the next 40 years, you will have $242,733 at age 60 not counting the effects of inflation for 60 years. Even if you add $100 a month for 40 years at 8%, you’ll only have $349,100 at age 60. That’s less than one tenth what the retirement guide led you to believe you would have and a whole lot less than you will really need to retire early.

A more realistic strategy is this. Start early - of course we all would like to have had the maturity and wealth to begin saving at age 20 but the fact is that many did not. Don’t think in terms of how little you can save for how long at current rates of return. Think in terms of how much can you save for the longest term possible (that means not retiring early) and at much more conservative rates - like 6-8%.

In commodity trading, an option is called a futures contract and it works in a very similar manner as the put and call options described in other posts to this blog but with much greater leverage and margins. For this reason, the futures contracts can have great value and there is a very active market in the buying and selling of futures contracts. However, it gets very involved and can move very fast, at times, such that this is regarded as being one of the most difficult investments to manage and follow properly. Most experienced traders will avoid the futures market entirely.

Our position, at 21st Century Economics, is that we are not addressing the professional Wall Street investor with our service. We, therefore, do not advocate investments that require minute-by-minute attention to the rises and falls of the value of the investment. Futures trading is like that.