Any experienced investor knows that no one can predict the future. Nevertheless, one should try to imagine many possible futures. Such mental agility helps an entrepreneurial investor develop contingency plans, as contingencies are the reality of every tomorrow. 

One of our coworkers teaches a Global Studies seminar at the University of California Santa Barbara, and every week he assigns several news articles and asks students to return the following week with questions inspired by each article. In effect, we perform this exercise on a larger scale every day, reading numerous newspapers, journals, newsletters, and blogs while formulating questions to stimulate our imagination. 

Let’s consider some of the questions inspired by several articles from a single issue (July 5-11, 2008) of The Economist weekly news magazine.  

The Butterfly Effect

One key theme of our book, The Entrepreneurial Investor (Wiley, 2007) is that “it’s all connected.” Some people call this ‘the butterfly effect,” based on a meteorologist’s 1965 observation that climate systems are so complex that a butterfly flapping its wings in China could cause thunderstorms in Kansas three days later. It’s an imaginative metaphor for both connectivity and multiplier effects. In the Internet era, financial butterfly effects can be dramatic as a tornado and instantaneous as a lightning strike; just ask Bear Stearns. 

Consideration of the butterfly effect adds breadth to our brainstorming. For example, we read that Starbucks (SBUX) will be closing 600 locations. Naturally we want to consider how this decision may affect the company’s profitability and share price, but it’s also useful to ask whether this decision indirectly hints at the future of the price of gasoline in the United States. How so? If consumer cash shortages impact the previously inelastic price of luxury coffee, perhaps gasoline prices are not completely inelastic – will conservation bring prices down soon?  

When brainstorming, every idea should hit the table, even if most of them bounce off pretty quickly. So, just as one might see a connection between Starbucks and gas prices, an investor might wonder how rising tensions between Iran and Israel might affect Starbucks, because the Strait of Hormuz (through which most mid-east oil travels) impacts the price of transporting coffee as surely as the Panama Canal (through which many coffee beans travel) does. It’s all connected. 

Steeling For Trouble

The Economist reports that the United Steelworkers union formed a partnership with Britain’s Unite, forming the first transatlantic union. If such unions gain strength through international alliances, how does this affect the profitability of multinational companies? Will this lead to higher steel prices?  Carmakers use a lot of steel, and steel prices have already doubled since the beginning of this year.  Not coincidentally, another big story covers the woes of America’s Big Three automakers, noting that GM (GM) faces a serious threat of bankruptcy, Ford (F) is not doing much better, and Chrysler may well be absorbed by a foreign competitor before year-end.  

What does a United States without a thriving automobile manufacturing business look like? How many jobs are at stake, not just in Detroit, but also in dealerships all over the country? Can GM’s foreign profits sustain the company while it retools for changing American tastes/needs? Will a failure or bailout of GM forever change the relationship of companies and unions? What role did pensions and healthcare decisions play in GM’s troubles? Would a drop in gasoline prices reinvigorate the American carmakers’ sales enough to disrupt their move to more fuel-efficient vehicles? Or are market forces doing what Congress resisted - increasing fuel efficiency standards? 

Global Conundrums

Colombia, Peru and Bolivia made news as FARC guerrillas were duped into releasing long-held hostages, and Bolivia strained relations with Peru by accusing the latter of hosting a secret American military base. Having seen the rise of Asian wealth and influence in recent years, one might wonder how quickly Latin America could become a more significant force in global economics. Brazil already ranks as one of the paradigm-breaking BRIC countries (Brazil, Russia, India and China), which are moving faster than expected from poverty to wealth, increasing competition for natural resources and reshuffling the world’s socio-political pecking order.  

Another international story that caught our eye concerned the economic woes of Spain. “Growth is slowing sharply and unemployment is rising. The housing bubble has burst and residential construction has seized up. Prices of petrol, electricity, food and a host of other things Spaniards buy have all gone up sharply…” Spain’s Prime Minister denies that the country has serious financial problems, and that raises a slightly cynical question: why are socialist Spain and the capitalist United States facing the same economic problems? Note also that Spanish truck drivers recently went on strike over high fuel prices, causing grocery shelves to remain empty for a week. What would happen if US store shelves emptied for a week or two?   

Domestic Issues

While chiding Congress for installing energy efficient light bulbs and then powering them with one of the dirtiest power plants in America, The Economist observed that whoever wins the election in November; the new president will be more attentive to green issues. How would an ecologically interested President and a stronger Democratic majority in Congress affect energy policy? Would we see construction of new nuclear plants or oil refineries, more wind farms, or more offshore drilling? Would we see tax credits for alternative energy initiatives, or windfall profits taxes on oil companies, or both? Frustrated Canadian politicians are trying to institute a carbon tax as a means to cut emissions. If American lawmakers cannot execute a cap-and-trade system, might they enact a similar tax? 

Of course, all of this connects directly to farm policy and economic stimuli, since food prices that would naturally rise with oil prices (because of petrochemical fertilizers and transportation) have risen faster and higher because of supply and demand imbalances attributed to biofuel farming. As many Americans saw for themselves, the recent economic stimulus checks were spent before they arrived, as prices for food and fuel rose sharply during the time between the stimulus package approval and the checks’ arrival. “Indeed, some prominent economists are now arguing that, in the words of Robert Shiller of Yale, policymakers should be designing a new stimulus plan and should ‘stand ready for another after that, and another.’” 

What portions of the economy might the next stimulus plan stimulate? Will there be major infrastructure projects to create jobs? Will farm bill subsidies stop paying for fallow land and start paying to rebuild a “strategic grain reserve?” Will new stimulus plans drive the deficit beyond China’s threshold for lending us money?  

A story from the UK section of the magazine also raises questions pertinent to Americans. Britain’s National Health Service just celebrated its 60^th anniversary. The article notes that despite its problems, Britain’s tax-supported healthcare system “has lasted long enough to look modern again” and has solved its most pressing problems. American individuals and businesses struggle noisily with the rapidly rising cost of healthcare and insurance. “At the last count, America spent 15.3% of its national wealth on health, compared with Britain’s total of 8.4%, but many Americans are uninsured.” Part of Britain’s success has been its tendency to increase doctors’ pay regularly while reducing their workload, while America’s insurance companies have done just the opposite. Insurance and pharmaceutical companies are powerful lobbyists, but one wonders whether a filibuster and veto-proof Democratic Congress, with the support of American doctors, might bring about a sweeping change in attitudes toward universal healthcare in the United States. 

Can such large-scale government programs work, or will politics forever create bureaucratic obstacles? Britain’s system is regularly criticized in the press and parliament for its inefficiency, even though individuals tend to praise the quality of care they receive. 

Healthcare In a Bottle

The stock market entered Bear territory (down 20% from peak), and The Economist noted that economic growth and profits are down while inflation and interest rates are rising, calling this the worst possible combination for the market’s future. Such news always inspires a key question for entrepreneurial investors: which good companies have been dragged down with all the others simply because the market tends to over-react to bad news? Where are the bargains? 

And market overreaction is an important lesson in this exercise of the imagination.  We often wonder what will happen if New Orleans floods again, or if huge desert communities like Las Vegas and Phoenix run out of water. When considering potential disasters, an entrepreneurial investor remembers that the market’s initial reaction is typically an overreaction. This is why entrepreneurial investors “keep their powder dry” through liquidity – the everyday “what-if” question is “Will we be ready when opportunity arises?” 

But we would like to conclude with two especially encouraging stories. First, there was a small article on the Phoenix Mars Probe, which may have discovered ice and certainly discovered soil adequate for growing asparagus, green beans and turnips. Notwithstanding our ambivalence toward turnips, we found the story of a man-made machine exploring an alien world inspirational. What other machines are we capable of building? Affordable electric cars? Nuclear waste recyclers? What wonders may yet be discovered in our solar system, in our oceans, or in the human imagination?  

Finally, the magazine reported results of a study that figured out how red wine’s antioxidants make the digestion of red meat safer. Apparently, “red wines are rich in polyphenols, a group of powerful antioxidents that are thought to protect against cancer and heart disease by destroying molecules that would otherwise damage cells.” Pairing red wine with red meat is not just flavorful; when the two mix in the stomach, the wine’s polyphenols prevent toxins released by the meat from entering your bloodstream. Some of us read this and ask, “What if there are major cancer breakthroughs and people start living 25% longer?” But this study raises many other interesting questions for an entrepreneurial investor: Cabernet or Merlot? Pinot or Shiraz? It’s all connected…

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Lance Helfert

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