Tag Archives: climate change

Risk-O-Meter

As is now customary ahead of Davos week, the latest World Economic Forum report on global risks was released and the usual graphic of the top 5 global risks in terms of likelihood and impact are reproduced below. Environmental risks and technology risks again dominate the likelihood list which is indicative of the current consensus. As this post highlights, the likelihood of irreversible climate change within the next 10 to 20 years is the short, medium and long-term issue of our times.

Although the report does state that “geopolitical and geo-economic tensions are rising among the world’s major powers” and that these “tensions represent the most urgent global risks at present”, I was somewhat surprised to see that geopolitical risk did not make the top 5 likelihood list this year. Despite the current market (wishful in my view) thinking of a kick the can down the road fudge outcome, Brexit in 2019 may result in a constitutional crisis in the UK or the possibility of a large portion of the population being alienated by a possible rushed outcome this Spring (e.g. hard Brexit or permanent custom union). His Orangeness and his ability to flame division, whether internally in the US after a bad Mueller report or against China to deflect from his pitiful negotiating style, are ever present possibilities for 2019 (if not hopefully remote ones). Although maybe somewhat alarmist, I can’t but help worry that his reign may end with some form of violent turmoil, he will not go quietly!

As an aside, the wonderful TV show “Brexit: The Uncivil War” from the UK’s Channel 4, which I think is on Netflix now, does raise the issue of how democracies will operate in a world where all sides can use technology to manipulate a (potentially decisive) disengaged minority to the political extremes. If the long-term success of democracy is dependent upon compromise, then we may be in trouble. Pundits say the implications of Brexit politics is a break from the traditional left/right or conservative/liberal divide, into a much more complex mixture of differing tribes. In fact, I would highly recommend this video from Dominic Cummings, the main subject of the show, who ably explains the parameters of the new political landscape (if you don’t have the time to watch it all, watch a few minutes after the 15-minute mark on how they did it).

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One other item that caught my attention in the WEF report, in section 6 called Open Secrets, was the assertion that when “the huge resources being devoted to quantum research lead to large-scale quantum computing, many of the tools that form the basis of current digital cryptography will be rendered obsolete”. The article further asserts that “public key algorithms, in particular, will be effortlessly crackable” and, under certain scenarios, “a collapse of cryptography would take with it much of the scaffolding of digital life”. Do I hear a new arms race approaching? The report predicts “as the prospect of quantum code-breaking looms closer, a transition to new alternatives—such as lattice-based and hashbased cryptography—will gather pace” although “some may even revert to low-tech solutions, taking sensitive information offline and relying on in-person exchanges”. Imagine having to rely on people meeting other people to get things done……..unthinkable!

A naughty or nice 2019?

They say if you keep making the same prediction, at some stage it will come true. Well, my 2018 post a year ago on the return of volatility eventually proved prescient (I made the same prediction for 2017!). Besides the equity markets (multiple posts with the latest one here), the non-company specific topics covered in this blog in 2018 ranged from the telecom sector (here), insurance (here, here, and here), climate change (here and here), to my own favourite posts on artificial intelligence (here, here and here).

The most popular post (by far thanks to a repost by InsuranceLinked)) this year was on the Lloyds’ of London market (here) and I again undertake to try to post more on insurance specific topics in 2019. My company specific posts in 2018 centered on CenturyLink (CTL), Apple (AAPL), PaddyPowerBetfair (PPB.L), and Nvidia (NVDA). Given that I am now on the side-lines on all these names, except CTL, until their operating results justify my estimate of fair value and the market direction is clearer, I hope to widen the range of firms I will post on in 2019, time permitting. Although this blog is primarily a means of trying to clarify my own thoughts on various topics by means of a public diary of sorts, it is gratifying to see that I got the highest number of views and visitors in 2018. I am most grateful to you, dear reader, for that.

In terms of predictions for the 2019 equity markets, the graph below shows the latest targets from market analysts. Given the volatility in Q4 2018, it is unsurprising that the range of estimates for 2019 is wider than previously. At the beginning of 2018, the consensus EPS estimate for the S&P500 was $146.00 with an average multiple just below 20. Current 2018 estimates of $157.00 resulted in a multiple of 16 for the year end S&P500 number. The drop from 20 to 16 illustrates the level of uncertainty in the current market

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For 2019, the consensus EPS estimate is (currently) $171.00 with an average 2019 year-end target of 2,900 implying a 17 multiple. Given that this EPS estimate of 9% growth includes sectors such as energy with an assumed healthy 10% EPS growth projection despite the oil price drop, it’s probable that this EPS estimate will come down during the upcoming earnings season as firms err on the conservative side for their 2019 projections.

The bears point to building pressures on top-line growth and on record profit margins. The golden boy of the moment, Michael Wilson of Morgan Stanley, calls the current 2019 EPS estimates “lofty”. The bulls point to the newly established (as of last Friday) Powell Put and the likely resolution of the US-China trade spat (because both sides need it). I am still dubious on a significant or timely relaxation of global quantitative tightening and don’t feel particularly inclined to bet money on the Orange One’s negotiating prowess with China. My guess is the Chinese will give enough for a fudge but not enough to satisfy Trump’s narcissistic need (and political need?) for a visible outright victory. The NAFTA negotiations and his stance on the Wall show outcomes bear little relation to the rhetoric of the man. These issues will be the story of 2019. Plus Brexit of course (or as I suspect the lack thereof).

Until we get further insight from the Q4 earnings calls, my current base assumption of 4% EPS growth to $164 with a multiple of 15 to 16 implies the S&P500 will be range bound around current levels of 2,400 – 2,600. Hopefully with less big moves up or down!

Historically, a non-recessionary bear market lasts on average 7 months according to Ed Clissold of Ned Davis Research (see their 2019 report here). According to Bank of America, since 1950 the S&P 500 has endured 11 retreats of 12% or more in prolonged bull markets with these corrections lasting 8 months on average. The exhibit below suggests that such corrections only take 5 months to recover peak to trough.

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To get a feel for the possible direction of the S&P500 over 2019, I looked at the historical path of the index over 300 trading days after a peak for 4 non-recessionary and 4 recessionary periods (remember recessions are usually declared after they have begun), as below.

Note: These graphs have been subsequently updated for the S&P500 close to the 18th January 2019. 

click to enlarges&p500 q42018 drop compared to 4 nonrecession drops in 1962 1987 1998 & 2015 updated

 

click to enlarges&p500 q42018 drop compared to 4 recession drops in 1957 1974 1990 & 2000 updated

 

I will leave it to you, dear reader, to decide which path represents the most likely one for 2019. It is interesting that the 1957 track most closely matches the moves to date  (Ed: as per the date of the post, obviously not after that date!) but history rarely exactly rhymes. I have no idea whether 2019 will be naughty or nice for equity investors. I can predict with 100% certainty that it will not be dull….

Given that Brightwater’s pure Alpha fund has reportingly returned an impressive 14.6% for 2018 net of fees, I will leave the last word to Ray Dalio, who has featured regularly in this blog in 2018, as per his recent article (which I highly recommend):

Typically at this phase of the short-term debt cycle (which is where we are now), the prices of the hottest stocks and other equity-like assets that do well when growth is strong (e.g., private equity and real estate) decline and corporate credit spreads and credit risks start to rise. Typically, that happens in the areas that have had the biggest debt growth, especially if that happens in the largely unregulated shadow banking system (i.e., the non-bank lending system). In the last cycle, it was in the mortgage debt market. In this cycle, it has been in corporate and government debt markets.

When the cracks start to appear, both those problems that one can anticipate and those that one can’t start to appear, so it is especially important to identify them quickly and stay one step ahead of them.

So, it appears to me that we are in the late stages of both the short-term and long-term debt cycles. In other words, a) we are in the late-cycle phase of the short-term debt cycle when profit and earnings growth are still strong and the tightening of credit is causing asset prices to decline, and b) we are in the late-cycle phase of the long-term debt cycle when asset prices and economies are sensitive to tightenings and when central banks don’t have much power to ease credit.

A very happy and healthy 2019 to all.

Net Zero Fantasy

As we enter a week where further market turmoil is likely against a background of further tensions between the US and China over the Huawei arrest, the climax of the Brexit debacle, and the yellow vest protests in France. All these issues can and will be resolved eventually but they pale in comparison to the political inaction over the latest climate change reports.

The US government, in the form of the United States Global Change Research Program (USGCRP), in a report in November concluded that “the evidence of human-caused climate change is overwhelming and continues to strengthen, that the impacts of climate change are intensifying across the country, and that climate-related threats to Americans’ physical, social, and economic well-being are rising” and warned that “these impacts are projected to intensify—but how much they intensify will depend on actions taken to reduce global greenhouse gas emis­sions and to adapt to the risks from climate change now and in the coming decades”. Of course, the Orange One again demonstrated his supreme myopic attitude with the dismissal “I don’t believe it”.

We now have the black comedy of oil producing states such as the US, Russia and Saudi Arabia arguing over whether to “welcome” or just “note” the latest IPCC report this week at the UN climate talks, known as COP24. The IPCC report on the impacts of a temperature rise of 1.5°C was launched last October and is a sobering read. The IPCC again states with a high level of confidence that “human activities are estimated to have caused approximately 1.0°C of global warming above pre-industrial levels, with a likely range of 0.8°C to 1.2°C” and that “global warming is likely to reach 1.5°C between 2030 and 2052 if it continues to increase at the current rate”.

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In order to avoid warming above 1.5°C, the world needs “global net anthropogenic CO2 emissions decline by about 45% from 2010 levels by 2030 (40–60% interquartile range), reaching net zero around 2050 (2045–2055 interquartile range)”. For limiting global warming to below 2°C, emissions need to “decline by about 25% by 2030 in most pathways (10–30% interquartile range) and reach net zero around 2070 (2065–2080 interquartile range)”.

Let’s face it, given the current political leadership across the globe, such declines are just fantasy. And I find that really depressing. The plea of David Attenborough at COP24 last week for leaders in the world to lead looks set to fall on deaf ears. Attenborough worryingly stated that “the continuation of our civilisations and the natural world upon which we depend, is in your hands (i.e. our leaders)”.

We’re pretty much toast then….

A Riskier World?

This year’s Davos gathering is likely to be dominated by Donald Trump’s presence. I look forward to seeing him barge past other political and industry leaders to get his prime photo opportunity. As US equity markets continue to make all time highs in an unrelentingly fashion, it is scary to see the melt-up market been cheered on by the vivacious talking heads.

Ahead of Davos, the latest World Economic Forum report on global risks was released today. 59% of the contributors to the annual global risks survey point to an increase in risks in 2018, with environmental and cybersecurity risks continuing their trend of growing prominence, as can be seen below.

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Undoubtedly, environmental risks are the biggest generational challenge we face and it is hard to argue with the statement that “we have been pushing our planet to the brink and the damage is becoming increasingly clear“. That said, what is also striking about these assessments (and its important to remember that they are not predictions) is how the economic risks (light blue squares) have, in the opinion of the contributors, receded as top risks in recent years. The report does state that although the “headline economic indicators suggest the world is finally getting back on track after the global crisis that erupted 10 years ago” there is “continuing underlying concerns”.  Amongst these concerns, the report highlights “potentially unsustainable asset prices, with the world now eight years into a bull run; elevated indebtedness, particularly in China; and continuing strains in the global financial system”.

A short article in the report entitled “Cognitive Bias and Risk Management” by Michele Wucker caught my attention. The article included the following:

Risk management starts with identifying and estimating the probability and impact of a given threat. We can then decide whether a risk falls within our tolerance limits and how to react to reduce the risk or at least our exposure to it. Time and again, however, individuals and organizations stumble during this process—for example, failing to respond to obvious but neglected high-impact “grey rhino” risks while scrambling to identify “black swan” events that, by definition, are not predictable.

and

One of the most pervasive cognitive blinders is the availability bias, which leads decision-makers to rely on examples and evidence that come immediately to mind. This draws people’s attention to emotionally salient events ahead of objectively more likely and impactful events.

I do wonder about cognitive blinders and grey rhinos for the year ahead.

Ignorance in action

The last time I posted on the climate change debate was here in November 2014 on the release of the synthesis reports on the IPCC’s 5th assessment. The post asked whether the debate would now move on, away from the climate change deniers, given the weight of scientific opinion. Well, that was before Mr Trump. In his inane rationale for withdrawing from the (nonbinding) Paris climate agreement, Trump has provided a classic illustration of Johann Wolfgang von Goethe’s quote that “there is nothing more frightful than ignorance in action”.

The Paris agreement is far from perfect. It does not however contain hard emissions targets but rather gives a framework for voluntary reductions. Admittingly previous voluntary reductions promised by many countries have been missed but even a flawed agreement is better than nothing. Recent declines in the growth in coal use in China and India were positive initial signs.

Maybe Mr Trump’s delusional thinking is that his masterful negotiations skills mean he can negotiate a global agreement with hard emission targets! More likely, he is acting politically to shore up his mid America coal loving support given the danger that some of his core support may just be realising that his healthcare and fiscal policies are not that favourable to those at lower incomes.

I recently came across this statement from January 1954 by the Tobacco Industry Research Committee, a tobacco firm group representatives, in reaction to some of the initial medical research showing that smoking was linked to lung cancer. The group stated that “we believe the products we make are not injurious to health”. My favorite bit is the arguments cited by “distinguished authorities” below countering the emerging scientific evidence:

  1. That medical research of recent years indicates many possible causes of lung cancer.
  2. That there is no agreement among the authorities regarding what the cause is.
  3. That there is no proof that cigarette smoking is one of the causes.
  4. That statistics purporting to link cigarette smoking with the disease could apply with equal force to any one of many other aspects of modern life. Indeed the validity of the statistics themselves is questioned by numerous scientists.

Don’t these arguments sound familiar?