The State of Refining

A few words about refining. This is not an area where I claim much expertise, beyond a materials science college course that covered hydrocarbon chemistry many years ago and pumping my own gas. World oil prices are distorted by the Ukraine war. In turn, gasoline prices are also distorted. You can see it in this chart:

Gasoline prices are behaving as though they are constrained by supply. Since gasoline is apparently an exportable product, U.S. domestic prices are affected by world market prices. So if you bid $3.00 a gallon for Exxon gas, but Brazil bids $4.00, guess who Exxon will sell the gasoline to? This appears to be well-documented (see WSJ article) but never referenced by politicians. Washington D.C. could regain control over prices by passing legislation prohibiting exports of fuel from the U.S. If they have decided not to do that, it may be because they know that it would be bad policy.

Refining is constrained because, although the U.S. is generally well-supplied with refineries, the number of existing working refineries is shrinking and has been for a long time. The industry, taking cues from actual declines in demand (driven by auto manufacturer fleet MPG requirements and increasing numbers of EVs on the road) and extremely popular left-leaning climate change rhetoric, has taken the message ("DON'T BUILD REFINERIES") seriously. 

Of course, the screaming on Twitter by know-nothings echoes the politically-motivated outrage and moral grandstanding by Biden. It's a temper tantrum, deserving of the same respect one would give a two year old's demands for candy. I find it much easier to believe the American Fuel & Petrochemical Manufacturers, especially when they cite a Motley Fool posting that cites Chevron's Mike Wirth saying that "he doesn't believe there will ever be another new oil refinery built in the U.S." 

Chevron like all of the other oil majors, is making money this year. But overall the oil business has had a tough past six years. Chevron made losses or near-zero earnings in 2015, 2016, 2017, 2019, and 2020.

It's very difficult to have sympathy for the critics of the oil industry. Sure, all customers want your best product for free, but, by definition, no industry can survive when it is directed to commit suicide. The lack of mature understanding and lack of cooperative spirit makes it clear that those criticizing the oil industry are not capable of providing supervision for a complex modern economy.

Oil supplies in the U.S. are tight, but not tight enough to be the bottleneck. Clearly it is refining, as you can see in these tweets outlining the long term business prospects and current utilization, which is so near 100% the industry is probably setting records:

CHART OF THE DAY: US refineries in the Gulf of Mexico (PADD3) are running the hottest for this time of the year in at least 30 years: 97.9% of their capacity running. Surreal. You can not run hardest than this. Whatever the White House says | #OOTT pic.twitter.com/NpcpkwDuBl

— Javier Blas (@JavierBlas) June 29, 2022

As long as the futures curve implies low prices in the future, it will be difficult to incentivize production. After having their teeth kicked in from 2014-2020, the survivors don’t want to commit to risky expensive capex unless they can hedge their risk.https://t.co/1WHZ6cOm4l

— cogito, ergo lorem ipsum (@randolph_zeke) June 14, 2022

A Barron's analysis found that profits of gas stations are actually down this year.

U.S. Government figures match what the industry is saying. The U.S. Energy Industry Administration data shows refineries over time if you want to check.

Once you understand the refinery situation, it's clear why tapping the Strategic Petroleum Reserve could and would result in sending oil to China. Refineries already have 100% of their supply lined up. Adding to crude supply then just sends it to the next hungry market, part of which will be overseas. Strategically, it might make a small amount of sense to capitalize on high oil prices by selling some of the SPR oil. After all, we got that SPR oil cheap when Trump decided to add to SPR reserves against a rainy day. The rainy day is here. The U.S. Government is making a profit from the oil shortage. What's wrong with that?

Links in this article:

https://www.wsj.com/articles/high-u-s-fuel-exports-are-contributing-to-5-a-gallon-gas-11655371801

https://www.fool.com/investing/2022/06/05/chevrons-ceo-says-no-more-us-oil-refineries-what-s/

https://www.afpm.org/newsroom/blog/refining-capacity-101-what-understand-demanding-restarts

https://www.eia.gov/dnav/pet/pet_pnp_cap1_dcu_nus_a.htm

Is it time to stop hyping the idea that AI has been hyped?

It has become fashionable to capitalize on the mistakes of individuals, who as humans are quick to anthropomorphize things, who encounter text-based (e.g. GPT-3) AI systems and conclude that they might be sentient. Come on people! Isn't it time to stop hyping the idea that AI has been hyped?

Here we have yet another story, yet another piece in social media, this one in LinkedIn, about the need to stop hyping AI.

Ever since the dawn of the Industrial Revolution in the 1700s, coming shortly after the full flower of The Enlightenment, we have experienced significant, continual profound changes in technology and society. This has led to both people anticipating more change, and to people failing to fully understand and keep up with changes that have already occurred. This includes the mundane, such as user interface changes to browsers and operating systems that wipe out personal productivity gained from daily practice, to profound societal challenges, such as erosion of community cohesion as religious institutions have declined in popularity and not been replaced with equivalent neighborhood-building systems.

With artificial intelligence, even the basic curve fitting model of deep learning that is in widespread practice is both taken for granted and yet not fully understood. When it comes to AGI, it is not the case that most people believe that it exists. Those who believe in dualism basically find the idea of AGI impossible. Then there are AI researchers who, having failed many ways in the past to create AI beyond curve-fitting or Eliza-era symbol manipulation, think that it is impossible for anyone else to create it either. Hubris never so clearly indicated that a contrary event was just around the corner.

The deeply learned cynics have certainly been keen to smash AI anticipation based on Terminator movie -like fears or suspicions. Social media, as always, is prone to promote outrage and the barely believable. Yet is there a sense that people are committing, en masse, to the firm belief that AGI exists right now? I don't see it. The existence of a single blog post, tweet, or Facebook message doesn't prove that there is mass hyping of AGI.

Becoming accustomed to new things involves so many different waves, all overlapping. First there is creation of the thing. It's not always a binary, "it was impossible, now it's practice" event. When the Wright brothers flew their airplane at Kitty Hawk, it was a short flight at low altitude with barely any payload. It took much more experimentation, engineering, and practice to get to the primitive airplanes that fought in World War 1. The same is true of AI. First we have curve fitting, then really good curve fitting, then profound curve fitting. Perhaps then we get some ambiguous results. If the first AGI has an IQ of 40, would you call it intelligent? No, you would call it stupid! It's sentience will be highly questionable. And yet there may never be a moment when you can say, "before this all was not sentient, and after this artificial sentience exists".

The second wave is getting the news out. The researcher does the experiment. The knowledge produced may have to be replicated, shared with other researchers, discussed, written up, then published. This takes months or even years. 

The third wave is belief among many. When the news comes out, did you read about it? Did you get the right message? After all, journalists are abysmal at getting the facts straight in fields they don't experience or understand fully. As it is discussed, some believe it, others discount the news story.

The fourth wave is belief within yourself. You've heard the news, but do you believe for yourself what was conveyed. You have to not just hear it, but have a mental model of it that works. It may take some time to get enough information that you can form an accurate belief.

The fifth wave is understanding the implications of your beliefs. It is one thing to understand a phenomenon. But what does that mean for your profession? For your home life? For your religion, your beliefs, your politics? Does it change your values, how you approach the goals of your life? Does it pose a danger to any of the aforementioned?

The current state of AI and AGI is subject to all of those waves. So articles about "hype" are troughs of such waves. They could be an indication of proper sober reflection. The "experts" still put AGI out five to 15 years or more. That some laypeople are confused to think that it is happening now is well within the adoption wave system. 

Contrarian Trading Physics

In the previous article, I may have left some with the impression that the "road to heaven" maxim as a contrarian principle was a mental trick, mere psychology. I apologize for the unfortunate emphasis. Contrarianism is built into physics. You can start with Newton's third law of motion:

To every action there is always opposed an equal reaction; or, the mutual actions of two bodies upon each other are always equal, and directed to contrary parts.

At the very least this implies that to make a change that you want to occur you must experience a force opposite to that you intend to apply. 

We can move forward to the trite and obvious, but frequently disobeyed maxims of trading securities:

Buy low, sell high.

You pay a high price for a cheery consensus.

Make a stand, lose a grand. Have a hunch, make a bunch.

To use the first law you usually have to buy when everyone is fearful, and sell when you feel like everything is going your way. The second is similar; if everyone agrees that you are buying the right investment, then it is probably too expensive. This is not just mind games. This is physics of group thought.

The third gets a little deeper into the psychology (self-contrarianism) of trading: When you try to make something happen, it often goes awry. When you are just inferring, often from scanty evidence, that something might happen, you are often right. 

This leads to some principles of trading that I sometimes use:

1. When you've done some research and found a good investment, buy a little at the start. If you buy too much, it will decline. Buying only a little either insures that it does go up, or that you will get a second chance to buy more at a lower price and to re-evaluate your logic.
2. If you have an informed hunch, buy fast and at the market. It's no use trying to capture a 5 cent spread with a limit order and missing a $2 gain over a week's time. If you find yourself hesitating, stop and don't do it.
3. When the market makes you nervous, but you like your stocks, switch it off, stop checking, and do something else entirely. This especially applies when I have what I call "market maker-stoppers", stocks that I will probably hold effectively forever anyway. I gain and they lose the bid-ask spread on the dozens of trades I never make.

Between 2020 and 2022 principle #3 probably made me more money than any other action. The market is full of noise. Once you have a position, just stick with it. 

This brings me to the most contrarian point of this blog: Though it is titled Vorpal Trade, very little of my commentary will really be aimed at short-term trading. Vorpal Investment just doesn't have the same ring. Which would people be more likely to remember? Which one captures your attention?

Now that I've slipped into the psychological aspects of trading again, it's time to cite biological examples. 

Muscles grow stronger when they are used. They grow weaker if they are not. Species undergo faster evolution in heterogeneous environments. A species which enjoys a uniformly benign environment is therefore less robust against changes to its environment. In any heterogeneous environment, the best ways for an animal to make a living are to move into ecological niches that no other animal is exploiting. In any species, members of the species are in conflict with those that prey on them, but possibly even more in conflict with other members of their own species when it comes to reproduction. Among plants, the tallest one gets the sunlight, but those plants which can specialize as vines and parasitize the tall plans by growing as vines will get the sunlight without investing in costly woody parts.

The structure of the financial system contains many, many contrarian elements. Government guarantees lead to systemic weaknesses. Mandates to service particular markets induce over-consumption leading to societal dead-weight losses and add systemic risk. Taxes reduce market sizes, distort markets, reduce and overall economic vitality. Subsidies lead to overuse, excessive prices and speculation, and destabilize markets. Good-meaning policies lead to more policies which lead to (undetected or "I don't want to see that") bad policies which undermine the financial system. 

I'll leave these statements here without proof, because this is not intended to be a political article. If you want to see some of the logic, here are a couple of places to start:

Lindsey, B., & Teles, S. M. (2017). The captured economy: How the powerful enrich themselves, slow down growth, and increase inequality. Oxford University Press.

Sowell, T. (2011). The housing boom and bust. Basic Books.

(this is part two of a series on contrarianism)

Is Human Level Artificial General Intelligence Possible?

In a highly regarded (4.6 stars out of 5 on Amazon) book, The Myth of Artificial Intelligence, Erik Larson makes the case the AGI is much more difficult and farther out than some of the hype might make people think. 

The Amazon capsule description make it clear Larson's position is that such hype is wrong:

Ever since Alan Turing, AI enthusiasts have equated artificial intelligence with human intelligence. This is a profound mistake. 

To the degree that his message is aimed at hype, he is probably correct. The problem is that not all predictions of AGI are hype or hyperbole, and those describing potential AGI outcomes are not necessarily enthusiasts.

One could make the case that Larson's book is a good reference for those seeking to capitalize on the expertise and work of past researchers like Larson in order to learn all the methods that have failed so far, or at least which don't look promising and are in other researchers' blind spots.

Though I haven't read the book, the main challenge to its thesis I see is that Larson is not addressing all of the AGI "construction cases", one of which is design through evolution. 

Today I bumped into this exchange, in which Ed Hagen cites a research paper on design through artificial evolution:

A cautionary tale:

Explorations in design space: unconventional electronics design through artificial evolutionhttps://t.co/XUpiwwsciH pic.twitter.com/H1LJfZyg0y

— Ed Hagen (@ed_hagen) May 13, 2022

The paper is available here. If the link doesn't work, use Google Scholar and search for "Explorations in Design Space: Unconventional electronics design through artificial evolution".

Just in case the Twitter message is deleted, I'm reproduced the snapshot of the abstract that Hagen cited here:

The primary point is this: Evolution can generate unusual designs that appear to be well outside the thought patterns of experienced designers. If AGI is possible, it is quite likely that it would be built using a design that Larson is unlikely to try or think would work.

In the Twitter thread Hagen goes on to cite another paper (actually, a 1993 Scientific American article) about the ability of the barn owl to locate prey in total darkness using differences in acoustic arrival times. It is a mechanism that at first seemed impossible using the "neuron toolkit" available, but once known to be possible, led to speculation about the design, which then was found to be present in barn owls. 

All of this fits neatly into Arthur Clarke's first law:

When a distinguished but elderly scientist states that something is possible, he is almost certainly right. When he states that something is impossible, he is very probably wrong.

Generating AGI via evolutionary methods is likely to violate the sensibilities of some who would like to be careful about how we bring AGI in existence. Growing it randomly in a soup of randomly changing evolutionary individual instances is not going to satisfy the AI equivalent of "biohazard" rules. But if all known and upstanding labs that follow the law adhere to such standards, then it will be only those labs operating outside industry safety standards who have a chance of growing such an AGI. Hence, standards too rigidly applied will then cause AGI to be grown somewhere darker and less controlled.

Detecting emergent AGI will then be even more difficult because we've been told it is not possible, or not possible at the present time, and the first discovery will not occur in a "name" lab. By the time the "impossible" is detected and confirmed, much more time will have passed than we would have liked.

[edited 7/8/22 to change book link, rephrase a sentence, and clarify the "hype" comments]

Small Cap Index Funds, Series I, Hedging Gas Costs

The half ended 6/30/22 is reportedly the worst first half of a year in many decades, depending on the index you are looking at. The extended stock market has been hit much harder than the large cap and especially Dow 30 stocks. If you are looking to trade against the trend and pick up a reversion-to-the-mean wave, look at buying into the hard hit extended market, Russell 2000, and small caps generally. Strangely, the downdraft has not hit the S&P SmallCap 600 the same way. It was off its 52-week high high of 1466.02 on 11/8/21 by about 23% as of mid-day Thursday 6/30/22 (1132.34 when I looked), somewhat less than NASDAQ. Why not buy into the NASDAQ index? Because the peak NASDAQ includes participation by tech names that were genuinely overextended in 2021, including TSLA, NFLX, NVDA, and FB. This also means that while it might seem "safe" to be in large caps that have not been dragged down as far (PEP is a good example), they are more likely to underperform the general market in the next 24 months. The market is willing to accept lower prospective returns because of the premium on safety right now.

In the long run, you want to have a higher allocation to small cap stocks anyway, so if you are currently underweighted in small caps, this might be the time to shift some assets there. SBBI still applies, especially after a substantial correction from market highs. 

Three Ideas

With current inflation at 8.6% or thereabouts, you may be feeling some pressure to deploy cash. Consider adding to a small cap index fund. As just stated, it is likely oversold, at least relative to the rest of the market. If you believe in value (as opposed to efficient market random walk theory), then it is discounted to where it was last year. And if you do believe in efficient market theory, there is no reason to believe that from this price, today, that it won't rise as should, so you ought to be buying small caps even if you don't believe in fundamental equity valuation as a cause for investment return.

The next thought came from my blind spot: Saving bonds. It took a Twitter post to wake me up to this, but Series I savings bonds are currently paying 9.62%. That is not a typo; Series I bonds contain a fixed interest rate component and one tied to the CPI measure of inflation. The only catch: You are limited to investing only $10,000 per year. It is worth pursuing because even if inflation subsides, this is an asset class that should be kept in your awareness anyway. For those approaching retirement, this is an excellent way to store some of the cash that you need to keep on hand against bear markets.

And that brings me to target date mutual funds. The theory is that most investors who save for retirement will eventually need to withdraw the money and live off it, but that withdrawals during bear markets would consume unfortunately large portions of the portfolio, assuming constant dollar withdrawals. The mitigation for this is keeping portions of cash and bonds in the portfolio as a buffer against bear markets, and the proportion kept in more stable assets then increases with the investor's age and presumably decreasing time horizon (until death). Target date mutual funds automate with process. It has become very popular with companies offering 401(k) and 403(b) plans, so much so that many companies have eliminated 90% of the mutual fund options they formerly offered, with target date funds making up as much as 90% of the choices available to the employee. 

This sad state of affairs is driven in part by theories of behavioral economics: Most people know little about investing and theoretically make poor choices (like not investing at all, and failing to pick up the free money offered to them via the company match), so the company and its hired mutual fund company instead play defense. Choice theory says that people given too many choices make none. So to help people make a choice, the company strips down the choices to just money market, bond fund, international fund, stock fund of some sort, and target date funds. Theoretically, most of the asset categories are there, but this induces employees to make a very substantial mistake.

The problem is with bonds. As I wrote in 2012, and which has remained true for over 10 years, the long bull market in bonds (circa 1980 to 2010) is over. When you start from low yields, it is difficult to make capital gains with bonds, and obviously the yield isn't going to make up for that. Mature target date funds (e.g. 2020, 2025) are loaded with bonds, and although the 2020 and 2025 target dates should involve relatively stable assets, with bond yields so low, they have suffered nearly as badly over the past 12 months as more aggressive equity mutual funds. 

Yields have risen a little. 10 year Treasuries traded up to 3.5% in the last few weeks, then rolled back. From this level, it is now theoretically possible to get cap gains from bonds, so you might make a little more money from bond funds in 2022 to 2027 than you did from 2010 to 2022. Maybe. I would still hesitate to make much use of bond funds or target date funds until inflation is lower (not until mid-2023 perhaps) or 10 year Treasuries are at 4%. For those in their 60s or retired, I would shy away from target date funds and make more explicit use of money market and equity funds, and the Series I savings bonds mentioned above.

The third idea involves hedging gasoline costs by investing in oil stocks. While gas at $4.50 to $6.00 per gallon is quite painful, you could mitigate it by investing in oil equities that are sensitive to the price of gasoline. The basic procedure: Figure out a time horizon, perhaps two to three years, and estimate how much gasoline you will need to buy over that time. Then estimate how much that will cost at prices of $4.50 per gallon vs say $3.00 per gallon. The difference is the amount that you now can attempt to capture through equity investments like OXY, CVX, XOM, PSX, SHEL, COP, BP, MPC, VLO. If gasoline continues to be expensive, you will do well in your oil investment. If gasoline drops in price, you get the benefit of reduced expenses. You will need to decide whether this is a serious hedge or just a psychological salve; as I wrote last week CVX is at a price that is too high if oil prices revert to $40 to $60 levels. Losing money on an equity investment may not sound like a good idea, just because you hate paying $80 for a full tank of gas. Of course, that is what makes it a hedge, if you want to make real money, make a prediction that is accurate and act on it beforehand. You can decide whether this is a token investment of 10 shares of XOM to make you feel better, or a serious prediction that world oil markets will be disrupted indefinitely.

The true benefit is the idea, the option to trade this as a hedge. You can obtain more control over your future net expenditures if you want that. Stock market pricing will be chaotic, and might even move the stock price in the wrong direction, but having the option to hedge may provide you with more of a feeling of control, more "thinking space" with less emotion and fewer cognitive mistakes. 

Two Roads to Contrarian Practice

The old proverb The road to hell is paved with good intentions has roots in human psychology, in perfectionism (Powers 2005) [1] and ethical intent valuation (Kruger 2004) [2]. The Powers study indicates that perfectionism backfires:

The results of both studies revealed a significant backfire effect of the implementation intentions on goal progress for participants high on a particular dimension of perfectionism (socially prescribed perfectionism). These perfectionists reported doing significantly worse at reaching their personal goals when they were asked to formulate implementation intentions than when they completed a control exercise. There also was evidence that implementation planning aroused negative affect for socially prescribed perfectionists. These results are the first to suggest that implementation planning may be contra-indicated for individuals with self-critical tendencies.

Kruger and Gilovich have argued that

Actions and intentions do not always align. Individuals often have good intentions that they fail to fulfill. The studies presented here suggest that actors and observers differ in the weight they assign to intentions when deciding whether an individual possesses a desirable trait. Participants were more likely to give themselves credit for their intentions than they were to give others credit for theirs...

But these studies, which cover only part of the phenomenon, may fall short in other ways, as pointed out by (Gioia 2021)[3]:

The assumptions we have typically used to formulate our theories and conduct our research have led us to be seen as irrelevant by an audience we should want to engage. Consequently, our approach to research and writing has put us on a road to hell. 

In other words, the intentions of researchers may be good, but their results, well...

So let's step away from academics for a moment. After all, you and I could probably come up with better stories about why this is true: People plan to be better than they actually are, and they fail to make sure that what they are doing is actually a good thing in its outcome. That happens because generating the intended result is hard. Having an intention is 100 times easier than following through in full, measuring the result, checking, and having the outcome audited by a third party. If you are measured by your words rather than outcomes, which is usually the case for most elite public intellectuals, then outcomes don't matter much to your reputation, salary increase, or Twitter follower count.

The Road to Heaven

One can take Nietzsche's aphorism from Twilight of the Idols

Out of life's school of war: What does not destroy me makes me stronger.*

and use it to flip the traditional proverb on its head to get

The road to heaven is paved with the bad intentions of others.

This a near-perfect copy of one of my first tweets on Twitter, and remains pinned today because I still feel it is subtle and profound. What this says is

When circumstances, the universe, or other people put obstacles in your path, your ethical and thoughtful response to them not only sets you up for success, but gives you moral authority and superior character.

This seems to be easily misinterpreted. Typically, someone will come with a Nazi-based example or a health problem to disprove it. But notice that by contradicting the saying or attempting to thwart it with rhetoric, they are fulfilling the implied prophecy of success through prolonged conflict!

The point is simply one should expect obstacles in any project, and by overcoming them you build character and succeed. If you are declaring a scientific hypothesis, the worst thing that could happen is that no one challenges it, until you have to go public. Instead, you need as many challenges of the hypothesis as soon as possible. If the challenges succeed then you have the raw data you need to revise the hypothesis. Your hypothesis gets better by being challenged, not by being accepted.

Contrarianism of the Road

The power of such proverbs is that they contradict naive common sense with a much more nuanced and useful understanding. When a politician says that their policy will help you ("road to hell"), you should be highly suspicious and check for the unintended consequences that they almost certainly are overlooking, probably on purpose. Conversely, when you encounter lemons ("road to heaven"), look for ways to not only make lemonade, but also to grow lemon trees, found a beverage company, cure scurvy, and create a line of skin care products using lemon oil.

[This is the first article in a series on contrarianism.]

* There is a useful answer to a StackExchange question that is worth reading about this aphorism. Some contend that the aphorism is widely misunderstood. It may be the case that Nietzsche's purpose is not fulfilled by the popular understanding, but that doesn't mean that the popular understanding, in its more nuanced form, is not useful as well.

References

1.   Powers, T. A., Koestner, R., & Topciu, R. A. (2005). Implementation Intentions, Perfectionism, and Goal Progress: Perhaps the Road to Hell Is Paved With Good Intentions. Personality and Social Psychology Bulletin, 31(7), 902–912. https://doi.org/10.1177/0146167204272311

2. Kruger, J., & Gilovich, T. (2004). Actions, intentions, and self-assessment: the road to self-enhancement is paved with good intentions. Personality & social psychology bulletin, 30(3), 328–339. https://doi.org/10.1177/0146167203259932

3. Gioia, D. (2021). On the road to hell: Why academia is viewed as irrelevant to practicing managers. Academy of Management Discoveries, (ja). Published Online:19 Oct 2021. https://doi.org/10.5465/amd.2021.0200

P.S.: If you search online for "road to heaven" most of the hits will be more recent than October 2020. But there is one question that was asked on Quora in 2014 that uses this phrasing. If you look at the log of that question, it looks like no one answers the question about heaven, preferring to focus on the traditional "road to hell" proverb and its meaning.

Chevron Corp (CVX) Valuation

The big bounce on Tuesday might have led you to believe that the downdraft in June was perhaps over, and that recession probabilities had eased. Actions of integrated oil company shares are contradicting that scenario, and may be indicating a recession. Chevron Corp (CVX) was as high as $182.40 on June 8, but is trading at b/a of 141.41/141.44 as I write this. What is it worth?

A Value Line report for CVX is available for free at the Value Line Dow 30 page. Using data from Value Line and a CFRA CVX report, it's evident that CVX, and likely the other oil majors, have had a rough time generating consistent revenue or profits in the last six or seven years. That leads to complications in estimating its earning potential. Future earnings are likely to be highly variable, not to mention political, so, instead of focusing on a single scenario, we look at several:

The first line assumes that oil prices stay at their current war-influenced prices for at least the next 10 years. The second line assumes that the war and its after effects end in 2022 or 2023, and that things are mostly back to "normal" by 2024. The third line uses the estimates published by CFRA for the current and next several years. The fourth line does the same but using Value Line actuals and estimates. The fifth line assumes that management has set the current dividend rate to 70% of their best estimate of long term average annual net income.

The duration (of earnings) reflect the volatile nature of oil company earnings, the already extant gradual decrease in average oil consumption, and the politics of climate change and electric vehicles. Discount rate is set at 5%. We could argue about the length of the decay portion of future cash flow and its rate of decline, but when you go out 15 to 20 years at a 5% discount rate, such changes won't be large.

The problem is that CVX was already selling well above full value in early June, and is still selling above its full value even now after a sharp decline.

If I had to guess, I would say that lines 2 and 5 are the right ones to use for a snap valuation of CVX. I would avoid buying CVX now, and sell it if I had it.

MMT Storm Warning

Central banks control interest rates and money supply, but they are not God and are still subject to market forces. Governments want low interest rates, providing temptation for the central bank to defy reality for too long. What happens if they fly too close to the sun? It depends upon whether you believe traditional monetary theory or Modern Monetary Theory (MMT). My June 16 posting alluded to some potential problems with the type of deficit spending that MMT adherents believe to be OK. Now there are signs coming from Japan that it is important to understand MMT in a hurry. 

First, some background. This Investopedia article on MMT covers some of the basics. The central idea of MMT is that

governments with a fiat currency system under their control can and should print as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken.

MMT proponents are optimistic about the side effects of government spending, typically saying that increased government spending has benefits with no side effects, and that traditional ideas of "crowding out" of debt investors will not cause interest rates to rise. Often they support expansive spending policies and use MMT to justify larger deficit spending.

Japan may be a current test of this idea, in that Japan has been holding interest rates at 0.25% and expanding its money supply in order to intervene in debt markets. A series of Zero Hedge recent articles have been sounding the alarm, warning that Japan's monetary policy has potential for an explosive collapse:

June 20: Bank of Japan Spends A Record $81 Billion To Avert Collapse, But $10 Trillion JGB Market Is Now Completely Broken

June 14: Japan On Verge Of Systemic Collapse With "Dramatic, Unpredictable Non-Linearities" In Financial Markets, DB Warns

June 14: Giant Hedge Fund Goes "Soros" On Bank Of Japan: Bets Billions That Japan, And MMT, Will Break

June 8: As Yen Crash Accelerates, It Puts Catastrophic End Of MMT Experiment In The Spotlight

March 30: Yen At Risk Of "Explosive" Downward Spiral With Kuroda Trapped... And Why China May Soon Devalue

The signal of interest is the value of the yen against other currencies. Over the past year it has moved lower, stair-stepping from 110 to the dollar, to 115, then ramping to 135 with much recent turbulence. 

Tug of War for Real Resources

According to the Investopedia article MMT says that

the only limit that the government has when it comes to spending is the availability of real resources, like workers, construction supplies, etc. When government spending is too great with respect to the resources available, inflation can surge if decision-makers are not careful.

We get inflation when too many dollars chase too few goods. Under MMT, how does government remedy that?

Taxes create an ongoing demand for currency and are a tool to take money out of an economy that is getting overheated, says MMT. This goes against the conventional idea that taxes are primarily meant to provide the government with money to spend to build infrastructure, fund social welfare programs, etc.

In other words, under MMT government must raise taxes to quell inflation. By removing money from the marketplace, there are fewer dollars chasing goods.

Inflation, however, leads to an ongoing confrontation with government if it is prevented from raising taxes. If raising taxes is too unpopular, then inflation continues and government cannot use this purported MMT mechanism for cutting inflation. Instead, it may roll out price controls, as has been discussed in recent op-eds in the mainstream media. 

Price controls or higher taxes in turn, however, lead to other side effects. Let's use potato chip manufacture as an example. With high taxes, wages paid to potato chip workers are worth less. The company has an incentive to pay workers in potato chips rather than dollars. With price controls, the dollar value of the chips is constrained, so even if the government forces a barter tax to be paid in dollars, the tax has less effect. If the workers then barter their potato chip wages for other goods, either government will receive less tax from unreported transactions, or reduced taxes (on fixed goods prices) even if they succeed at taxing the barter. In short, MMT leads to pressure to use something other than the sovereign's currency as a medium of exchange.

Another way of seeing this is to note that MMT depends on government having a monopoly on a medium of exchange. If it is in competition with other currencies, then market participants may be able to escape from any coercion that is implied by MMT money expansion. Then MMT succeeds only if government is an honest and trustworthy market participant, and refrains from policies that are coercive. In the case of a medium of exchange, "coercive" means not engaging in behavior that would cause a devaluation of the medium of exchange. Inflation causes devaluation, so in order to show good behavior, government then has to refrain from policies that cause it.

If higher taxes were truly an option for government, then it might get away with using MMT-like policies. But so far all real-world reactions to taxes appear to be significant, in that higher taxes significantly impact output. In practice, setting tax policy is constrained.

The Politics of MMT

Supporters of MMT are generally progressive, believing in Keynesianism, higher government spending, more involvement of government in the economy, and higher taxes. Perhaps this is not surprising in that proponents of traditional monetary theory are generally classically liberal believers in the free market, which go with lower taxes, smaller governments, and less involvement of government in the economy.

Nevertheless, some prominent left-leaning economists are not on board with MMT. The Investopedia article cites Paul Krugman's criticism of MMT:

Nobel Prize-winning economist Paul Krugman’s views on U.S. debt are similar to many MMT ideologues, but Krugman has been strongly opposed to the theory. In an op-ed in The New York Times in 2011, he warned the U.S. would see hyperinflation if it was put into practice and investors refused to buy U.S. bonds.

“Do the math, and it becomes clear that any attempt to extract too much from seigniorage—more than a few percent of GDP, probably—leads to an infinite upward spiral in inflation,” he wrote, “In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds.”

The question to ask is when would investors refuse to buy U.S. bonds? There are several scenarios:

• When they can move their money into real assets (real estate, commodities) with higher rates of return.
• When they can move money into other currencies offering higher rates of return.
• When the interest rates on government debt are significantly lower than inflation, and trading in real goods as a medium of exchange is possible. (Think in terms of buying the next five year's goods in advance, since the value of the goods would advance in parallel with inflation.)
• When they run out of money.

The first three strategies are also worthwhile defenses against hyperinflation.

Japan is especially vulnerable right now to the second problem, which is that Japanese investors can do better by buying dollars and investing in U.S. debt. As the yen declines in value they benefit. This leads to the situation covered in the Zero Hedge articles.

We have already seen the first scenario happen, starting in 2020. People bought toilet paper or houses. 

Ultimate Recourse

Behavior at the margins illustrates the consequences of deficit spending and use of MMT beliefs. When taxes are high, labor force participation declines due to early retirements and consumption of government transfer payments. Clipping a few percentage points off production then drags on economic output, lowering tax receipts and depressing production and general economic activity. This causes inflation. MMT then responds with higher taxes, causing further marginal declines in production, and more inflation. MMT makes no provision for the consumer's "ultimate recourse", which is to do nothing and vote for politicians willing to pay them to do nothing. 

Producers, on the other hand, have the ultimate recourse of producing only for their own account. A farmer who eats what he produces, barters for what others make, and does not sell into the market will escape MMT's effects. 

In effect, the government must make a market for its own currency, and ignoring the interests of the customers of the medium of exchange will result in diminishing the customer base and the robustness of the marketplace for that currency. 

Coming Soon: Making More Mistakes, Faster

Now that the market has corrected enough that there may be some well-priced stocks to be bought, you may see more articles from me in the next few weeks or months. I never announced it, and it may not be completely related, but when most stocks are full-priced, it takes a greater effort to put together a valuation and background story, so I am less likely to publish when the market is overpriced. I did come to view the market as overpriced for parts of 2021. The rally of 2020 was a surprise. That of 2021 even more so.

This is almost certainly ego-driven: I'd much rather publish an article which eventually is shown to be correct, than to publish something that is unfortunate and mistaken. This is a continual hazard when commenting on markets. The usual antidote among newsletter writers is a combination of equivocation and obscurity, so that while you are being dazzled or entertained, whatever happens later can somehow be likened to what was written before.

I think I have a partial solution to this problem: I can write articles in which I actually attempt to make mistakes. This won't be hard [sic]. The motivation is that rather than hoping you will think I am right, that I help you better by printing (virtually) more ideas, faster, with less filtering, and that you can, from your own perspective, correct for my mistakes and see what really needs to be done. I can't vouch for my ability to be wrong [sic]. In my own experience, attempting to reverse yourself in placing trades does not work. That is, you cannot be your own contrarian. It is far easier and more successful to be a contrarian to something one reads somewhere else. And it's not just a matter of not-invented-here. Somehow the brain just works better when it is presented with information that is from somewhere else. So my goal is simple: just continue to write and comment on the markets as I see them. Any mistakes will be easy and free, and you can benefit from them even if I can't.

Actually, that's not true. An article I wrote yesterday was written by a different person. I'm a different person today. So long as I am sufficiently good at changing from day to day and don't drag my ego along with me, I too can benefit from my being wrong in print.

I have been working on article on contrarianism that is getting close to being ready for publication. If all goes well, you will see it here in the next day or two. It should go very well with this article, which in reality is about contrarianism too.

Target vs. Amazon

As a kind of warm-up exercise, we can see that in the last few days Amazon said that it's Amazon's Prime Day will be on July 12 and 13 this year. Within a day or so, Target announced that it was scheduling its own Deal Days event for July 11 through 13. 

Perhaps Target is thinking:

• they get free publicity for their own sale, since people will conflate the Amazon and Target events
• people will spend all their money on the 11th, nothing left for Amazon!
• Target's sale will be seen as better since it is for three days, not two
• people will mentally equate Target's product selection with Amazon's

Contrary take: People will compare Target and Amazon service and fulfillment, as well as prices. Frankly, Target could lose frequently in this comparison. Also, this kind of alignment clearly marks Target as a follower behind Amazon.

Marketwatch reports that "Target said during its most recent earnings [discussion] that it had a glut of inventory to sell." Will retail competition slay inflation? Unfortunately, neither event includes discounts on gasoline, housing, higher education, or medical care. Both sales may accidentally feature lots of products made in China. But most Americans have too much stuff already, and right now they want to spend time outside and spend money on experiences, not buy things for inside the house.

Gasoline is Gold

Mini-theory: gasoline is expensive because people are doing all the outdoor things they were blocked from doing in the two-year pandemic lockdown. In which case we have yet another unintended consequence of aggressive social control public health policy. Demand won't let up until everyone has slaked their thirst for living rather than waiting inside, masked, watching Netflix and eating microwave popcorn.

Current Thoughts

Federal Reserve raised its benchmark interest rate 0.75% to a range of 1.5%-1.75%. These rates are still too low, and will be followed rapidly with more hikes. The Fed is behind the curve. Worse, "amateur pundits" were ahead of the Fed in calling for this move and the Fed has lost some credibility. Does it understand the markets?

Thoughts: The initial surge of post-COVID, stimulus-caused inflation was highly predictable. The additional surge of "return to normal" from pent-up activity was also predictable. When the country went into lockdown, the economy at that time was already hot and in need of higher rates; there may have been some residual of that still in late 2021 and early 2022, but that would not have been easy to call. What the Fed and many misunderstood was the secondary effects of the combination of return-to-work and stimulus money sloshing through the system. These will be transitory yet leave long-lasting marks on the economy. Gas prices at $5 (actually, diesel prices at $6) will do damage that could last past 2024. The sharp tightening of the housing market will leave many without good options and paying rent, both in the colloquial sense and economic sense, far beyond when they should have. The sharp rise in the housing market should have been a signal to the Fed to hike rates much earlier. Why didn't they? Excess concern with politics and appearances, and a sharp impact on Government borrowing costs.

What are the odds that interest rates will go structurally higher, causing a large step up in Government financing costs? Before COVID U.S. debt was too high at $24 to $26 trillion, but at least interest rates were low. Post COVID, if 10 year and 30 year rates have a secular rise to 5% or higher, the U.S. Government will be significantly hampered in its ability to service its debt. $30T at 5% is $1.5T in interest payments a year, vs. $24T at 2% and payments of $0.48T. In other words, the penalty for the bouts of COVID stimulus may be an extra $1T of interest payments annually, indefinitely.

Put options assigned early, traders may be thinking the market will be lower today and Friday, and higher next week. Certainly the emotions from the sharp losses last week and this week could dissipate over the weekend.

Though short term interest rates are sharply higher, not all banks are responding with higher savings rates. Capital One's online savings rate is still 0.3%, while Ally has raised its savings account rates at least three times, from 0.5% to 0.6%, then to 0.75%, and recently to 0.9%.

Marketwatch: Eleanor Laise and Katie Marriner report that housing prices in small towns have exploded. There is no inventory left, and the homes are often smaller, in need of work, and outdated. "Many baby boomers have sought out retirement properties far from the bigger cities" is part of the problem. To check, I recently looked at homes for sale near Lynchburg, TN, and found many $400k+ properties. The bonus: a number of these "over-priced" houses come with property, from 20 to 90 acres. Another aspect of the problem: areas near high density cities are most affected. Property in the Shenandoah Valley in Virginia was in short supply more than 10 years ago. The article also cites tight supply in New England, where proximity to Boston and NYC means that there is an oversupply of people fleeing urban areas.

(10:00 a.m. update)

Barrons reports 6/15/22 that Facebook ad rates have declined in each of the last 6 months. This includes declines of declines of 15% in March, 19% in April, and 19% in May. Instagram ad rates were up 15% in May, however. FB sells for a little over 12x TTM EPS of $13.21.

In a 6/1/22 WSJ article Karen Langley reported that some investors were seeing bargains in small caps. The decline in small caps has outpaced the market YTD. However, it was too soon then to turn bullish. As of today, the four stocks mentioned in the article have fallen significantly further. Using prices as of about 9:30 a.m. today, SHAK is down another 18.5% since the 6/1 article. ANF is down 9.4%, BCRX down 6.1%, and CUBI down 17.7%.