Equity valuations and disaster scenarios
19 August, 2009
I had a drink recently with a friend who regards himself (not without reason) as an astute investor, and naturally I asked him for a view on which way stock markets were going to move. I expected the normal analysis about markets going sideways, or being slightly overbought, or about to rebound and so on. But what he hit me with was something altogether more surprising, and (if he’s right) alarming.
His thesis is that our view of the markets is unreasonably influenced by what he saw as a “golden” period spanning the last 50 years or so. During that period we produced, consumed and generally made merry as if there was no tomorrow, aided by extraordinary advances in science, technology, medicine and financial engineering. And we did this while consuming, and failing to replace, a global inheritance of natural and environmental resources. Not to mention allowing the global population to go from 3 billion in 1960 to 7 billion in two year’s time, and racking up enormous debts in many of the world’s major economies.
He sees this convergence of exceptional factors as having lulled us into a false sense of security about achievable living standards, and about equity valuations. He thinks the party is effectively over, and that while technological and agricultural innovation will ease the problems, we are set for a prolonged period of underperformance in stock markets.
And as if that’s not enough, he seems to have absorbed the lessons of “The Black Swan” and thinks that equity valuations anyway need discounting for the combined effect of unlikely but severely negative future events. He listed off several examples of what he had in mind:
Nuclear / biological terrorism
War or nuclear attack in Middle East or India/Pakistan or Korea
Major natural disaster eg earthquake in Japan or California
Russia (or terrorists) cuts off gas supply to Western Europe
Eastern European debt crisis
Severe civil unrest in China
Sudden and dramatic destabilisation of the US Dollar
A global disease pandemic
I was glad to see that being struck by a meteor didn’t feature on his list.
Apart from possible short-term threats, he sees in the medium term a growing problem from shortages of resources, including hydrocarbons, water, and food, and from the adverse effects of global warming and climate change. Not surprisingly, he doesn’t see any upside for equities generally in widespread famine, war and disease.
I protested that markets had survived and had recovered from World Wars, Cold Wars, flu pandemics, and that he was underestimating human resourcefulness. He said that I, in turn, was underestimating the effect of overpopulation and climate change. He was putting his money where his mouth was and had sold 80% of his shares.
Cheerful fellow, no?