Following up on our earlier post on the latest musings by One River CIO Eric Peters, here is a bonus anecdote from his latest Weekend notes, looking at why the future may be exactly the opposite of what conventional wisdom believes.
“Where will we be in seven years?” asked Lithium, handsfree on Highway One, repeating my question.
We were talking about stocks, which investors assume return 7% per year on average, forever. That means they rise 60% every 7yrs, which would leave the S&P 500 at 4300 in 2025.
But GMO now forecasts that US large cap equities will return -2% per year in nominal terms each year for the next seven (-4.2% per year in real terms), leaving the S&P 500 at 2320, down 14% from today in 2025.
“The key consideration in answering that question is earnings destruction,” said Lithium, banking hard, the pacific sparkling to his left. “We’re in a massively disruptive period. Technology is bringing the consumer and producer closer.
You see it most clearly in retail – Amazon – but a version of this dynamic is happening throughout the economy.” The service sector sits between production and consumption, it’s roughly 80% of the US economy.
“Lots of old companies with legacy models are getting hollowed out by technology. Autos, payments, even energy.” Lithium switched to ludicrous mode, his Tesla leaping. “They’re dead men walking, they just don’t know it yet.” Blockchain, machine learning, artificial intelligence.
“If you could make $1bln but it destroyed $5bln in other people’s profits, would you?” asked Lithium. “If you believe in these new technologies, you must recognize they will destroy profits in all sorts of ways.”
Our job as investors is to figure out where. “Has Amazon made all the profits that they’ve destroyed in retail?
Will Uber make more profits than they destroy? Will Tesla? Google?” asked Lithium.
“Right now, we’re at this classic late-cycle moment where everything appears to work. Both the disrupter and incumbent have gotten an equity boost — less profit per unit of equity market cap. That tells you what you need to know about stocks.”
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As an added bonus, here are two additional vignettes from the latest weekly letter:
Causation: “An outside consultant visited recently and pointed out that the stock market never goes down materially when the PMI is above 50,” said the investor. US manufacturing PMI is 59.3 — on fire, and tax reform has yet to really kick in. “But with the financialization of the economy, is it not the other way around now?” he said. “Will a stock market decline not cause the PMI to fall below 50?” he asked. “Our worry is that the level of interest rates that hurts the real economy is now much higher than the level of rates that hurts the financial economy.”
Genous: “Banks were good heterogenous risk takers,” said the investor. “They’d scan the universe, observe a mispriced asset and buy it, expanding their balance sheet.” Then came 2008, the Volcker Rule. “Now risk is taken by homogeneous indexes, narrowly defined mandates, pigeon-holed perspectives, with no latitude to think.” And yet the system works provided inflows persist, or perhaps it works because inflows persist. “Outflows produce indiscriminate selling. An index cannot expand its balance sheet to hold onto grossly underpriced assets. It just sells.”