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A team of reporters from Reuters calculated how much the world's investment banks had disclosed writing down from derivatives in the past year, from the third quarter of 2007 through the second quarter in 2008, ending July 31. The total? $404 billion. In just four quarters, Wall Street wiped out its previous 10 years of profits. Even the airlines aren't that bad. And that $404 billion doesn't include the losses the financial services industry incurred in the last few weeks on those black-box creations of collateralized debt obligations and credit default swaps that blew up in their faces. JP Morgan, for instance, just reported $3.6 billion in additional write-downs on derivatives for its most recent quarter.
The market plunge of recent weeks has destroyed many things: trillions of dollars in stock market wealth, the retirement plans of untold Americans and the myth that the stock market had evolved to become immune to worldwide crashes. It also ended the era of the great "white shoe" investment banks. With the failures of Bear Stearns and Lehman Brothers, Merrill Lynch's capitulation to a Bank of America purchase, and Morgan Stanley's and Goldman Sachs' shift to become commercial banks to shore up their balance sheets, the independent investment banks spawned by the Glass-Steagall Act are all gone.
The reasons for this have been covered extensively, but here's a quick rundown of what I see as the path to this end. The decision in the 1970s to allow investment banks to go public shifted them from partnership structures, where the long-term health of the banks took highest consideration, to a publicly traded model where turbo-charging quarterly profits became a necessity to meet investor demands.
Capitol Hill's elimination of Glass-Steagall in 1998 opened the door for the investment banks to start dabbling in ever-riskier ways in consumer insurance, credit cards and mortgages. The decision this decade to increase the amount investment banks could leverage to 30 times their assets meant greater risk-taking and encouraged over-valuing the derivative instruments that investment banks kept on their proprietary trading books.
Then there is the phenomenon of cheap money--at no time since the 1930s were interest rates to financial institutions so low as from 2002 to 2005, which encouraged more wildcatting in the financial markets since, after all, the downside was so low. On top of all of that, add in the laissez-fair approach to regulating the markets, so extreme of late that enforcement staff withered under SEC chairman Christopher Cox; he even rejected an offer by Congress for more enforcement funding. Essentially, the U.S. government stepped aside after the tech bubble to allow a Wall Street bubble to form.
Of course there will be hundreds of banks, led by megabanks Bank of America, JP Morgan Chase, Citigroup and Wells Fargo--but they will be working in a world of greater oversight, more restrictions and, eventually, higher interest rates. Never again will we see such a combination of factors that led to Wall Street firms seeming like such unstoppable profit machines as we did this past decade.
With the end of one era, another must replace it. While investors are scrambling to play defense, it's worth noting that the family of Cabot growth newsletters positioned our readers to be largely in cash by the time the market began its knife-like plunge last month. And we're already looking ahead to what the next great investment trend will be.
As editor of the Cabot Green Investor, I see the next market boom as one based on sounder fundamentals and more sustainable demand than the latest Wall Street bubble. The gathering movement to cleaner, more sustainable sources of energy and a healthier consumer lifestyle means there will be long-term stock winners, even if the broader market takes an extended time to find its feet for the next bull run.
Why? There are many reasons. But let me run down three of the most compelling.
1.) The Price of Oil. Ten years ago, oil was $17.50 a barrel. Gasoline averaged $1.03 a gallon in the U.S., cheaper than bottled water on a supermarket's shelves. It's hard to believe now. Even though oil has retreated from its high of $147 a barrel hit this summer, it's still up 300% at the recent price of $70. And that's before the potential of a cold Northeast winter could send prices rocketing again. Prices may be easing because of concerns over what worldwide demand will do if our economic downturn deepens, but they will never come close to the lows of a decade ago. Consider that U.S. oil imports have risen almost unimpeded since 1986 (but for three years of statistically insignificant dips) to more than 10 million barrels a day. By 2030, the International Energy Agency sees worldwide demand rising 50%, led by Asia and Latin America. Quite simply, alternatives are needed to meet the ever-increasing demand, especially if it turns out to be true what many suspect--that the world has passed it peak production of oil.
2.) Rising Consumer Consciousness. Polls consistently show three-quarters or more of Americans want alternative energy. One reason is the rising cost of energy, seen in $3-a-gallon gasoline and the 15% higher energy bill the average household will have to pay to heat their home this winter. The other reason is environmental concern--a 2007 poll found 76% of Americans believe that the effects of global warming are now apparent and that action needs to be taken, while another survey found 12% of consumers would pay a noticeable premium for Green products, while many more would choose a comparably priced Green product over another conventional option. As evidence of this, just look at the success of the Toyota Prius, Whole Foods Market and the fact even die-hard old-line companies like British Petroleum and Clorox are going Green. Even retailers like Wal-Mart are committing to slash energy usage by 30% and offering once-niche products like organic milk and chemical-free baby products to their customers.
3.) Technology Has Caught Up to the Hype. But having the demand elements present means nothing if the products aren't there to meet demand. Unlike earlier energy crises, the technology to transform the way we power our houses, fuel our cars and enjoy our lives is nearing critical mass. Raymond Lane, the venerable venture capitalist who poured start-up money into the likes of Intuit and Google, told the Wall Street Journal last year that he believes green energy technology "will be bigger than the Internet ... by an order of magnitude, maybe two."
Some of the greatest strides are being made in solar. When Jimmy Carter installed solar panels on top of the White House during the 1970s energy crisis, the price per watt of solar was more than $27. No wonder Ronald Reagan had them taken down. Now, solar is leap years ahead--the price per watt is $4.85. Tremendous strides are being made in nanotechnology and in solar panels made from non-silicon sources, which are making the next generation of panels cheaper and easier to use than ever before. Within a few years, solar will achieve price parity with electricity at $1 per watt.
Wind power is even more advanced commercially, and we're seeing momentum in wind projects in Texas, Massachusetts, New Jersey, New York and elsewhere. And no country on earth possesses more geothermal energy potential than the United States; we're seeing some smart companies leap early onto geothermal resources ahead of what could be the next energy sector boom. Then there is ocean wave and tidal power to consider--and biofuels, natural gas engine conversions, nuclear power, clean coal, recycling, waste remediation, LED lighting, energy grid optimizers, organic food companies, Green lifestyle retailers and many other exciting sectors. Many of these received tax and financial incentives in the Wall Street rescue bill that will underpin Green sector growth into 2009 and beyond.
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Cabot readers have been among the early investors to capitalize the Green trend. In 2007, they learned of the market-leading thin-film solar technology of First Solar, a stock that went from 70 when first recommended to a high of 300 in the course of a year. Thanks to Cabot's time-tested method of technical and fundamental analysis, we took some profits along the way before finally recommending selling the position when shares still traded above 220--before the stock's plunge to 103 earlier this month.
Cabot Green Investor readers also profited from Green stock recommendations even in this difficult year. We called for buying wind turbine and high-efficiency wire maker American Superconductor in May when shares traded at 26. The stock quickly rallied to above 40. Seeing that shares were technically overbought, we recommended selling half of our position at 41, just six weeks later. After more market fluctuations, we took the remainder of profits at 32 in early August. Shares are now at 13. American Superconductor is a business we believe has long term potential in its developing relationship with major Chinese firms, and we continue to watch it. It's one of the 10 Green companies we are keeping readers abreast of right now for when the market has finally formed its bottom and the time to buy is right. Other stocks that have delivered profits to readers have in 2008 include a Chinese biodiesel company, an Australian recycling firm and a U.S. hazardous waste remediator, among others.
Of course, in a year where the S&P 500 has plunged 36% and the benchmark alternative energy indexes are off 47% and more, we've had some losers like everyone else. But our disciplined method of analyzing a stock's momentum and technical indicators, along with keeping its fundamentals in our sights, leads us to cut losses quickly to preserve capital and ride our winners. The net result is that Cabot Green Investor has far outperformed every Green mutual fund, ETF and index out there, as well as the S&P, Dow Jones Industrial Average and every other broad market measure. That discipline has left a lot more money in readers' pockets to re-invest in the market when the Green boom continues.
For Cabot Wealth Advisory
Editor's Note: Brendan Coffey, editor of Cabot Green Investor, uses Cabot's growth investing market timing indicators to get subscribers in and out of the market at the just the right time. This has saved subscribers' portfolios from much of the market declines of the last several months and preserved their capital to invest during the next bull market. Now is the time to build your watch list for the market's next uptrend and Brendan's got his eye on several top-notch Green stocks that are poised to break out when the market moves higher. Get started with Brendan's watch list today, so you'll be ready to get back into the market when the time is right.