It’s the scary word that we try to avoid, manage and eliminate from our lives. The stock market is risky, no doubt. There are crashes and entire decades where the returns are essentially zero; however, to- date, the long-term direction has been up and to the right, steadily increasing in value over time. It has been a remarkable way to compound your assets. That is the entire stock market-- a diversified portfolio of companies. Beneath the surface, there are segments with fantastic returns, and those where whole industries that have vanished. Financial history is riddled with stories of blue chip companies like photography giants Kodak and Polaroid, or internet companies like Netscape and AOL more recently, who’s products and services haven’t stood the test of time. Concentrated portfolios can lead to substantially more risk.
Existential risks to sectors will only increase as the world becomes more digital and technology-driven. There is one such threat which may acutely harm Houstonians- the health of the energy sector.
Many Houstonians already have a lot of their wealth tied to the price of crude and crude products. Their jobs, company stock options and home values are inextricably linked in the health of these markets. Much of this cannot be helped (your job is in Houston and you must live somewhere), but a behavioral bias that affects many is a sense of control by investing in a market that they know. For Houstonian that is the energy sector.
This concentration is unwise, especially since there is a chance there are catastrophic risks due to three major factors.
Environmental Regulations-- China is pushing for 12% of new cars to be electric by 2020, and just last week, France issued a statement that all new cars will be electric or hybrids by 2040. Automakers are preparing for this as evidenced by Volvo’s announcement this week that all their new vehicles will be electric or hybrid by 2018,
Proliferation of self-driving cars—Billions of dollars are being spent to figure out how to make self-driving cars a reality. If this becomes the norm, due to the cost structure of battery-powered cars and relative ease of computers driving electric cars, the fuel powering transportation will shift even further from oil to electric.
Falling cost of production-- As the marginal costs drop, it becomes easier and cheaper to find oil and gas, exasperating the oversupply problem.
The increase in electricity usage at the expense of gasoline, combined with the lower marginal cost of exploring and producing crude may significantly change the crude and refining markets permanently. Blue chip companies with billions of dollars of hard assets could be severely affected if the need to refine crude or transport gasoline around the country is cut. If crude prices were to drop into the $20s per barrel, exploration and Production assets with higher production cost may be white elephants.
While this scenario may seem far-fetched, it is certainly a possibility, and must be considered when looking at your overall risk. Working with a financial advisor can help ensure you are thinking through these and other issues, to ensure you don’t have a “crude” awakening.