Unknown Future Position of Stocks: Peak Oil and Energy

I read a lot about folks recommending 100% stock allocations.  The argument always seems to be that markets inevitably always increase so you are better off investing in stocks.  But is this true?  Do stocks always go up, or is the future position of stocks always unknown.

Inspiration for this Post, Energy and the Stock Market

Before we begin, credit where it is due, this post was inspired by a post from Erik at The Mastermind Within.  You can view his post on what might impact long term stock trajectory here .  Now if you read his post the general gist is his concerns about the future of energy.  He is concerned about the pace of the movement towards sustainable energy and thus basing future stock return assumptions on our current energy systems.  I’m not entirely on board with this concern.  But, I do share his concerns about basing your future expectations of the stock market on the status quo. Hence this post postulating the future position of stocks and responding to his thoughts.

Impossible to Run Out of Energy

Why don’t I buy in fully to his concept of energy sustainability?  Well lets start with some environmental economics as it may be an interesting digression to some.  It’s impossible to run out of energy.   This includes the fallacious concept of peak oil. What you say, isn’t there a finite amount of oil in the ground?  Why yes there is.  Just as there is a finite amount of steel, gold, and any other type of ground deposit.  If we assume the same level of consumption until depletion anything will run out.  But economics disputes this can ever happen.

Supply and Demand Points to Declining Oil Usage as Supplies Dwindle

If you recall my post a few weeks ago, supply and demand drives the price of a good.  Under the same theory this means as the available supply of oil decreases, the cost will gradually increase.     This is the concern to which Erik refers.   To what point you ask?  Until it’s marginal cost, that is the cost of producing one addition unit of oil matches the cost of producing its alternatives.  At that point the volume of oil usage will decrease and the volume of the alternative will increase in equal periods.  Because why would you buy something more expensive then it’s alternative?

How Can There Be Enough Alternatives?

It is a common question, we’ve tried for years to come up with an alternative to no avail.  Well, that’s not entirely true.  We’ve tried for years to come up with an alternative with a similar cost structure to oil to no avail.  But we basically have more than one alternative that is viable if the supply dwindles for oil and the price sky rockets.    

The problem is they aren’t financially viable at oils current price.  In fact we have one source that is essentially limitless, solar.  Solar puts an upper cap on the potential price of oil as with enough funds we could put solar panels in outer space or the moon and power the whole world.   (note I used the off world option here only to combat comments about scarcity of land, but I do believe there is plenty of land for solar as we are today)

It’s not a matter of technology so much as cost of the technology.  But rising costs of oil enable that technology to be cheaper than oil.  IE. the rising costs of oil (in essence the dwindling supply) enable the alternatives themselves.  This is why we have fracking today where it was not financially viable just ten years ago.

Solar and Other Options at the Margins

And now you’re probably saying, but the price of solar on the moon would be astronomical (pun intended).  Well perhaps.  But the beauty of the supply and demand thing is the movement doesn’t just happen over night.  It happens at the margins.  So a little moves each year creating economies of scale and innovation in the replacement technologies.  Eventually they lower in cost as well.  IE.  the cost of the alternatives will never be as high as it is today.  

In fact through most of recorded history the alternative ended up being lower than what was replaced.  Through most of our time on this planet all natural resources have lowered in price through technological advancement, not increased.

A great example of this was the bet between Julian Simon and Paul Ehrlich over the price of industrial metals in the 80s.   All were being used at a tremendous rate and there was fear they would be exhausted.  The alternatives plastic and recycling came on the scene.  The price of these metals ended up declining over a decade as these new technologies took over.  The same will happen to oil, though perhaps not with the full outcome that energy will be as cheap as it is today.  It will be cheaper than solar is today.  I personally believe it will be cheaper, but time will tell.

The Future Position of Stocks

So if I’m not worried about energy what am I worried about that could stop the consistent upward movement of the economy?  I touched on another possible scenario early on in this blog’s history, the end of technological change.  At some point we will have invented everything we can invent, or at least see a major slow down in invention.    I suggest you read more about the scenario in the linked post if you are curious about what would happen. 

Technological Change is Currently Accelerating

That being said all signs point today to the opposite.  Technological change has increased in pace over the last decade with the invention of better information sharing and more efficient processing.  Just 40 years ago anything at a major company, shipping, inventory, accounting, etc were all done by hand.  Personal computers were still a thing reserved for a few researchers.  40 years later we’re talking about robots replacing our jobs, self driving cars, and bionic people.    As such I’m not worried we are reaching this point any time soon.

Government Stability and the Future Position of Stocks

These 2 are the most obvious reasons the future position of stocks is unknown, but they are also the 2 least likely during your lifetime.  The more likely issue is visible in world history and in those less fortunate countries, developing nations.  Do you know what denotes most countries we view as having less developed economies?  Instability.  The simple reality is a country without a stable government is one that won’t have a stable economy.  Now what I mean by stable government here is not in the political sense.  I’m not talking about changes in the political party, policies, or anything else like that.  To see what I truly mean we must look at what the bible calls the four horseman of the apocalypse.

The 4 Horsemen have been Absent

I’m not going to religious in this post so don’t you worry.  But I am going to tell you that the four horsemen are Death, Famine, War, and Pestilence.    Do you know what the biggest thing denoting developed economies versus developing economies is?  A recent lack of the four horsemen.  

• No War.  Sure there have been wars, even large ones, but they’ve all been on foreign soils.  There has been no world war in 70+ years and no full scale war  fought in a developed nation in that timeline.   Developing nations usually can’t make that claim.
• No Famine.  Food is plentiful these days as long as you live in a developed nation.  
• No Pestilence.  There haven’t been any large scale plagues in the last 70 or so years.   Sure we have sickness and disease but not on the scale of the middle ages or even of the developing world.

The Horsemen are Due to Return

The thing is, none of these things is guaranteed to remain absent.  If you review history they happen regularly and in some cases their likelihood has actually increased.  Take disease for example.  Can you imagine how quickly something can spread if it were airborne with today’s jet travel?  What would a massive plague due to the stock market?  Nothing good unless the company you invest in invented the cure.  The same goes for these other examples.  If someone blows up your means of production in a war, how much will you produce?  If your workforce all starves who will build things and who will consume them?  Scary enough if you look through history this is one of the longest period of lack of these type of events in world history.  We’re due if you believe in such momentum indicators.

The Risks are Many, with Varying Degrees of Likelihood

Too morbid or once in a lifetime for you?  Let’s go smaller scale but potentially more likely and just as impactful.  We hit on the energy situation and the exhaustion of resources earlier as not being likely any time soon.    However, while sustainability might not be a concern, availability shocks might be.  You see the infrastructure that provides energy may not be as robust as the sources of energy.  If that infrastructure were to fail for any significant amount of time what would happen?  If half the east coast lost power for a month how many people would survive and what would that due to an electronic operated stock exchange as we have today?     Lets step away from things that might kill you for a second and explore one more possibility.  What if someone hacked the world’s stock market and basically wrecked it?  What then?  

Don’t Invest for Black Swans, but Don’t Turn a Blind Eye to them Either

These are all interesting what ifs, but none are beyond the world of possibility.  All would be considered black swans, so high on the impact scale and so low on the probability that you shouldn’t lose sleep or let them drive your regular investment movements.  But they are very real potential scenarios.  Even without these doomsday scenarios in the last hundred years we’ve had more than one decade where the market has lost money.  You can point out all you want that the market eventually recovered, but that wouldn’t help you one bit had you needed that gain during that ten year period. (or in the case of the great depression 20 years).

Indexing and Risk Tolerance are The Best Options for Uncertainty 

So besides making my point that the future of the stock market is always unknowable, where does that leave us?  Glad you asked.    We’re right back where we started, with index funds and investing according to your risk tolerance.  Index funds aren’t a solution for an always growing economy, or for knowing what comes next.  Just the opposite.  They are the best option for not having a #@## clue what comes next.   Heres a hint, we don’t have a clue about the future position of stocks.  Odds are high the market will continue it’s march upward in the long run, but you never know.