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ARP Observations

The Biggest Opportunity of a Lifetime?

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See all articlesThe Absolute Return Letter

A new generation has been ‘born’ - the Selfie Generation - and they continue to have a rather dramatic impact on financial markets, but that is an opportunity for all those not obsessed with taking pictures of themselves.

You probably know what I mean when I refer to the Baby Boomers — all those who were born in the first 15 years after the end of World War II. You may also have heard of Generation X, perhaps better known as the offspring of the Baby Boomers and sometimes referred to as the Echo Boomers.

Have you ever heard of the Selfie Generation, though?  All those who spend hours every day posting on various social media that they are there (whether at a gig, a football match, or elsewhere) rather than just enjoying the experience.

The emergence of the Selfie Generation has significant investment implications, which is why I bring it up in this context. When I was young(er), smartphones didn’t exist, but that all changed a good ten years ago when the first ones arrived. Suddenly, having a smartphone became as important to some people as food and water. Even more noticeably, digitalisation in general, and smartphones in particular, have had a shortening effect on our attention spans, making them briefer than ever before. According to a 2017 study by NeuroTracker (Source: https://neurotracker.net/2017/05/24/humans-attention-span-shorter-than-goldfish/),  the average human attention span is now no more than eight seconds — less than that of goldfish!

I first entered the financial industry in 1984, and back then long-term investing was still measured in years, but not anymore. When I talk to investors from the Selfie Generation, I am often left with the impression that ‘long-term’ means next Monday morning. Yet therein lies an opportunity for investors willing to look at the real long term.

The mega-trends that will change the world

The near term is often characterised by much noise, which is why we don’t allow it to dictate our investment strategy.  Instead, our investment style at Absolute Return Partners is one that tunes in to a number of structural trends that we have identified over the years; structural trends that are pretty much set in stone and that are certain to have a meaningful impact on the performance of financial markets in the years to come.

The fact that the eyes of many investors from the Selfie Generation begin to glaze over when we mention those structural trends only confirms that a major opportunity is unfolding. So, what are these trends? Without further ado, let me present all eight of them (Exhibit 1).

Exhibit 1: The Eight Structural Mega-Trends

1. The End of the Debt Super-Cycle

2. Retirement of the Baby Boomers

3. Declining Spending Power of the Middle Classes

4. Rise of the East

5. Disruption

6. Running Out of Freshwater

7. Electrification of Everything

8. Mean Reversion of Wealth-to-GDP

Source: Absolute Return Partners LLP. See https://www.arpinvestments.com/investment-themes.

Allow me to make a few points. Firstly, the number of mega-trends (eight) is not static. In my book from March 2018, The End of Indexing, I listed only six trends because that was all we had identified at the time of publication. Over time, I am sure more will be added to the list and, every now and then, some will probably be removed as well.

Secondly, one of the mega-trends mentioned in the book — ‘the death of fossil fuels’ — has since been downgraded to a sub-trend and replaced by a new mega-trend called ‘electrification of everything’ with the former now being a sub-trend of the latter. I will go into more detail on this investment theme below.

Thirdly, I now consider one of the mega-trends mentioned in my book — ‘mean reversion of wealth-to-GDP’ — the collective result of the other seven mega-trends. Wealth in society simply cannot outgrow GDP for any extended period of time (or vice versa). In the largest economy of them all — the United States — the long-term mean is about 380%; i.e. the mean value of US wealth is 3.8 times US GDP. Every time wealth has deviated significantly from that mean value, it has mean-reverted. Every single time! The ratio is now slightly above 500%, so US household wealth will have to drop 25-30% — it is only a question of when it happens.

Let’s tune into mega-trend no. 7, which I believe will have a massive impact on society for many years to come. The underlying driver behind this trend is the desire amongst governments all over the world to reduce emissions of carbon dioxide. If successful, this will lead to a significant reduction in greenhouse gases as long as fossil fuels are not used to generate the electricity needed. In that context, it is worth noting that Hong Kong authorities have listed Tesla as a more polluting car than modern petrol cars. Why? Because most electricity in Hong Kong is generated by burning coal.

Fusion energy

This is where fusion energy enters the frame (Note: The next few paragraphs on the fusion process are copied verbatim from my book, The End of Indexing). Fusion is the most basic form of energy in the universe. It is what powers the sun and the stars, where energy is produced by a nuclear reaction in which two atoms of the same lightweight element, usually an isotope of hydrogen, combine into a single molecule of helium.

When scientists attempt to replicate that process, the most important ingredients are sea water and lithium, both of which are in ample supply; thus, vast amounts of energy could be produced at a very reasonable cost — at least theoretically. Even better, the fusion process does not suffer from all the safety issues that accompany traditional nuclear power. So far so good, but there is a problem — and a big one at that.

Researchers can produce plenty of energy from fusion but not in a controlled way. The best example is the hydrogen bomb, where a huge amount of energy is released in a highly destructive manner. If the same amount of energy can be released gradually — in a controlled manner — we will have found the eternal solution to planet Earth’s energy requirements.

We would have virtually unlimited access to cheap energy, and greenhouse gases would be a thing of the past. There would be little nuclear waste, and productivity would rise dramatically across the world, effectively dealing with the debt overhang. These factors in combination would resolve some of the biggest challenges humanity is faced with today.

Having said that, creating a controlled fusion reaction has proven very difficult. Because the nuclei have the same charge, they repel one other. To overcome the natural repulsion of the nuclei, you must give them sufficient energy. That means heating them up to at least twelve million degrees, but as you heat a gas or plasma up it expands, and the atoms move further apart.

The trick is to contain the heated plasma long enough that the nuclei have the chance to collide and overcome the repulsive force. Researchers have now achieved this and reached the energy break-even point, but there is still a long way to go before the technology can be rolled out commercially.

The good news is that the reports coming in from research laboratories all over the world are quite astonishing. The fusion process — converting hydrogen to helium — releases about ten million times more energy than what is released when burning the same amount of hydrogen. Fusion is also far more powerful than fission (traditional nuclear energy), as fusion converts a much higher percentage of the mass within an atom into energy, meaning that it will require only a modest amount of seawater and lithium to fuel the entire world.

To illustrate just how powerful it is, the lithium from one laptop battery combined with half a bathtub of seawater would provide the fuel for 200,000 kWh of electricity — the same as 70 tonnes of coal and equivalent to 30 years of UK per capita energy consumption.

In early 2018, I stated that we were probably still 30 years away from commercialisation of fusion energy. However, researchers have made considerable progress over the last year and now believe that we can probably add fusion energy to the grid within 15 years.

Given this progress, it is not premature to start thinking about the wider investment implications. While some investors may respond with “nice to know, but let’s take another look in ten years’ time”, we believe now is a good time to incorporate it in one’s investment strategy.

Why renewable energy forms do not offer the best solution

In light of all of this, fusion energy is our overwhelming favourite to become the world’s default choice when looking for a sustainable source of affordable energy to replace fossil fuels. Nevertheless, many investors are laying odds on renewable energy forms. Newspapers like the Financial Times are gung-ho about wind and solar and frequently argue that an abundance of cheap, clean power will soon change everything (See for example this article: https://www.ft.com/content/4079d82a-9e1f-11e8-b196-da9d6c239ca8).

The key word here is cheap. Although some will argue that renewables are not 100% clean (pointing to habitat loss, use of hazardous materials, etc.), these energy sources are certainly much cleaner than fossil fuels. Most of the environmental problems caused by fossil fuels would simply disappear if all electricity were generated by renewables. However, according to 2016 data from the EU, for every percentage point increase in the use of renewables in the electricity mix, electricity bills go up by 4.25 percentage points, and by almost 6 percentage points if one excludes solar-rich Portugal and Spain.

In other words, if renewable energy is getting cheaper to produce — as some claim it is — EU households haven’t yet started to reap the benefits. Their bills continue to rise as more electricity is generated by renewables. An electricity bill rising far beyond the level of CPI is akin to a non-productive use of capital and affects GDP growth negatively.

The comparatively high cost of renewables means that productivity growth, and therefore also GDP growth, will continue to slow, unless (or until) we come up with a more cost-effective solution. This doesn’t imply that there is no role for renewables. There certainly is. It does imply, however, that in all likelihood renewables will eventually be pushed aside, if (when) a game-changing new technology emerges which will allow us to generate almost endless amounts of electricity at virtually no cost.

Investment Implications

The investment implications of a commercial roll-out of fusion energy are quite dramatic. Even before it happens, the electrification of everything will have a dramatic impact on many asset classes and investment strategies. Lithium is a simple example. Think about the ongoing electrification of the global car fleet. Lithium is a significant component in electric car batteries, so demand for lithium will increase for many years to come whether fusion energy ever happens or not.

Alternatively, combine the electrification theme with mega-trend no. 4 (‘rise of the East’). Unless the growing middle classes of Asia have fundamentally different desires from the rest of us, they too will want to go digital. Consequently, demand for laptop computers and smartphones — both of which are big users of lithium — will grow for many years to come. When fusion energy is eventually introduced, demand for lithium will only increase further.

Another implication of ‘electrification of everything’ is that commercial banks may ultimately cease to exist. Just like Amazon has disrupted retailers all over the world in recent years, blockchain may disrupt commercial banks in the years to come. The main caveat is that everything needs to be electrified before we can take full advantage of this new technology, but the writing is on the wall.

All of the above may unfold even if fusion energy is never rolled out. Once fusion energy is upon us, more dramatic things will happen. Coal and natural gas prices will almost certainly go to zero (with implications for entire countries) as there will no longer be any use for those fossil fuels. The chemical industry will continue to use oil — mostly to manufacture various plastic products — so oil prices will never go to zero, but they will most likely end up dramatically lower than they are today.

Finally, in terms of the bigger picture, bear in mind that this is only the tip of the iceberg. Economies that are dependent on the fossil fuel industry to create economic growth — and there are many non-OPEC countries in that category — will most likely struggle for a period of time. The one that immediately springs to mind is the biggest of them all — the US economy.

Speaking of OPEC (the Organization of Petroleum Exporting Countries), political priorities will most likely change as OPEC’s powers begin to fade. And, as that happens, other countries — those rich in lithium — will move to the forefront. I have even joked that OPEC at some point in the future could be replaced by OLEC. With the biggest lithium reserves in South America, and the biggest lithium producing company being Chilean, could Chile become the new Saudi Arabia? Not as far-fetched as you may think. At the very least, the South American continent’s prominence and political influence will most likely grow as fusion energy becomes more than just a distant vision.

About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.