Tracking Policy Forces that Drive Technology, Capital Formation & Growth














Major economic change is almost always the result of a change in government policy that drives a wedge between the after-tax return on one type of asset relative to others. This leads to a SHIFT in asset demands as investors attempt to rebalance their portfolios to take advantage of the return differential. The rebalancing drives asset price changes, and ultimately shows up in the creation or destruction of assets.

Formally, these asset market disturbances are identical to the temperature and pressure differentials that drive the storm systems on a weather map. It is worth remembering that economic shifts, and the risks and opportunities they represent, are always transitory.


These are the themes that I use to develop investment strategies.

Fed. After raising rates TK times in 2 years, the Fed’s next move will be to lower rates early in 2007 in response to cooling inflation and growth numbers. Risk: Fed or Treasury measures to limit bank real estate or private equity lending that could interrupt credit availability to small businesses.

New Congress. After their win in November, Democrats will try to force changes in tax, regulatory, and foreign policy.

Tax Rates. Hopes for estate tax repeal, Alternative Minimum Tax (AMT) relief, and making today’s tax rates on income, dividends, and capital gains permanent died on Election Day. But current rates are locked in through the 2008 election.

Iraq. Violence in Iraq is escalating as opponents sense weakening U.S. resolve and an early withdrawal.

China. China’s is opening its capital markets to foreign firms and preparing to host the 2008 Olympics, while Congress debates proposals to tax Chinese imports and force a revaluation of the currency. At risk--destabilizing China’s growing economy.

Tech/Telecom. China and India are investing aggressively in Information and Communications Technology (ICT) to drive future growth. In the U.S., proposed telecom reform legislation to spur capital spending died in the Senate. At stake—U.S. productivity and competitiveness and the future location of next generation R&D labs.


The principal of arbitrage lies at the heart of economic analysis. Indeed, it may be the only positive statement that economics has to make. It is, however, immensely powerful. Arbitrage, in turn, stands on the strong shoulders of thermodynamics, the most robust area in all of physics

Thermodynamics says simply that temperature differentials cannot persist over time between objects in physical communication. The end result is thermal equilibrium--the state in which there is no further tendency for temperature to change. Thermal equilibirium is the physicist's definition of death.

Almost all activity in life reflects the physical manifestations of thermodynamic processes. It is why the chemical reactions occur in our cells. It is why sunlight leads to photosynthesis. It is why volcanoes erupt and tectonic plates shift to make earthquakes. And it is why weather systems form.

In fact, weather systems are the best and simplest metaphor for economic change. We all know what happens when high and low pressure systems try to occupy the same space--thunder, lightning, tornadoes, and hurricanes.

I think of global investing as an exercise in meteorology. My job is to identify thethermodynamic events--usually changes in tax rates, government spending, regulatory policies, or monetary policy--that lead to localized temperature or pressure differentials which set up the arbitrage situations we use to make money.

A change in zoning lawsthat alters cash flows, for example, creates a return differential that forces a change in the value of a piece of land. A tax law change that impacts after-tax returns leads to a return differential that forces a change in the value of a piece of capital equipment. A change in monetary policy that increases inflation increases the returns on tangible assets relative to securities, forcing a change in stock and bond prices. All can be viewed as weather systems moving across the weather map of the global economy.

I also like the weather map metaphor because it reminds me of two important facts. First, extraordinary investments, like weather systems, are transitory phenomena. Even the best investments don't generate excepitonal returns forever.

Second, investing, like meteorology and thermodynamics, is not an exact science. It can help you to identify the storm systems that are going to make things happen. And it can tell you what things will look like when the storm has passed and thermal equilibrium has been once again restored. But it tells you very little about what happens in between.

There is no exact science that describes the disequilibrium states which occur while change is taking place either in physics or economics. This is important because all of the real money is made and lost during the disequilibrium adjustment--nobody makes or loses money in equilibrium. That's why faith in the end result and the liquidity to withstand the turbulence and chaos along the way are so important.

The global weather map gives me a hat rack to give structure to the thousands of factoids that fill the news every day so I can boil it all down to a manageable number of themes to watch closely.

The way to make money investing is to identify a storm system that is powerful enough and likely to be long-lasting enough to serve as an energy source for revaluing a portfolio. Then you move capital into position to take advantage of the implied prices changes.

For the past twenty years the weather map has been obscured by one huge storm system, a stationary El niņo front, as the world went through convulsions learning to live without inflation. Although we are still cleaning up the wreckage, that storm is over now. In its place we have a large number of localized weather systems as individual countries attempt to compete for the capital they need to grow.

This environment favors hedge fund investors over long-only investors who can no longer ride falling interest and rising valuations. And it favors investors who can break camp quickly to take advantage of change over the battleships we built for the long bull market. Investors will have to be quicker, have a bigger canvas, and be willing to take both long and short positions to benefit from these conditions.