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Dr. Horace “Woody” Brock is the founder and president of Strategic Economic Decisions (www.sedinc.com), a consulting firm focused on economic forecasting and market analysis. His clients include the world’s largest hedge funds, private equity firms, and corporations, and he is a frequent speaker on economic topics. Dr. Brock was the keynote speaker at the Portfolio Construction Conference held in Sydney, Australia, on August 28, and this article is based on that talk, as well as our conversation with him afterwards.
Nearly five years ago, Woody Brock forecast that oil prices would soar, although at the time he did not know by how much. His predictions were accurate and, equally important, they were accurate for the right reasons.
Brock provides a sparklingly clear explanation of the behavior of the oil markets, and a dire prediction for their future. Arguing that this crisis is badly misunderstood, Brock dismisses the idea that speculators are driving prices, as well as any role that OPEC might play.
Brock’s Analytical Framework
To analyze the oil markets, Brock eschews an approach that relies on data and the resulting information overload that can hinder the understanding of market dynamics. Instead, he begins with a sound theory to determine which variables matter and why. (Incidentally, he claims that all great theories have no more than five variables.)
“We are brought up thinking that crunching numbers can get an edge,” Brock says. “But the degree to which this can be accomplished is much less that you think.”
To illustrate his views, Brock cites Einstein’s work in general relativity. Einstein did not spend his time observing a multitude of data points. Instead, he constructed his theories based on the laws of mathematics and physics. In 1919, Einstein’s theory was tested and ultimately proven by observing the bending of light in an eclipse. When Einstein was offered the photographic plates from this experiment, he turned down the offer, supposedly said that he would be sorry for the Almighty if the results did not agree with the theory.
Brock cites Einstein’s observation that “Good theories are good because they work better.”
Brock’s has developed and tested theories that explain some of the most important economic issues. For example, his work has shown that the only truly important variable in forecasting long-term equity returns is the valuation of earnings (i.e, the P/E ratio). Earnings growth, interest and dividend rates play much smaller roles. The great bull market from 1980-2000 was the result of P/E ratios climbing from 8 to 33, after which they receded to 15. In the current decade, earnings growth has been “fantastic” and interest rates low, yet anemic returns have resulted from the decline in P/E rates. [See the article by Vitaliy Katsenelson in today’s issue on this same topic.]
He has also studied the claim that government deficits can be inflationary (e.g., the claim that when the government funds a major program, such as a war, through deficit spending, this inevitably is inflationary). Brock has shown that deficits are inflationary only when they are “monetized,” through the printing of more money and the increase in the money supply. His works also extends to the question of whether foreign governments can drive down the value of the dollar through capital inflows, which would result if they were to sell their holdings of US treasury securities. Brock shows that governments cannot, in general, impact interest rates at all, but can indeed cause massive overshoots of the dollar up or down. "The dollar does all the work," says Brock.
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