Vierd

I was watching this documentary of Miles Davis jamming around in the studio. He started playing something, stopped. And he said ‘Vierd, where did that come from?’

You kind of wonder the same thing about the market from time to time. This is the ultimate whiplash market for the MoMo men. All the big momentum trades; short banks, long wheat, long gold, curve steepeners etc – all have been mullered of late. And if you tried to go the other way, you were pretty sure to get caught up in the chop.

When gold reversed badly a month or so ago, I knew it was time to pull in my momentum horns. I have been running maybe a third of my normal leveraged positions since. Which is just as well, as I’ve lost money on almost every trade. It’s a swing trader’s market, no doubt. And for good reason. Since January 2007, momentum has been king. It’s pulled in the big money, and it’s got to be a massively crowded trading style.

And, as it does, I think the macro is contributing to it. The US will be accelerating over the next three to six months, while Europe slows down. That’s not exactly conducive to big dollar short positions. And then there’s inflation in Asia and Eastern Europe, rate hikes etc.

That’s a major reason that I don’t run ‘one trick’ money; value / growth / momentum / swing etc. Quite simply, when everyone is in, the risk/reward goes sour. There’s nothing odd in Bill Miller losing his winning streak over the past two years. Value was the best performing style, by a country mile, from 2000-2006. As a big value investor, you’ve got to expect some payback. For a great account of value investing through the late 1990s and early 2000s – check out ‘Capital Account’ by Edward Chancellor for the fund managers Marathon. It was almost enough to turn me into a value investor myself.

Now, my big call for the past few years has been energy efficiency. In 2004 I put out a very bullish paper on the engineers. I was a big buyer of ABB, Alstom and GEA. I own all three today.

A year or so ago, I refined the argument. The basic question I wanted to answer; how far could this thing go?

Now, forgive me for a minute – this is going to get a bit academic. Economists have always had loads of models to explain equilibrium. For a long time, they struggled to explain growth. Then Robert Solow took the Cobb-Douglas equation, which uses capital and labour factor inputs to explain growth at firm level, and he applied it to the whole economy. His model explained 54% of US growth from 1900-2000. And for that, Solow won the Nobel Prize. It shows they’ve always held the bar pretty low for economists.

And to explain the rest? The economists wave their arms around a lot and say productivity.

Unhappy with this state of affairs, Dr. Richard Ayres thought about a third scarce resource; energy. And he thought about the increasing efficiency with which energy was used (back in 1900, power stations ran at 20% efficiency or so. Now, the best local closed loop systems can run 70-80%). Factor that into an improved Cobb-Douglas equation (the Linux model in the chart below), and you explain 95% of US growth in the 20th century.

This is where it gets interesting. Energy and ‘energy efficiency’ account for 45% of the growth in US value added over the past 100 years. But they only account for around 7% of the total returns in the US economy (labour is at around 67%, the rest of the capital stock gets around 26%).

Now, the issue here is that, if energy gets scarce – and my view is that this is exactly what will happen, then it will start taking returns from capital and labour. How much? Well, up to its contribution to growth; another 40%, or around six times what it’s currently receiving.

Of course, that’s too aggressive. The process of redistributing those returns would be highly unpleasant – likely involving a deeper recession, consumers economising, and some loosening of energy markets. So it won’t go in a straight line. But the theory is there. We could go a distance towards that number.

So, in my book, the biggest risk out there is not a high VAR, it is that energy gets ever more scarce. And that is a central call in my thematic portfolio, which I’m playing through the following energy, engineering and resource stocks;

ABB, AP Moller-Maersk, Cosan, ENRC, Ocean Rig, Petrobras, Stanelco, SSAB, Alstom, Patterson, Schneider, Technip and Vallourec. If you follow a few of these names – you’ll know that some of them have started to move pretty aggressively of late. That’s made up for the chopping around in my leveraged fund, and leaves me up 19% from my mid-February start.