The Price Clients Pay for Worst-Case Forecasts
An unhealthy focus on doom-and-gloom has been going on for a long time. Stearns invites us to consider the world's progress since 1800. "The history books tell us about the American Civil War, which wasn't any fun, the Russian Revolution, China's purges and economic upheavals, the 1918 flu epidemic, and two world wars." he says. "What we are not taught in history classes is that during that time period of upheaval and catastrophes, the population of the world has multiplied six times, the average life expectancy has more than doubled and real income over inflation has multiplied over nine times."
More recently, in the 1960s, leading futurists, like Paul Ehrlich, were predicting that the world's rising population would cause shortages of food, energy and affordable health care. The result would be rationing, starvation and the stagnation of the average human quality of life. "And yet despite the Korean War, the Cold War, the Vietnam War, the dotcom bust, 9/11 and the most recent Great Recession," says Stearns, "infant mortality is down by over one-third and getting ready to go down substantially more in the next 10 years. The average human consumes one-third more calories, life expectancy has increased by over one-third and real income over inflation has multiplied over three times."
And more relevant to the advisory profession, stocks (represented by the S&P 500) have gone up 9,649.74% since 1950 – not counting dividend reinvestment. That's hardly a disaster scenario.
So how can we look at the future more realistically? Stearns offers a quick tour of some of the scariest issues. He starts with energy.
"In 1974, Jimmy Carter said that we could use up all the proven reserves of oil in the entire world by the end of the next decade," he says. "In 1970, the world had 550 billion barrels of proven reserves. Between 1970 and 1990 we actually used 600 billion, so theoretically we should have already run out. Instead, actual U.S. crude oil production is expected to exceed Saudi Arabia's somewhere out in 2015 or so."
To that, Stearns adds the natural gas situation, which could hardly be more favorable. "Within three to five years, the U.S. will become the largest natural gas exporter in the world," he says. "It is estimated that the U.S. will be totally energy-independent within five years, perhaps sooner."
This, he says, will lead to other beneficial effects that are the exact opposite of the discouraging projections you see in the papers. "Manufacturers are quietly bringing their plants back into the U.S., and using natural gas to run them," says Stearns. "This gives them a more stable energy footprint, and in some cases even a lower-cost footprint. I sit in on a lot of those meetings with companies," Stearns adds, "and I can tell you, they want stable even more than they want cheap."
This introduces another issue that we read about a lot: Jobs are migrating overseas, and the U.S. doesn't manufacture anything anymore. Stearns practices in what was once the heart of the furniture manufacturing industry in the U.S., and a number of his clients moved their operations offshore to take advantage of cheap labor. Now, he says, the trend is reversing – in part due to the energy situation, in part because U.S. wages have gone nowhere while wages in Southeast Asia have risen dramatically.
Bigger picture, Stearns quotes from a book entitled Technological Revolutions in Financial Capital, by Carlotta Perez, which suggests that every major technological revolution goes through an "installation period" that looks, misleadingly, like an economic boom. When new technologies are being installed, there is a lot of excitement, and people overpay for the wrong metrics (like eyeballs), and there is an inevitable crash. Think: the tech boom of 2000 or the speculative railroad bubble in the 19th century. This is eventually followed by what Perez calls the deployment period, when the technology finally starts to enhance economic production in a big way.
We've seen an installment period in information technology, and it ended badly. "In the deployment period, the cycle of things starts to work together," says Stearns. "We think of the current technology boom in terms of smart phones and things we use every day, but big companies are taking mobile technology to a whole new level."
The technology multiplier
Most advisors are looking at the Shiller trailing-PE10 as a measure of the stock market. But what if a new deployment period of computer and mobile technology creates an unexpected surge of corporate productivity? Stearns calls this a "technology multiplier," and identifies it as a potential super-trend that will change the way corporations and individuals do business and render historical stock charts ineffective as predictors of future returns.
A technology multiplier is a combination of disparate technologies that create something entirely unexpected. For example? "My firm co-sponsored a simulcast, and it included a kid, recently graduated from high school, who had invented a nuclear reactor," says Stearns. "It was probably about twice the size of your kitchen table, and that reactor used fuel rods from existing nuclear reactors that were spent; in other words, it was using that stuff that we have trouble figuring out what to do with. He has a company, fully venture-capitalized, and they expect the first prototype within two years. They will be selling little boxes that could light up 100,000 homes in the next five years."
What do you multiply that by? "Another speaker was talking about the future of fresh water, which was a huge issue at the World Economic Forum," says Stearns. "He was talking about a new reverse-osmosis system that works with nuclear energy, which would solve all the fresh-water supply problems of the world. It is not hard," Stearns adds, "to see how you marry those two concepts together and take something that we all think is just an intractable problem that can't possibly be solved, and just solve it like that."
But at least we know that healthcare is going to hell in a handbasket. Medicare is broke and poised to put the U.S. government trillions of dollars in debt. Right?
Stearns offers no comment on the government-sponsored health insurance exchanges. Instead, he points to another innovation. "At our nanotechnology center [a research facility that Stearns is helping develop in what he laughingly refers to as his spare time], we've been working on a handheld device which would detect a concussion," he says. "We were originally commissioned to do this by the NCAA and NFL, because football players tend to have a lot of them. It would tell you, through an on-field blood test, immediately whether you should pull somebody out of the game or send them to the hospital."
While working on this project, Stearns has become aware of other handheld devices being worked on all over the world, including one at Tel Aviv University that will detect an immeasurably broad range of diseases. "This is not 20 years from now that these will be commercial and out," he says. "In most cases, this is 3-5 years."
Consider what a device like that could do to the current sky-high projections of future health-care costs. "In the last six months of life, what are the biggest Medicare costs?" Stearns asks rhetorically, before answering himself: "A lot of tests. But," he asks, "what if those tests were 80% to 90% less costly than they are today? A lot of those future cost assumptions are going to be wildly off-base."
The point: all of the debates going on around what is going to happen ten years from now, with our budget deficits and skyrocketing costs, may be rendered invalid by technologies that are close to deployment. "Five years ago, people were sure we were running out of oil," Stearns cautions. "We may be making the same kind of mistake in healthcare."
At least we know that the federal debt is wildly out of control, and if something isn't done – which is unlikely given the state of our Congressional debates – the U.S. will end up like Greece. Right?
"The story you don't read about in the papers," says Stearns, "is that when you combine this very clunky sequestration with better tax revenues than expected, all of a sudden our deficit is coming down. In fact," he says, "some respected economists are worrying that it may be coming down too fast."
Two years ago, when the U.S. debt-to-GDP ratio was approaching 90%, false readings of the Reinhart-Rogoff research suggested that was a red line that, if crossed, which would plunge the U.S economy into recession or depression. No such crisis occurred. The debt-to-GDP ratio has flattened out, and the most recent CBO report projects that it will remain at roughly its current level as far out as 2022.
Perhaps more to the point, 10 years ago, in the early 1990s when interest rates were considerably higher, the annual debt payments the U.S. made on its aggregate borrowings totaled 19% of the total budget. That's twice the percentage that the U.S. pays today. The Reinhart-Rogoff red line isn’t as close as people think.
Reframing the role of the advisor
Stearns makes two key points. One is that advisors and clients who get caught up in the headlines, who believe that the future is 75% negative and 25% positive, will pay an opportunity cost by underweighting equities. If the world could get through all of those massive challenges of the past century, then it will sail through a paralyzed Congress and higher-than-normal debt levels without crushing future stock returns or plunging the world into a disaster scenario.
But the more important point is that advisors of the future will need to become skilled antidotes to the 24/7 negativism that comes from the news media, and get better at reframing global issues for their clients. This problem has actually been growing, slowly and without a lot of fanfare, since the early 1980s, when advisors were complaining about the misinformation, short-term thinking and hot investment recommendations their clients were getting from Money magazine. Today's cable financial channels, filled with talking heads who routinely predict the future and creatures like Jim Cramer screaming into the camera are incomparably more compelling and attention-grabbing – and harmful to rational thinking.
Stearns believes that this challenge will accelerate in a new way. "Before long, clients will be able to send Siri or a new Google Personal Assistant out into the web and ask about the investment portfolio their advisor is managing," says Stearns. Those information bots will be much smarter than they are wise, and they will efficiently pull advice and information from every possible source, including doomsayers, gold bugs, stock touts and people whose idea of a safe portfolio is a rifle and a cabin with canned goods up in the mountains. Inevitably, this electronic personal assistant will bring back an 'optimized' portfolio that is very different from what you would recommend for your clients, and then you'll have to rely on your emotional maturity and reframing skills to bring the client back to reality.
"You may have them perfectly positioned in their portfolio," says Stearns, "but the system has gotten data that suggest that they are not. They're going to walk into your office, just like they do with doctors now, with a self-diagnosis and a suggested course of treatment."
"And then," Stearns adds, "they come in to us and expect us to refute it, or give them a different perspective. Many times, their mind is made up and they don't want a different perspective." Your role, increasingly the role that advisors in the future will play, is to help the client see through the fog of short-term thinking and negative projections, and recognize the opportunities that tend to outweigh the dangers.
And, of course, that can only happen if you're able to unplug from the prevailing viewpoint yourself, and recognize what is easy to see in hindsight, never easy to see looking forward: that the future has always been bright, and betting against its brightness has never before been a good bet.
Bob Veres's Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog or subscribe to get the Fee Samples report at: www.bobveres.com. Or check out his Insider's Forum Conference (September 17-19 in Dallas) at www.insidersforum.com.