Admit it. It’s discomforting. It makes you ill at ease. It makes you question the world around you. In a matter of a few days the markets have plunged into chaos and disorder. What changed? Gone is ebullience, replaced by fear and despair. Such is today’s world of high frequency trading, financial concentration and a massive index bubble. What used to take weeks, if not months, can now take place in just a few days. As shown in the graph below, in just one week the Dow fell over 4,000 points breaking through its 50-day and 200-day averages. Even if you are not an investor, you are aware of what is happening in the markets.
The world is bracing for a possible pandemic. There is gravity to the coronavirus and the possibility to spread and infect populations around the globe. But if there is any country to best minimize its lethality it is the U.S.
In the short term, it’s impacting travel and global supply chains. Companies like Apple, Hyundai and Nissan are forced to close factories or cut production outside of China. The result is global manufacturing inventory levels have plunged to their lowest levels since 2012. While at the same time rising orders could deplete these low levels of inventory even faster.
Even as the virus is spreading to other nations, the good news is that China is reporting a slowdown in the number of outbreaks and deaths. In the words of the late John Bogle, “this too, shall pass.” When it does, which could be as soon as the end of the second, third, or fourth quarter of this year, economic activity will sharply pick up in order to replenish depleted inventories.
But what if things don’t improve or this turns into an actual pandemic? What then? A black swan event such as this could possibly derail the current recovery or, worse, lead to a possible recession. We can’t rule out the worst.
Changes in the Global Supply Chain
On a positive note, I believe with containment, restrictions on travel, a possible vaccine and the best possible medical care and facilities in the world, this virus will eventually be contained. What will change and has now become a widely discussed theme on our podcast and elsewhere, is the global supply chain. The coronavirus points to the clear danger of concentrating manufacturing supply chains in one country. The rerouting of global supply chains was already moving from China to other countries as companies diversify their supply chains making them less vulnerable to disruptions from either tariffs or pandemics as we see now.
The global order and supply chain management is in the process of reversing as globalization trends reverse themselves and political alignments reorder themselves. These are topics we covered earlier this year in an FS Insider interview with geopolitical strategist Peter Zeihan on his new book Disunited Nations: The Scramble for Power in an Ungoverned World. His book deals with many of the issues of the transition to clean energy which will not go smoothly or work in many countries during this new realignment of the economic order.
Coca Cola, Exxon Mobil and IBM
I want to share with you a few slides from last year’s client meetings. They are a graph of three companies during the great financial crisis when the S&P 500 lost close to 60% of its value. These three companies experienced half the loss and recovered quickly once the bear market ended. More importantly is what happened to their dividends during the greatest financial crisis since the Great Depression. Had you done nothing, you would have received your dividends and those dividends went up every year during the financial crisis. During the financial crisis IBM increased its dividend 95% and 199% since the crisis ended. Coca Cola increased its dividend over 32% and Exxon raised its dividend 30%.
The stock prices of all three companies fell a little over 30% during one of the biggest and longest lasting bear markets in history. But the dividends continue uninterrupted. I cannot guarantee future performance of any company. Nothing in life or the markets is guaranteed. But I can say with a high degree of confidence that a dividend aristocrat (company that has raised its dividend every year for 25 years or more) is likely to continue doing so in the future.
In a world of negative interest rates and 1 to 5 year treasury yields now down below 1% as of this writing, it is nice to be able to provide income and yields that are far above the market and that continue to rise each year. No one enjoys seeing a stock they own fall in price but the reason we own these companies is for their dividends and the possibility of dividend increases. That will not change despite fluctuations in stock prices. Historically, a company with rising profits, cash flows and rising dividends eventually rises in value along with rising stock prices.
A Note on Energy
The feeling on Wall Street is fossil fuels are dead, passé and investment shibboleth. This is a false narrative pedaled by Wall Street and Washington with the belief we have reached “peak demand” for oil and fossil fuels. Things have reached such extremes that U.S. energy stocks are at the lowest price relative to the S&P 500 since the attack on Pearl Harbor.
The current state of energy companies has more to do with their success and the shale revolution that took U.S. oil production from just over 5 million barrels per day (MBD) to the current rate of 12.6 MBD, turning the U.S. once again to the world’s largest energy producer in less than a decade, far above either Saudi Arabia or Russia. The other factor is the mistaken belief in what Wall Street and Washington are promulgating as “peak demand.”
In my opinion, this false narrative is going to be shattered by the middle of the decade when we’ll be more likely to experience another oil shock instead of an oil collapse. I would like to point to two studies, one geological by the Geological Survey of Finland and one geopolitical by Zeihan. They both come to the same conclusions but from two different perspectives: Oil is the lifeblood of the global industrial economy.
If the price rises as it did in 2009, economic growth cannot happen. According to the Finland study, the global system was still 84.7% dependent on fossil fuels. Oil accounts for 90% of the global supply chain and all manufactured products depend on the availability of oil-derived products or services. It is a prerequisite for the transportation of large quantities of goods over long distances. Oil, information technology, container ships, trucks, train and aircraft form the backbone of globalization and our current industrial ecosystem. According to the study’s authors, a global lack of oil could represent a systemic risk to the functioning of global economies. As shown in the Finland study, everything in our modern world either runs on or is made from oil.
The study concludes the transition to clean energy and electric vehicles will not be smooth and will take much longer than what is commonly believed with the risk of disruption. Zeihan reaches the same conclusion from a different perspective geopolitically. Without energy there is no industrial lifestyle. The problem with oil, according to Zeihan, is it is not where people are, and it is only thanks to American naval sea supremacy that has allowed oil to reach the people with minimum fuss. He points out that clean energy needs economies of scale: huge utility-level facilities in calm, sunny deserts or windswept plains—zones not well-known for hosting large population centers. This is in abundance in countries like the U.S., Australia, Mexico, Argentina and South Africa. For the bulk of the other 85% of the earth’s land, green tech isn’t yet productive enough to be all that useful at displacing fossil fuels in scale. Zeihan emphasized four-fifths of the world’s international crude oil is waterborne. As the U.S. downsizes its navy and withdraws from being the world’s policeman, the transport of oil to where it’s needed will become more perilous.
In another important point from OilPrice.com, about 70% of the world’s oil supply comes from fields discovered before 1970, and the bulk of that oil comes from 10-20 enormous fields now in decline. Over 81% of existing oil production is already in decline with average decline rates from 5-7%. In order to make the transition to clean energy, we will need the discovery of four additional Saudi Arabia’s by 2040. U.S. shale is now running on fumes and needs higher oil prices in order to grow. Without oil the world does not grow.
That is the reason we own oil and oil companies that pay good dividends. If you’re alive today or were just born, you will live in the oil age for the rest of this century despite what the pundits on Wall Street and Washington tell you.
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