Portfolio manager’s Letter August 2004
Jim Rogers says, “The Nineteenth century was the British Century, the Twentieth Century was the American Century, and the twenty first century will be the Chinese Century”. While I have no doubt about the first two parts of this quote, I think (being that we are only four years in) it might be a tad early to start making labels for our new century. American Industry has been written-off before (as in the nineteen seventies) only to come back strong in the eighties and the nineties.
Still, I do not expect America to dominate the world economy in the future to the extent that it did in the twentieth century. Certainly there are trends in place that will have profound implications for all investors in the next ten to twenty years. I always prefer to focus on individual companies, and the way that a particular business is performing. But to value a business, you have to define a durable competitive advantage. I think it likely that for the next twenty years durable competitive advantages will be defined by macro trends that are now in place.
Commodity Inflation
In a world economy dominated by mostly free markets and a rapidly expanding world middle class, the price of basic commodities will have to increase. According to National Geographic (June 2004), in 2002, on average, an American consumed 1208 gallons of oil. The average person in China consumed 54 gallons. If China’s per capita consumption driven by growth in autos and other quality-of-life articles increases to 250 gallons by 2025, Chinese demand for oil will grow to 10 billion barrels of oil annually from its current level. This is more than the total used in this country today.
As of April 2004, Chinese crude demand had jumped by 27% (or about 15 gallon per person) year on year. And the impact on the price of oil is clearly obvious. A relatively same increase per person has driven oil prices to $44 per barrel. But oil is only one commodity, and a rapidly growing middle class in China and India will use lots of other natural resources.
The only way to limit the demand of these natural resources will be through price adjustments in the world markets like the one we are experiencing in petroleum now. In order to restrain consumption to sustainable levels, it will require higher prices. This is one point were I agree with Rogers.
Dollar Weakness
The second trend that appears unavoidable to me is a weak dollar. For years our trading partners have supported the dollar for selfish reasons. Foreign central banks buy American debt to keep their currencies weak relative to the dollar. They want to be able to sell their goods into the American market and a strong dollar makes their merchandise cheaper for the American consumer. But the purchase of American debt by Japan and others has left the dollar overvalued. Now we have a huge trade deficit. The market’s eventual solution to the trade imbalances will lead to a much cheaper dollar.
While the decline of the dollar will have a negative impact on some business, and will exacerbate inflation in this country, it will make American goods cheaper abroad. This will increase the competitiveness of American companies that produce goods or provide services here and sell them in other parts of the world.
The Last Century
In 1950 The United States with 5% of the world population produced 31% of all the worlds’ goods and services; by 2003 our market share had dropped to 21%. This trend will most likely continue (perhaps even accelerate). But unlike Jim Rogers, this is not a trend that particularly disturbs me. After all, even though our share of world production has fallen by 50% in the last fifty years, our living standard has increased substantially. It would be hard to argue that America is worse off because it’s declining share of the world market.
Also, although the British Empire disappeared during the twentieth century, the average person living in the British Isles had a vastly improved standard of living in the year 2000 compared to his ancestors living in 1900.
Global Output
From CIA World Fact Book for 2003. “Global output rose by 3.7% in 2003, led by China (9.1%), India (7.6%), and Russia (7.3%) … Growth results posted by the major industrial countries varied from a loss by Germany (-0.1%) to a strong gain by the United States (3.1%). The developing nations also varied in their growth results, with many countries facing population increases that erode gains in output. Externally, the nation-state, as a bedrock economic-political institution, is steadily losing control over international flows of people, goods, funds, and technology.”
“Strong growth” in the United States (3.1%) still lagged behind global average (3.7%). It was one third of the growth experienced in China and less the one half the rate of India and Russia.
If 2003 trends quoted in the paragraph above from the World Fact Book where to continue for the next twenty years, several interesting things would happen:
- The world GDP would double by 2022.
- China’s GDP would be larger than ours by 2013 and be twice as big as the US by 2025.
- India’s GDP would pass us in 2035.
Of course it is highly unlikely that the present trends will continue uninterrupted. But even if all of the above came to pass, it would hardly be a disaster. First of all, any time the world GDP doubles in 19 years there is going to be a substantial increase in living standards everywhere. Even though growth in America might lag some other counties, we are starting with a considerable edge and will probably be able say ahead in per capita GDP. So, while it is unlikely that America will dominate the world economy to the extent that it did in the twentieth century, I see no reason why we will not be able to continue to improve our standard of living.
The economy of the world has changed dramatically in the last twenty years, and it makes no sense to me to expect the pace of change to slow. For the investor there will be, as always, many opportunities to profit from this change, and many disasters waiting for those with their eyes glued to the rear view mirror. The decline of the dollar and increases of commodity prices will have dramatically different impacts on different businesses. So if present trends continue (no guarantees), investors looking for domestic equities may find opportunities by looking for companies that can:
- Sell goods or services to China, India, and the rest of the world.
- Make money on rising commodity prices, (buy companies that sell natural resources, not business that have to purchase large quantities of commodities).
- Companies whose competitive advantage will increase as the value of the dollar declines and inflation increases.
Foreign Stocks, Buying the Crisis
This is not to say that foreign stocks in general will be better investments that American companies, or that any particular foreign stock is a good investment right now. Fortunately emerging countries are prone to economic problems. For the value investor buying the crisis looks to be a good way to buy dollars for 50 cents. So one way to buy emerging equities is to wait for a good crisis and buy a country specific ETF.
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