"Kee" Points with Jim Kee, Ph.D.

The feedback I get from Kee Points is fairly consistent: “I like it, but keep it short!” With that in mind, today’s note is divided into two parts – my comments on the latest Wall Street Journal Forecasting Survey, and highlights from our 9th annual South Texas Money Management Energy Symposium. Hopefully you will just read that which is of most interest to you!

The Wall Street Journal Forecasting Survey – “Growth Rebound”: Every month the Wall Street Journal surveys its 50 plus panelists for their outlook regarding key variables like GDP, inflation, and interest rates. Based on the latest survey, the average outlook for GDP growth in the second quarter is 3.3%, but the expectations for 2014 overall have been lowered to 2.43% from 2.7%. That’s because of that low .1% first quarter number (so a pop in Q2 then slowly improving). Inflation (CPI) is expected to increase from current 1.5% levels to 2.0% by year’s end, and then hold fairly constant at that rate. Interest rates (10-year Treasury yields) are expected to increase from the current 2.5% level to about 3.2% by year’s end. No fed rate hikes are expected until 2015 (La Jolla Economics; Wall Street Journal).

My thoughts: The nation’s expert on forecasting science is Wharton’s Jon Scott Armstrong. If you have any interest at all in business studies and verification, i.e. “what works” in advertising, forecasting, etc., you should peruse his web site at Wharton. I am sureyou will enjoy it!

Armstrong’s “golden rule” of forecasting is to be conservative, and to combine forecasts in simple ways. That’s what I do using everything from market price data, like corporate quality spreads and leading economic indicators, to consensus estimates based upon economists’ varied models, to even throwbacks to the old Wesley Clair Mitchell approach (1920’s) via the Economic Cycle Research Institute. The theoretical background for my thinking, the context within which to put all of this, is Friedman’s plucking or (random) shock-based model of economic fluctuations. With respect to GDP, all of the above point to continued expansion.

As for inflation, I’ll repeat the fact that you have to have unambiguous signals from three variables – exchange rates, goods prices, and interest rates – in order to have a valid inflation or deflation signal. And it has to be all three, not just one or two. Right now inflation is squarely in check, and inflation expectations remained well-anchored. That’s not what many noted economists expected at this point in time. Well known capitulations on this point, the growing “I was wrong about inflation and the Fed” camp, include Larry Kudlow and Arthur Laffer.

And inflation expectations are important for interest rates: There is no way you can get a return to double-digit interest rates in the US without a return to double-digit inflation, and that’s not in the cards right now. But expectations are for higher rates, and in my opinion the one variable that is wreaking havoc on interest rate forecasting is the degree to which US Treasuries are serving as a safe haven for global assets (other interest rate drivers include growth, the term premium, inflation expectations, banking conditions). That’s the component of interest rates that has been hard to quantify, but it has also been one of the driving factors of interest rate movements since the 2007-09 crisis. I think this will continue to be the case; it has made interest rates very hard to predict.


Energy Conference Notes


We had our 9th annual South Texas Money Management Energy Symposium last Thursday, and as is tradition I jotted down what I thought were some intriguing points that might interest our clients. Energy continues to fill the headlines. Today’s Wall Street Journal has an energy section showing that daily oil production in the US has increased 44% since 2005. And according to Texas A&M, almost 100% of the wells drilled today are “fractured,” with each “fracked” well taking the place of 10 vertical wells that would have been drilled before the horizontal drilling and fracking technology revolution. Imagine what south Texas would look like with 10 times as many wells! It really is like the oil boom days of the past. So here goes, by author and title of talk:


Russell Gold, “Fracking with Nukes?” Yes, the Atomic Energy Commission did experiment with using nuclear weapons for releasing natural gas in the 1960s.


Peter Zeihan, Zeihan on Geopolitics, “Around the world in 20 minutes.” Always provocative, Zeihan argued that Russia is imploding because of population decline. In five years they won’t have enough people of appropriate age to field an army. That’s why they are interested in peripheral countries. My inference is that Zeihan felt such adventurism is both inevitable and/but limited.


Amy Myers Jaffe, University of California-Davis, “The Global Energy Landscape.” I sensed that Amy felt the opposite, that the situation in Russia/Ukraine/Europe could escalate globally. Some interesting observations from Amy were: we Texans have Putin to thank for keeping oil prices high; we have free trade agreements with Mexico and Canada, so if we don’t export our crude oil they will; wealthy energy beneficiaries in River Oaks are the ones buying Teslas or electric cars(!); and climate changers and rail safety are two threats to the Keystone pipelines.


Daniel Ahn, IMF, “Factors Influencing Today’s Energy Prices.”: The more academic Dr. Ahn asserted that the negative impact of a slower growth China on commodities and commodity intensive countries like Australia is being woefully underestimated.


Arthur Berman, Labyrinth Consulting Services, Inc., “Reality Check on Shale.” Mr. Berman pointed out exactly what I see using models that convert accounting data into cash flow, namely, that most shale plays are not profitable! That is, they do not earn a sufficient rate of return on investment (ROI) to cover the cost of obtaining the funds for that investment (the cost of capital).


Scott Tinker, University of Texas, “US Shale and the Future of US Energy Production.” Like Dr. Ahn, too much info to relay here. But Tinker countered Berman’s talk somewhat, arguing that every play has some wells that are profitable. This is something that has come up in prior symposia, namely, that the profitability of a well depends upon the company drilling it and the location, even within a certain “play” like the Eagle Ford shale or the Marcellus.


Panel: Royalty Owner Issues (George Person, Trey Scott): Basically, you need an attorney, if for no other reason that the other side has them!