Advisor Roundtable: Investing in Megatrends
As I discussed in Best Stock Screening Tools on the Web, top-down investing analyzes macro “big picture” investment themes and “requires the mind of a philosopher, economist, scholar, and industry expert.” I thought to myself, I’ve got access to this type of talent right here at Investing Daily, so why don’t I ask them for some top-down themes? Specifically, I asked Investing Daily’s circle of investment philosopher kings the following:
What is the most important megatrend investors should be acting on?
The answers ranged far afield, from energy to aging demographics to emerging market urbanization to financial risk management. Read on to find out the details:
Rising global use of electricity is a megatrend that’s transcended boom and bust cycles for more than a century. And as developing economies grow and global connectivity expands, it’s set to do so in the 21st century as well. Electricity is more malleable than any other form of energy because it can be produced in so many different ways.
In the past few years, wind power has become economic in many areas for the first time, for example, and solar is rapidly getting there. Even nuclear energy is seeing a renaissance, thanks to new and less expensive plant designs. In developed and resource-depleted countries like the
The most important megatrend facing the global economy is the rising cost of commodities, particularly natural resources. With disposable incomes rising rapidly across the emerging markets, energy demand in particular will continue to increase.
Currently, oil production capacity is ample due to the fact that global demand has been temporarily weakened by the European debt crisis. But demand is already recovering and spare capacity is falling; finding new supplies of oil to meet demand is also becoming increasingly difficult. The complexities involved with drilling deepwater wells in the
Meanwhile, governments in Western countries spout nonsense about speculation and impractical green energy. It’s only a matter of time before oil prices spike as they did in the summer of 2008.
Urbanization and the infrastructure associated with it is the biggest megatrend investors need to watch for the foreseeable future. According to the United Nations, the global urban population has increased by 50 percent between 1990 and 2011, and as the industrialization of the emerging markets continues, urban growth should remain vibrant. By 2030, the U.N. estimates that 54 percent of
Under current economic circumstances,
There is no monetary magic or fiscal finagling stimulating enough to overcome deflationary demographics.
The world’s developed economies — and even emerging ones such as
The Federal Reserve’s rapid, unprecedented increase in the money supply is often cited as a sure signal that inflation is on the way. Don’t believe it. The primary pressures remain deflationary — persistent high unemployment and underuse of private capital. Private demand is weak because not enough people are taking home regular paychecks, to say nothing of the decade-long stagnation in real wages. And the potential currency created by the Fed to cope with a fractured financial system is still parked on public and private balance sheets. It’s important to note, too, that folks are still lending money to the
The real problems lurk another 10 years out; that’s when the
The 2008-09 financial crisis was largely caused by derivatives run wild. Sure, the great economic recession caused by the unprecedented decline in real estate prices was the trigger, but it was the tremendous financial leverage enabled by credit default swaps (CDS) and structured products such as collateralized mortgage obligations (CMOs) that magnified an economic slowdown into the worst financial crisis since the Great Depression of the 1930s. JP Morgan Chase’s (NYSE: JPM) recent multi-billion loss on credit default swaps demonstrates that the problem of opaque derivatives trading continues even now after the passage of Dodd-Frank financial reform legislation.
Given this backdrop, you may be surprised that my megatrend of the future is derivatives! In fact, I’m a big fan of derivatives if used wisely. Derivatives are not inherently evil; they are low-cost risk management tools that transfer risk from a more risk-averse party to another party that is better able to handle the risk. Commodities firms, for example, use derivatives all the time to lock in prices for their goods and reduce the volatility of their future earnings. As the global financial system becomes more complicated and fast-paced, risk management is going to become one of the great growth stories of the 21st century.
The key is to ensure that derivatives are traded only by entities that can handle the risk. As I wrote in my article Is AIG a Sinking Ship?, American International Group (NYSE: AIG) needed a huge government bailout because it was allowed to sell a virtually unlimited number of CDS’s without having the capital necessary to fulfill its obligations if they went the wrong way. The Dodd-Frank financial reform legislation addresses derivatives and requires that “routine” derivatives be traded on a financial exchange where all trades are guaranteed by a triple-A-rated central clearinghouse. Exchanges do not allow parties to trade derivatives unless they can demonstrate sufficient capital requirements. Big winners from Dodd-Frank should include exchanges such as CME Group (NasdaqGS: CME) and InterContinentalExchange (NYSE: ICE).
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