WWRR Vol.2.008

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Thursday, 30 August 2018 Page 1 

For important disclosures please refer to page 21. 

Christopher Wood christopher.wood@clsa.com +852 2600 8516 

Japan, India and turning on 

Tokyo 

Jerome Powell made a politically astute speech at Jackson Hole last Friday which was interpreted by 

markets as dovish, primarily because he stated that “we have seen no clear sign of an acceleration 

(in inflation) above 2%”. Still there has been minimal impact in terms of any change in monetary 

tightening expectations from what was discussed here recently (see GREED & fear – The dollar as a 

weapon, 16 August 2018), with the Fed funds futures still discounting 75bp of rate hikes by the end 

of 2019. 

But what has happened of late is that the yield curve has continued to flatten. The spread between 

the 10-year and the 2-year Treasury bond yields has declined from 33bp at the start of August to 

19bp last Friday, the lowest level since July 2007, and is now 21bp (see Figure 1). As for the 10-year 

Treasury bond yield, CLSA’s technical analyst Laurence Balanco’s view is that it is on the cusp of 

confirming a top in yield terms and a break below the 200-day moving average, which coincides with 

the 30 May lows at the 2.75-2.78% area (see CLSA research Price Action Global – Upside/downside 

exhaustion, 24 August 2018). 

Figure 1 

US yield curve (10Y-2Y and 30Y-10Y Treasury bond yield spreads) 

350 (bp) 10Y-2Y 30Y-10Y (RHS) (bp) 

300 

250 

200 

150 

100 

50 

0 

(50) 

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 

Source: CLSA, Bloomberg 

180 

160 

140 

120 

100 

80 

60 

40 

20 

0 

Figure 2 

US 10-year Treasury bond yield 

3.2 (%) 

3.1 

3.0 

2.9 

2.8 

2.7 

2.6 

2.5 

2.4 

2.3 

2.2 

2.1 

2.0 

1.9 

1.8 

1.7 

1.6 

1.5 

1.4 

1.3 

Jan-13 

Mar-13 

May-13 

Jul-13 

Sep-13 

Nov-13 

Jan-14 

Mar-14 

May-14 

Jul-14 

Sep-14 

Nov-14 

Jan-15 

Mar-15 

May-15 

Jul-15 

Sep-15 

Nov-15 

Jan-16 

Mar-16 

May-16 

Jul-16 

Sep-16 

Nov-16 

Jan-17 

Mar-17 

May-17 

Jul-17 

Sep-17 

Nov-17 

Jan-18 

Mar-18 

May-18 

Jul-18 

Sep-18 

Source: Bloomberg


Meanwhile, the S&P500 finally made a new high for the year on 24 August, breaking the previous 

one in late January (see Figure 3). This demolishes GREED & fear’s previous working hypothesis, 

namely that January was the high for this cycle. It has also served to highlight further the 

contrasting performance year to date between America and the rest of the world, most particularly 

since the start of the second quarter when the dollar rally hit Asia and emerging markets. The 

S&P500 has risen by 9% year-to-date and is up 12.9% since 2 April. By contrast, the MSCI AC World 

ex-US Index has declined by 4.3% in US dollar terms so far this year and is down 2.5% since 2 April 

(see Figure 3). Meanwhile, the MSCI Emerging Markets Index and the MSCI AC Asia ex-Japan Index 

have fallen by 7.6% and 5.6% respectively in US dollar terms year-to-date and are down 8.5% and 

6% since the start of April (see Figure 4). 

Figure 3 

S&P500 relative to MSCI AC World ex-US Index 

3,000 

S&P500 

SPX/MSCI AC World ex-US Index (RHS) 

10.5 

2,500 

9.5 

8.5 

2,000 

7.5 

1,500 

6.5 

5.5 

1,000 

4.5 

500 

3.5 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Source: CLSA, Datastream 

Figure 4 

S&P500, MSCI AC World ex-US, Emerging Markets and Asia ex-Japan 2018 year-to-date performance in US dollar terms 

12 

(%YTD) 

9 

6 

3 

0 

-3 

-6 

-9 

-12 

S&P500 

MSCI AC World ex-US 

-15 

MSCI Emerging Markets 

MSCI AC Asia ex-Japan 

Jan 18 Feb 18 Mar 18 Apr 18 May 18 Jun 18 Jul 18 Aug 18 


The US equity rally has been driven primarily by the boost to earnings from tax reform and the 

related phenomenon of surging share buybacks. S&P500 actual reported share buybacks rose by 

42% YoY to a record US$189bn in 1Q18 (see Figure 5). While there were another US$410bn worth 

of buyback announcements in 2Q18, according to Bloomberg. This buyback frenzy has revived 

attention of late on the shrinking nature of America’s equity market, and the related and ongoing 

boom in private equity. The number of listed domestic companies in the US has declined from a 

Thursday, 30 August 2018 Page 2


peak of 8,090 in 1996 to 4,336 in 2017 (see Figure 6). This focus has also been encouraged by 

Donald Trump’s recent comment about moving away from quarterly earnings, and the short-termism 

quarterly reporting encourages. GREED & fear has a certain sympathy with this view. The “earnings 

guidance” game and the related phenomena of buying back shares on credit are clearly not healthy. 

But GREED & fear could have said that many years ago, and did. What is evident is that this year 

promises to be a record year for share buybacks, breaking the previous annual record of US$589bn 

in 2007, just prior to the global financial crisis. 

Figure 5 

S&P500 actual reported share buybacks 

200 

(US$bn) 

S&P500 share buybacks 

180 

160 

140 

120 

100 

80 

60 

40 

20 

0 

1999 

2000 

2001 

2002 

2003 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Note: Data up to 1Q18. Source: S&P Dow Jones Indices 

Figure 6 

Number of listed domestic companies in the US 

8,500 

8,000 

7,500 

7,000 

6,500 

6,000 

5,500 

5,000 

4,500 

4,000 

1980 

1982 

1984 

1986 

1988 

1990 

1992 

1994 

1996 

1998 

2000 

2002 

2004 

2006 

2008 

2010 

2012 

2014 

2016 

Source: World Bank, World Federation of Exchanges 

Meanwhile, as to the question of whether America continues to outperform Asia and emerging 

markets, it will in GREED & fear’s view rest primarily on the action in the US dollar. As previously 

written here (see GREED & fear - The dollar as a weapon, 16 August 2018), this will depend primarily 

on whether the combination of fiscal easing and monetary tightening continues. Fiscal easing seems 

a certainty with the Donald which means monetary policy will be the key variable. This is why the 

action in the US yield curve represents the best hope for Asia and emerging market investors 

looking for renewed outperformance. For the yield curve is the best signal that the Fed is unlikely to 

raise rates as much as anticipated. Implicit in the above view is GREED & fear’s assumption that the 

main reason for Asian and emerging market underperformance is US dollar strength rather than any 



systemic crisis. As previously discussed here (see GREED & fear - The dollar as a weapon, 16 August 

2018), Turkey is not viewed as systemic by GREED & fear while China is not seen as in crisis. 

GREED & fear has just arrived in Tokyo for the first time in six months. The main message gleaned so 

far in initial meetings is that the Bank of Japan remains unconvinced that wage growth has really 

gained traction despite the ever greater tightening witnessed in the labour market. True, there has 

been a seemingly encouraging pickup this year in the base wages of full-time workers. Average 

monthly scheduled cash earnings for full-time employee rose by 1.1% YoY in 2Q18, up from 0.3% 

YoY in 4Q17 (see Figure 7). Still the view is that this statistic has been distorted or exaggerated by 

the change in the sample category used by the Ministry of Health, Labour and Welfare in its monthly 

statistics. Thus, full-time workers’ scheduled earnings growth on a same-sample basis is running at 

0.6% YoY in 2Q18, according to the Labour Ministry (see Figure 8). 

Figure 7 

Japan wage growth for full-time and part-time employees 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

-0.5 

-1.0 

-1.5 

(%YoY, 3mma) 

Source: CLSA, Ministry of Health, Labour and Welfare 

Part-time workers (average hourly wage) 

Full-time workers (monthly scheduled cash earnings) 

Jan 06 

May 06 

Sep 06 

Jan 07 

May 07 

Sep 07 

Jan 08 

May 08 

Sep 08 

Jan 09 

May 09 

Sep 09 

Jan 10 

May 10 

Sep 10 

Jan 11 

May 11 

Sep 11 

Jan 12 

May 12 

Sep 12 

Jan 13 

May 13 

Sep 13 

Jan 14 

May 14 

Sep 14 

Jan 15 

May 15 

Sep 15 

Jan 16 

May 16 

Sep 16 

Jan 17 

May 17 

Sep 17 

Jan 18 

May 18 

Figure 8 

Japan wage growth for full-time workers (usual reported figures vs same-sample basis estimates) 

1.4 

1.2 

1.0 

(%YoY) 

Monthly scheduled cash earnings growth (full-time employees) 

Same sample basis 

0.8 

0.6 

0.4 

0.2 

0.0 

Jan 17 

Feb 17 

Mar 17 

Apr 17 

May 17 

Jun 17 

Jul 17 

Aug 17 

Sep 17 

Oct 17 

Nov 17 

Dec 17 

Jan 18 

Feb 18 

Mar 18 

Apr 18 

May 18 

Jun 18 


The result is that permanent wages are still thought to be growing at only the 0.5-0.7% YoY range 

by the central bank, which is well below what the Shinzo Abe government or indeed the Bank of 

Japan would like to see. As a result, they are still running well below the 2% YoY hourly wage 

growth temporary workers are enjoying (see Figure 7), though the problem remains that temporary 



workers’ average hourly wages in absolute terms are still 43% below what is earned by permanent 

employees (see Figure 9). In this respect, labour reform remains the missing link in Abenomics, in 

terms of ending the unhealthy divide between temporary and permanent labour with temporary 

workers still accounting for 38% of the workforce (see Figure 10). Indeed, such labour reform that 

has happened of late has made the market even more rigid since there was a law passed in late June 

which limits the number of hours employees can work to prevent so-called “overwork”. Thus, 

employees are limited to a cap of 100 hours of overtime work a month and 720 hours of overtime a 

year. This law will be effective from April 2019 for large companies and a year later for smaller firms. 

Figure 9 

Japan average hourly wage: Full-time workers / part-time workers ratio 

2.10 

2.05 

2.00 

1.95 

1.90 

1.85 

1.80 

1.75 

1.70 

(x) 

Average hourly wage : full-time workers / part-time workers 

FY04 

FY05 

FY06 

FY07 

FY08 

FY09 

FY10 

FY11 

FY12 

FY13 

FY14 

FY15 

FY16 

FY17 

1QFY18 


Figure 10 

Japan number of employees by type of employment 

(m) 

Regular employees 

Non-regular employees 

60 

% non-regular (RHS) 

50 

40 

30 

20 

10 

0 

1984 

1985 

1986 

1987 

1988 

1989 

1990 

1991 

1992 

1993 

1994 

1995 

1996 

1997 

1998 

1999 

2000 

2001 

2002 

2003 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Source: CLSA, Japan Statistics Bureau 

(%) 

39 

37 

35 

33 

31 

29 

27 

25 

23 

21 

19 

17 

15 

This legislation, drafted to counter suicides and other social ills, did not exempt white-collar workers 

contrary to efforts by the Abe administration, save for those highly paid employees with annual 

incomes of more than ¥10.75m (US$97,000) such as financial traders and bankers! 

The conclusion from all of the above remains a lack of conviction that inflation is gaining traction, 

which is why of course the Bank of Japan in late July revised down its fiscal 2020 inflation target, 

excluding consumption tax hike effects, from 1.8% to 1.6%. Remember the sales tax is due to be 

raised from 8% to 10% in October next year. But even the latter inflation target looks optimistic 

against core-core CPI inflation (excluding fresh food and energy) of 0.3%YoY for July (see Figure 11). 



Figure 11 

Japan core CPI inflation (adjusted for sales tax hike effects) 

1.5 

(%YoY) 

1.0 

0.5 

0.0 

(0.5) 

(1.0) 

(1.5) 

Source: Statistics Bureau, Bank of Japan 

Japan core CPI (excl. fresh food) 

CPI excl. fresh food & energy 

Jan 11 

Apr 11 

Jul 11 

Oct 11 

Jan 12 

Apr 12 

Jul 12 

Oct 12 

Jan 13 

Apr 13 

Jul 13 

Oct 13 

Jan 14 

Apr 14 

Jul 14 

Oct 14 

Jan 15 

Apr 15 

Jul 15 

Oct 15 

Jan 16 

Apr 16 

Jul 16 

Oct 16 

Jan 17 

Apr 17 

Jul 17 

Oct 17 

Jan 18 

Apr 18 

Jul 18 

Still, this does not mean there is total despair or that Abenomics is a total failure since it has been 

evident for some time that labour compensation is improving. The best way of showing this, given 

the increasing participation rate of both females and elderly people, remains aggregate 

compensation paid in the economy. This has risen by a total of ¥29tn over the past five years of 

Abenomics. Thus, total compensation of employees rose by 4.3% YoY in 2Q18 and is up 14% since 

bottoming in 4Q09 to a record annualised ¥285tn in 2Q18 (see Figure 12). 

Figure 12 

Japan nominal compensation of employees 

6 

(%YoY) 

%YoY 

(Yen tn saar) 

285 

4 

Japan nominal compensation of employees (RHS) 

280 

275 

2 

270 

0 

265 

(2) 

260 

255 

(4) 

250 

(6) 

245 

1994 

1995 

1996 

1997 

1998 

1999 

2000 

2001 

2002 

2003 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Source: CLSA, Japan Cabinet Office 

This fact is probably the main reason why Prime Minster Abe continues to remain popular after 

more than five consecutive years as prime minister, with his popularity recently rebounding from 

what appears to have been a pseudo scandal. The latest Nikkei poll conducted over the past 

weekend shows that Abe’s approval rating rose from 45% in July to 48% in August and up from a 

recent low of 42% in May (see Figure 13). The improvement in the job market can also be seen, for 

example, in the ease with which graduates can now get jobs. Thus, the employment rate of jobseeking 

new university graduates rose by 0.4ppt YoY to a record 98% at the beginning of April, the 

seventh consecutive year of increases, according to an annual survey conducted by the labour and 

education ministries (see Figure 14). Meanwhile, the perennial concerns about Japanese 

demographics, and related lack of immigration, are being defied to a significant extent by the 



continuing rise in the participation rate. The total labour force participation rate has increased from 

a low of 59% in 4Q12 to 61.5% in 2Q18 (see Figure 15). 

Figure 13 

Approval rating for Prime Minister Shinzo Abe’s Cabinet 

80 

(%) 

75 

70 

65 

60 

55 

50 

45 

40 

35 

Dec 12 

Mar 13 

Jun 13 

Aug 13 

Nov 13 

Feb 14 

May 14 

Aug 14 

Oct 14 

Dec 14 

Mar 15 

Jun 15 

Sep 15 

Nov 15 

Feb 16 

May 16 

Aug 16 

Nov 16 

Feb 17 

May 17 

Aug 17 

Nov 17 

Jan 18 

Apr 18 

Jul 18 

Note: Latest poll conducted on 24-26 August 2018. Source: Nikkei polls 

Figure 14 

Japan employment rate of job-seeking new university graduates (as of 1 April) 

99% 

98% 

Employment rate of job-seeking new university graduates 

97% 

96% 

95% 

94% 

93% 

92% 

91% 

90% 

1997 

1998 

1999 

2000 

2001 

2002 

2003 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Source: Ministry of Health, Labour and Welfare 

Figure 15 

Japan labour force participation rate 

72 

(%, sea. adj. 3mma) Japan labour force participation rate 

70 

68 

66 

64 

62 

60 

58 

1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013 2018 

Source: Statistics Bureau 



The above also explains, as discussed here the last time GREED & fear was in Tokyo (see GREED & 

fear - Lower beta Asean and Kuroda semantics, 8 March 2018), why the Abe administration, and 

therefore also the Bank of Japan, given that BoJ Governor Haruhiko Kuroda is a political appointee, 

is no longer obsessed about meeting the 2% inflation target. This is also why what the market, if not 

the central bank, calls “stealth tapering” has commenced in terms of the BoJ decision on 31 July to 

abandon its commitment to fix the 10-year JGB “around zero” for a new undertaking to let the yield 

move in a range of 20bp above or below zero. 

Still, while this move would seem to amount to a form of tapering, the effect has been to some 

extent undermined by a BoJ attempt at “forward guidance” with the BoJ pledging at the same July 

policy meeting to maintain “current extremely low levels of short- and long-term interest rates for 

an extended period of time”. GREED & fear would not get too hung up in the confusion stemming 

from these seemingly contradictory actions. The simple reality is that Kuroda is coming under 

political pressure to start to normalise monetary policy, not least as a result of lobbying from the 

financial services sector which has been a major casualty from negative or zero interest rates. In this 

respect, the mixed message is best explained by Kuroda’s need to save face since he remains so far 

below the 2% inflation target he first committed to back in early 2013 at the launch of Abenomics. 

Meanwhile, the two main current concerns of the Japanese central bank are the lack of greater 

traction in wages given the tight labour market and the risk that another bout of US dollar strength, 

triggered either by events in Europe or emerging markets or worse case both, precipitates another 

wave of “risk off” in markets which would likely send the yen higher against the dollar as well as 

other currencies. This to GREED & fear remains a real risk given that, on a real effective exchange 

rate basis, the yen remains undervalued (see Figure 16) while the market is now of the view that the 

BoJ has commenced “stealth tapering” which should be yen positive. 

Figure 16 

Japan real effective exchange rate 

150 

140 

(2010=100) 

130 

120 

110 

100 

90 

80 

70 

60 

50 

1970 

1972 

1974 

1976 

1978 

1980 

1982 

1984 

1986 

1988 

1990 

1992 

1994 

1996 

1998 

2000 

2002 

2004 

2006 

2008 

2010 

2012 

2014 

2016 

2018 

Source: BIS, Bank of Japan 

Meanwhile, from a stock market standpoint, it is of note that foreign investors are on course to sell 

more Japanese stocks year to date in US dollar in net terms than in any year since 1987 (see 

Bloomberg article: “A US$35 billion selloff is pulling down Japan’s stock market”, 29 August 2018). Thus, 

foreigners sold a net ¥3.9tn worth of Japanese stocks so far in 2018, according to Japan Exchange 

Group data through the week ended 24 August. This has already exceeded the previous annual 

record net selling of ¥3.7tn reached in 2008 and 2016 since the weekly data series began in late 

1993 (see Figure 17). 



This foreign exit seems somewhat strange to GREED & fear since Japanese fundamentals are hardly 

disastrous from an equity market standpoint though “trade war” concerns are an obvious negative. 

Earnings growth remains satisfactory while share buybacks continue to rise. It is also the case that 

Japan has so far outperformed Europe and emerging markets year to date, if not the American 

market, in US dollar terms. The MSCI Japan Index is down 2.8% in US dollar terms year-to-date, 

compared with a 7.6% decline in the MSCI Emerging Markets and a 3.9% decline in the MSCI AC 

Europe Index, while the S&P500 is up 9% year-to-date (see Figure 18). 

Figure 17 

Foreign net buying of Japanese stocks 

16 

14 

(Yen tn) 

Foreign net buying of Japanese stocks 

12 

10 

8 

6 

4 

2 

0 

(2) 

(4) 

(6) 

1994 

1995 

1996 

1997 

1998 

1999 

2000 

2001 

2002 

2003 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Note: Data up to the week ended 24 August 2018. Source: Japan Exchange Group, Bloomberg 

Figure 18 

MSCI Japan, Emerging Markets, Europe and S&P500 year-to-date performance in US dollar terms 

15 

(%YTD) MSCI Japan S&P500 

10 

MSCI Emerging Markets 

MSCI AC Europe 

5 

0 

-5 

-10 

-15 

Jan 18 

Jan 18 

Jan 18 

Feb 18 

Feb 18 

Mar 18 

Mar 18 

Apr 18 

Apr 18 

May 18 

May 18 

Jun 18 

Jun 18 

Jul 18 

Jul 18 

Jul 18 

Aug 18 

Aug 18 


So why the foreign exodus out of Japan? This is not an easy one to answer. But in the absence of a 

better explanation, GREED & fear would cite the growing loss of credibility of the Japanese stock 

market as a result of the BoJ’s ongoing buying of equities via the purchase of ETFs. Unfortunately, 

despite the commencement of stealth tapering, the Japanese central bank continues to persist with 

this unwise policy. It has now bought a total of ¥23tn worth of equities and is committed to buying 

another ¥6tn this year (see Figure 19). Yet the longer this policy persists, the greater the overhang 

and the greater the distortion to the functioning of the equity market, just as the BoJ’s massive 

ownership of JGBs has undoubtedly distorted if not killed the JGB market. 



Figure 19 

Bank of Japan holdings of Japanese equities 

24 

(Yen tn) Stocks ETFs J-Reits 

21 

18 

15 

12 

9 

6 

3 

0 

Jan 03 

Jul 03 

Jan 04 

Jul 04 

Jan 05 

Jul 05 

Jan 06 

Jul 06 

Jan 07 

Jul 07 

Jan 08 

Jul 08 

Jan 09 

Jul 09 

Jan 10 

Jul 10 

Jan 11 

Jul 11 

Jan 12 

Jul 12 

Jan 13 

Jul 13 

Jan 14 

Jul 14 

Jan 15 

Jul 15 

Jan 16 

Jul 16 

Jan 17 

Jul 17 

Jan 18 

Jul 18 

Note: Data up to 20 August 2018. Source: Bank of Japan 

As previously discussed here (see GREED & fear – Revisionism, 2 August 2018), the best way to 

reverse out of this ridiculous policy would be to transfer the BoJ equity holding to the Government 

Pension Investment Fund (GPIF) off market. That would increase the equity weighting of the 

government pension fund from 26% to 37%. Now would be as good a time as any to do this since 

the GPIF is currently showing a positive return from its increased allocation to equities, a policy 

which is one of the most positive outcomes of Abenomics. The GPIF’s asset allocation to domestic 

equities has risen from 9.7% in March 2009 to 25.6% at the end of June 2018 (see Figure 20), while 

the GPIF made ¥2.6tn of capital gains in the quarter ended 30 June and ¥10tn in FY17. 

Figure 20 

GPIF’s asset allocation in domestic equities 

26% 

(%) 

24% 

22% 

20% 

18% 

16% 

14% 

12% 

10% 

8% 

Mar02 

Mar03 

Mar04 

Mar05 

Mar06 

Mar07 

Mar08 

Mar09 

Mar10 

Mar11 

Mar12 

Mar13 

Mar14 

Mar15 

Mar16 

Mar17 

Mar18 

Jun18 

Source: Japan Government Pension Investment Fund (GPIF) 

Still, for now Abe will not be focused on such a technical issue since he is concentrating on his 

campaign for the LDP presidential election on 20 September, a vote which he is expected to win in a 

landslide. Still, the issue of how the BoJ reverses out of its equity buying strategy will need to be 

addressed sooner or later. 



A word is due on India this week. Just as GREED & fear has been surprised by the extent of US 

equity outperformance this year, in the context of ongoing Fed tightening, so GREED & fear is 

surprised by the extent of Indian outperformance year-to-date in an Asia and emerging market 

context in US dollar terms. So, GREED & fear suspects, are many fund managers. 

Figure 21 

MSCI India relative to MSCI AC Asia Pacific ex-Japan Index in US dollar terms 

115 (1/1/10=100) 

MSCI India relative to MSCI AC Asia Pacific ex-Japan 

110 

105 

100 

95 

90 

85 

80 

75 

70 

65 

60 

Jan-10 

Apr-10 

Jul-10 

Oct-10 

Jan-11 

Apr-11 

Jul-11 

Oct-11 

Jan-12 

Apr-12 

Jul-12 

Oct-12 

Jan-13 

Apr-13 

Jul-13 

Oct-13 

Jan-14 

Apr-14 

Jul-14 

Oct-14 

Jan-15 

Apr-15 

Jul-15 

Oct-15 

Jan-16 

Apr-16 

Jul-16 

Oct-16 

Jan-17 

Apr-17 

Jul-17 

Oct-17 

Jan-18 

Apr-18 

Jul-18 


The Indian outperformance has become quiet marked. The MSCI India Index has declined by only 

1.3% in US dollar terms year-to-date, while the MSCI AC Asia Pacific ex-Japan Index and the MSCI 

Emerging Markets Index are down 5.1% and 7.6% respectively over the same period. The MSCI India 

has also risen by 10.2% since bottoming in late May, while the Asia Pacific ex-Japan and emerging 

markets benchmark indices are down 4.1% and 5.5% over the same period (see Figure 21). This is all 

the more impressive given that the rupee is down 9.5% year to date. 

Unlike America, where GREED & fear has been recommending an Underweight for global investors, 

GREED & fear has been positioned for an Overweight in India. Still, this is primarily on a structural 

view since GREED & fear will admit to having had no conviction at the start of 2018 that India would 

outperform this year which is why the triple overweight in the Asia Pacific ex-Japan relative-return 

portfolio was cut to a double overweight in February. Still, GREED & fear’s double overweight has 

been a lot higher than the positioning of most investors. 

Why has India been so resilient and defied bearish expectations? One reason why is that India, as 

primarily a domestic-driven economy, is clearly much less exposed to Trump-driven trade concerns. 

But in GREED & fear’s view the stock market’s resilience may also be a sign that India is contra 

cyclical in the sense that the economy is accelerating at a time when many other markets in Asia 

could be near their cyclical peak. In this respect, it needs to be remembered that it is 10 years since 

the last investment cycle peaked. The gross fixed capital formation to nominal GDP ratio has 

declined from an estimated 36% in FY08 to 28.5% in the past three fiscal years (see Figure 22). 

When that new investment cycle commences it will be very bullish for the stock market. This is the 

main reason why GREED & fear has been less concerned about the undoubtedly high valuations in 

India. This is because, as has been pointed out by CLSA’s Indian strategist Mahesh Nandurkar for 

some time, in macro terms, the level of corporate profits in India relative to GDP is depressed, 

reflecting the lack of an investment cycle. Thus, corporate profits as a percentage of GDP have 

declined from 7.1% in FY08 to 3.1% in FY18 ended 31 March (see Figure 23). 



Figure 22 

India gross fixed capital formation as % of nominal GDP 

36 

(% GDP) 

34 

32 

30 

28 

26 

24 

22 

20 

FY97 

FY98 

FY99 

FY00 

FY01 

FY02 

FY03 

FY04 

FY05 

FY06 

FY07 

FY08 

FY09 

FY10 

FY11 

FY12 

FY13 

FY14 

FY15 

FY16 

FY17 

FY18 

Note: Data prior to FY12 estimated based on the historical Source: CLSA, MOSPI, CEIC Data 

Figure 23 

India corporate profits as % of GDP 

8 

(%GDP) 

7 

6 

5.2 5.6 6.8 7.1 5.0 

5.6 

5.2 

4.7 

5 

4.5 

4.2 4.2 

4 

3 

2 

1.7 2.0 2.9 

3.5 

2.9 3.0 

3.1 3.3 

1 

0 

FY01 

FY02 

FY03 

FY04 

FY05 

FY06 

FY07 

FY08 

FY09 

FY10 

FY11 

FY12 

FY13 

FY14 

FY15 

FY16 

FY17 

FY18 

FY19E 

Source: CMIE, ACE Equity, MOSPI, CLSA 

Is there any evidence of a new investment cycle? The data is reasonably encouraging. Real gross 

fixed capital formation rose by 14.4% YoY in 1Q18, while manufacturing sector capacity utilisation 

rose from 74.1% in 4Q17 to 75.2% in 1Q18, the highest level since 1Q16 (see Figure 24). The 

industrial production index for capital goods also increased by 9.6% YoY in June and was up 8.4% 

YoY in 1H18 (see Figure 25). 

Still the difficulty with Indian macro data of late is the undoubted distortion created by the 

two ”shocks” of demonetisation in November 2016 and the introduction of the Goods and Services 

Tax (GST) in July 2017. That said, at a time when fund managers had at the start of this year given 

up on a capex cycle ever happening again in India, the equity market’s resilience may be a signal that 

it is nearer at hand than the consensus thinks. This would also mean that the stock market will be 

much more resilient to monetary tightening and a higher oil price than currently assumed. It would 

also mean that any correction, caused by the inevitable concerns that Prime Minister Narendra Modi 

will not be re-elected in next April-May’s general election, will be a buying opportunity. GREED & 

fear continues to believe that Modi will be re-elected. 



Figure 24 

India capacity utilisation rate 

84 

82 

80 

(%) 

India capacity utilisation 

Rolling 4 quarter average 

78 

76 

74 

72 

70 

Mar 09 

Jun 09 

Sep 09 

Dec 09 

Mar 10 

Jun 10 

Sep 10 

Dec 10 

Mar 11 

Jun 11 

Sep 11 

Dec 11 

Mar 12 

Jun 12 

Sep 12 

Dec 12 

Mar 13 

Jun 13 

Sep 13 

Dec 13 

Mar 14 

Jun 14 

Sep 14 

Dec 14 

Mar 15 

Jun 15 

Sep 15 

Dec 15 

Mar 16 

Jun 16 

Sep 16 

Dec 16 

Mar 17 

Jun 17 

Sep 17 

Dec 17 

Mar 18 

Source: Reserve Bank of India - Quarterly Order Books, Inventories and Capacity Utilisation Survey 

Figure 25 

India industrial production growth for capital goods 

12 

(%YoY, 6mma) 

10 

8 

6 

4 

2 

0 

-2 

-4 

-6 

Sep 13 

Nov 13 

Jan 14 

Mar 14 

May 14 

Jul 14 

Sep 14 

Nov 14 

Jan 15 

Mar 15 

May 15 

Jul 15 

Sep 15 

Nov 15 

Jan 16 

Mar 16 

May 16 

Jul 16 

Sep 16 

Nov 16 

Jan 17 

Mar 17 

May 17 

Jul 17 

Sep 17 

Nov 17 

Jan 18 

Mar 18 

May 18 

Source: MOSPI 

Meanwhile, if GREED & fear cut the overweight in India from a triple to double in the relative-return 

portfolio, fortunately the same did not happen in the long-only portfolio which remains 48% 

invested in India. Still, the portfolio remains heavily geared into housing finance and related property 

plays which have not been the main drivers of performance this year unlike last year in the Indian 

stock market. The Nifty Index has risen by 11% in rupee terms year-to-date and is up 17% from its 

23 March low, while the Nifty Realty Index has declined by 20% year-to-date and is down 6% since 

late March (see Figure 26). 

Still, GREED & fear continues to believe that the property cycle is turning up in India, as does CLSA’s 

Indian office. And the data supports this view. CLSA’s Indian property analyst Abhinav Sinha notes 

in a new report that pre-sales for listed developers and the industry in general are up in the 25-30% 

range in 1HCY18 (see Figure 27 and CLSA research India Property – Residential recovery broadening, 

23 August 2018). So, while pricing is still lagging volume, the trend is clearly improving (see Figure 

28). Meanwhile rising mortgage rates, up 30bp from a 12-year low of 8.4% in 1Q18 (see Figure 29), 

are less of a concern than they might be because of affordability running at the best level in more 

than 10 years (see Figure 30). 



Figure 26 

Nifty Realty Index relative to Nifty Index 

180 

170 

160 

150 

140 

130 

120 

110 

(End 2016=100) 

Nifty Realty Index relative to Nifty Index 

100 

Jan 17 

Feb 17 

Mar 17 

Apr 17 

May 17 

Jun 17 

Jul 17 

Aug 17 

Sep 17 

Oct 17 

Nov 17 

Dec 17 

Jan 18 

Feb 18 

Mar 18 

Apr 18 

May 18 

Jun 18 

Jul 18 

Aug 18 

Sep 18 

Source: CLSA, Bloomberg 

Figure 27 

India combined quarterly residential pre-sales of 12 listed developers 

70 

60 

50 

40 

30 

20 

10 

0 

(Rs bn) 

1QFY16 

2QFY16 

Source: CLSA, Companies 

3QFY16 

Qtrly pre-sales value 

4QFY16 

1QFY17 

2QFY17 

3QFY17 

4QFY17 

Trailing 4Q pre-sales, RHS 

1QFY18 

2QFY18 

3QFY18 

4QFY18 

(Rs bn) 

1QFY19 

250 

230 

210 

190 

170 

150 

130 

110 

90 

70 

50 

Figure 28 

India average residential property price trend in prime locations of key cities 

25 

20 

15 

10 

5 

0 

(5) 

(10) 

(%YoY) 

Average pricing change across 7 cities 

(15) 

Sep 07 

Mar'08 

Sep'08 

Mar'09 

Sep'09 

Mar'10 

Sep'10 

Mar'11 

Sep'11 

Mar'12 

Sep'12 

Mar'13 

Sep'13 

Mar'14 

Sep'14 

Mar'15 

Sep'15 

Mar'16 

Sep'16 

Mar'17 

Sep'17 

Source: CLSA, Cushman & Wakefield. *Mumbai, Delhi, Gurgaon, Bengaluru, Pune, Chennai, Hyderabad. 

Mar'18 



Figure 29 

India mortgage rates 

13% 

(%) India mortgage rates 

12% 

11% 

10% 

9% 

8% 

7% 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

Source: CLSA, SBI, HDFC 

Figure 30 

India housing affordability 

(%) Affordability: Mortgage payment to post-tax income ratio 

60 

56 54 

41 

50 

45 49 46 46 45 

41 

40 

30 

36 

31 

28 27 

34 

38 

34 

35 

31 30 

20 

10 

0 

FY01 

FY02 

FY03 

FY04 

FY05 

FY06 

FY07 

FY08 

FY09 

FY10 

FY11 

FY12 

FY13 

FY14 

FY15 

FY16 

FY17 

Note: Mortgage payment to post-tax income ratio of a Rs6m mid-income apartment. Source: CLSA 

FY18 

FY19CL 

Figure 31 

Net inflows into Indian equity mutual funds adjusted for Arbitrage funds 

4.5 

4.0 

(US$bn) 

Net inflows in equity funds adjusted for Arbitrage funds 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

(0.5) 

Apr-14 

Jun-14 

Aug-14 

Oct-14 

Dec-14 

Feb-15 

Apr-15 

Jun-15 

Aug-15 

Oct-15 

Dec-15 

Feb-16 

Apr-16 

Jun-16 

Aug-16 

Oct-16 

Dec-16 

Feb-17 

Apr-17 

Jun-17 

Aug-17 

Oct-17 

Dec-17 

Feb-18 

Apr-18 

Jun-18 

Note: Include 65% of flows into balanced funds. Source: CLSA, AMFI, Bloomberg 

Finally, on India, it is also worth noting again the continuing resilience of inflows into domestic 

equity mutual funds, which is another reason for the stock market’s resilience this year. Net inflows 

into domestic equity mutual funds, excluding arbitrage funds, totalled US$16bn in the first seven 



months of this year, compared with US$12.4bn in January-July 2017 (see Figure 31). This 

increasingly looks like it is a secular, not a cyclical phenomenon, in which case it is extremely bullish. 

On another topic, millennials are primarily known for spending their time fondling tiny computers 

called “smartphones” and providing the cannon fodder for the “sharing economy”. But in the 

investment area there has so far been one area which has aroused their interest. This has been, of 

course, the crypto currency boom and the related search for the best applications to implement 

blockchain technology. 

Still, a second area of interest is now emerging in the area of cannabis investing as legalisation 

momentum gathers pace resulting in the opportunity to invest in a brand new consumer market. On 

this point, GREED & fear was interested to read about a deal announced earlier this month where 

Constellation Brands, a seller of liquor brands such as Corona beer and Svedka Vodka, will increase 

its stake in Canopy Growth, Canada’s largest publicly traded diversified cannabis company, from 

10% to 38%. Apart from the obvious desire of Constellation to secure a presence in a burgeoning 

new market, the interesting point was the valuation with the deal done at a 51% premium to the 

previous closing price valuing Canopy at 103x trailing 12-month sales. The company was not 

profitable last year. Canopy’s share price has since risen to C$59.8 or 127x trailing sales, according 

to Bloomberg (see Figure 32). 

Similarly, GREED & fear was also interested to read that UK alcohol giant Diageo is also pursuing a 

deal with a Canadian cannabis company (see BNN Bloomberg article: “UK alcohol giant Diageo circling 

Canada for cannabis deals” by David George-Cosh, 24 August 2018). Diageo has reportedly met with 

several Canadian companies in the past month to gauge their interest in a deal for a potential 

investment or collaboration to create new cannabis-infused beverages. 

Figure 32 

Canopy Growth share price and price to sales ratio 

70 

(C$) 

Canopy Growth share price 

Price to sales (RHS) 

(x) 

140 

60 

120 

50 

100 

40 

80 

30 

60 

20 

40 

10 

20 

0 

0 

Sep 17 

Oct 17 

Nov 17 

Dec 17 

Jan 18 

Feb 18 

Mar 18 

Apr 18 

May 18 

Jun 18 

Jul 18 

Aug 18 

Sep 18 

Source: Bloomberg 

Certainly, Canadian quoted cannabis companies enjoy lofty valuations even though they are down 

45% from their peak (see Figure 33). All of the large licensed producers are not yet making any 

money. The reason that Canada is the epicentre of the cannabis story from an investment 

standpoint is because full-scale legalisation is due to be implemented on 17 October. When that 

historic event occurs, it is likely in GREED & fear’s view to act as a catalyst for pressure for 

legalisation to grow elsewhere, most particularly in America. At present 30 states in America have 

some form of a legalised cannabis programme if medicinal applications are included, while nine of 



these states have legalised recreational use. But if a person buys a cannabis product in, say, Denver 

and then flies with it to Los Angeles, he or she is breaking federal government laws even though 

recreational use is allowed in both Colorado and California. 

Figure 33 

Bloomberg Canada Cannabis Competitive Peers Index 

350 

Bloomberg Canada Cannabis Competitive Peers Index 

300 

250 

200 

150 

100 

50 

Jan 17 

Feb 17 

Mar 17 

Apr 17 

May 17 

Jun 17 

Jul 17 

Aug 17 

Sep 17 

Oct 17 

Nov 17 

Dec 17 

Jan 18 

Feb 18 

Mar 18 

Apr 18 

May 18 

Jun 18 

Jul 18 

Aug 18 

Source: Bloomberg 

Figure 34 

Poll: Support for legalising marijuana use in the US 

80 

70 

(%) 

Republicans Independents Democrats 

60 

50 

40 

30 

20 

2003 2004 2006 2010 2011 2012 2013 2014 2015 2016 2017 

Note: The latest figures are based on a 5-11 October 2017 poll. Source: Gallup Polls 

Why is legalisation coming? First and foremost, unlike most areas of contention in divisive American 

politics, cannabis legalisation does not appear to be a partisan issue. GREED & fear read recently, for 

example, that more than 50% of Republicans support legalisation (see Figure 34). GREED & fear also 

doubts that The Donald has huge problems with the issue though the American president will 

certainly be aware, as are the cashed up tobacco and liquor industries, of the commercial 

opportunities. GREED & fear recently saw an estimate from the Marijuana Business Daily that the US 

cannabis market is forecast to reach US$20bn by 2022, up from US$6bn in 2017, while the legal 

and illicit cannabis market is currently estimated at more than US$50bn. This puts it around the 

same size as other consumer goods industries such as smartphones and wine though, for now at 

least, still below cigarettes and beer which are running at around US$80bn and US$110bn. 

There are two other reasons why the call for cannabis legalisation is gaining momentum in America. 

The first is the growing awareness of the reduced collateral damage from use of cannabis compared 

with alcohol, both for the individual concerned and for society at large since “stoned” people do not 



tend to be violent. But the second reason is more powerful. That is the dramatically increased 

awareness in America during the past two years of the country’s opioid addiction crisis in terms of 

the growing numbers of Americans addicted to “pain killing” prescription drugs such as OxyContin. 

Thus, Alan Krueger, former chairman of the President’s Council of Economic Advisers released a 

study in October 2016 that showed that nearly half of all prime working-age male dropouts from the 

workforce, comprising then nearly 7m people, were on daily “pain killer” medication (see Boston Fed 

Economic Conference paper: “Where Have All the Workers Gone?”, 4 October 2016). In practice this 

costly medication is often paid for primarily by Medicaid, America’s means-tested health benefits 

programme. Yes, America does have a form of socialised medicine, however basic. 

America’s opioid crisis has existed for some time, as have the rise of the non-participation rate in the 

labour force and the related stagnant level of household incomes. The US labour force participation 

rate has declined from a peak of 67.3% in April 2000 to 62.9% in July 2018, while the number of 

Americans not in the labour force rose to a record 95.9m in May and was 95.6m in July (see Figure 

35). But it only became a topic of media focus amongst East Coast and West Coast elites after the 

November 2016 election as explanations were sought as to how the people in the middle of the 

country, known as the flyover zone, could have elected such a person as Donald Trump. See, for 

example, a lengthy article on the opioid issue (Commentary Magazine: “Our Miserable 21st Century”, 

by Nicholas Eberstadt, 15 February 2017). 

Figure 35 

US labour force participation rate and Americans not in the labour force 

100 (m) 

Americans not in the labour force 

95 

US labour force participation rate (RHS) 

90 

85 

80 

75 

70 

65 

(%) 

68 

67 

66 

65 

64 

63 

60 

1990 

1991 

1992 

1993 

1994 

1995 

1996 

1997 

1998 

1999 

2000 

2001 

2002 

2003 

2004 

2005 

2006 

2007 

2008 

2009 

2010 

2011 

2012 

2013 

2014 

2015 

2016 

2017 

2018 

62 

Source: US Bureau of Labour Statistics 

Faced with the choice between Americans being addicted to opioids which are ultimately heroin 

derivatives, or having open access to cannabis, it is not hard to see which would be a better 

alternative in a society where there is now much greater focus on the fallout from ever greater 

wealth inequality, as indeed there is in the Western world at large, most particularly as “artificial 

intelligence” threatens more and more lower paying jobs. In this respect, Aldous Huxley’s vision in 

Brave New World (Chatto & Windus, 1932) of a future society where the masses are living on soma 

might turn out to be a more accurate vision of the future than George Orwell’s 1984 (Nineteen 

Eighty-Four, Secker & Warburg, 1949). 

Certainly, no one should underestimate the ability of a legalised cannabis market to stimulate 

consumption by coming up with an attractive and diversified range of products. On this point, when 

last in America earlier this year, GREED & fear visited for the first time a cannabis store in Denver, 

and was struck by the clever merchandising in terms of the many different cannabis-related 



products on offer. In this respect, where bottled water and premium coffee brands have gone, 

cannabis is likely to follow. But this is an area where Asia will definitely not be leading. 

Meanwhile, it is too premature to assume that wealth inequality in America has peaked despite the 

revision to US data discussed here recently which has resulted in a significant increase in the 

household savings rate from 3.2% to 6.8% for May (see GREED & fear – Revisionism, 2 August 2018). 

The reason why is that the increase in the savings rate is primarily driven by upward revisions in the 

proprietors' income and investment income categories rather by an increase in the compensation of 

employees. Thus, US personal savings in 1Q18 were revised up from an annualised US$481bn to 

US$1.09tn, with disposable income revised up by US$516bn or 3.5% to US$15.3tn. Within this 

aggregate, proprietors’ income and investment income (interest and dividend income) were revised 

up by US$129bn and US$215bn (or 9.1% and 8.6%) respectively to US$1.55tn and US$2.72tn. By 

contrast, compensation of employees was revised up by only US$101bn or 1% to US$10.7tn (see 

Figure 36-38). 

Figure 36 

Revision in 1Q18 US personal income and savings 

Contrib. to 

US$bn saar 

Contrib. to chg in 1Q18 %YoY 

chg in personal 

Data for 1Q18 New Old change %chg savings income New Old 

Personal income 17,319 16,851 469 2.8% 76% 100% 4.3% 3.7% 

Compensation of employees 10,710 10,609 101 1.0% 17% 22% 4.5% 4.4% 

Proprietors' income 1,550 1,421 129 9.1% 21% 28% 5.1% 2.9% 

Rental income of persons 749 762 -13 -1.7% -2% -3% 4.2% 4.3% 

Income receipts on assets 2,720 2,504 215 8.6% 35% 46% 4.3% 3.5% 

Personal current transfer receipts 2,934 2,911 23 0.8% 4% 5% 3.5% 2.8% 

Less: Contrib. for govt social ins 1,344 1,356 -12 -0.9% 2% 3% 4.9% 5.6% 

Less: Personal current taxes 2,030 2,078 -48 -2.3% 8% -- 1.3% 2.9% 

Equals: Disposable personal income 15,289 14,773 516 3.5% 84% -- 4.7% 3.8% 

Less: Personal outlays 14,195 14,292 -98 -0.7% 16% -- 4.5% 4.5% 

Equals: Personal savings 1,094 481 614 128% 100% -- 7.8% -13.3% 

Personal savings rate % 7.2 3.3 3.9 118% -- -- -- -- 

Source: CLSA, US Bureau of Economic Analysis 

Figure 37 

Revision in US proprietors’ income 

1,600 

(US$bn saar) Proprietors' income Old data 

1,500 

1,400 

1,300 

1,200 

1,100 

1,000 

900 

800 

Mar 06 

Sep 06 

Mar 07 

Sep 07 

Mar 08 

Sep 08 

Mar 09 

Sep 09 

Mar 10 

Sep 10 

Mar 11 

Sep 11 

Mar 12 

Sep 12 

Mar 13 

Sep 13 

Mar 14 

Sep 14 

Mar 15 

Sep 15 

Mar 16 

Sep 16 

Mar 17 

Sep 17 

Mar 18 




Figure 38 

Revision in US personal investment income (interest income and dividend income) 

2,800 

(US$bn saar) Personal income receipts on assets Old data 

2,600 

2,400 

2,200 

2,000 

1,800 

1,600 

Mar 06 

Sep 06 

Mar 07 

Sep 07 

Mar 08 

Sep 08 

Mar 09 

Sep 09 

Mar 10 

Sep 10 

Mar 11 

Sep 11 

Mar 12 

Sep 12 

Mar 13 

Sep 13 

Mar 14 

Sep 14 

Mar 15 

Sep 15 

Mar 16 

Sep 16 

Mar 17 

Sep 17 

Mar 18 


As a result, proprietors’ income and investment income contributed to 74% of the revision in total 

personal income, compared with only 22% contributed by compensation of employees. The other 

point, of course, as regards compensation for labour is that the pickup in average hourly earnings 

growth in the past two years looks even less impressive when viewed in real rather than nominal 

terms. Thus, US real average hourly earnings declined by 0.2% YoY in July and are up only an 

annualised 0.2% over the past two years (see Figure 39). 

Figure 39 

US real average hourly earnings growth 

5 

4 

3 

2 

1 

0 

-1 

-2 

(%YoY) 

US real average hourly earnings growth of private employees 

-3 

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 

Source: US Bureau of Labour Statistics 


xxx 

xxx

xxx

50 Master Moves That Shaped 

Berkshire Hathaway 

AP 

50 Master Moves That Shaped Berkshire Hathaway 

The defining decisions that Warren Buffett has taken in the 50 years 

that he has been leading Berkshire Hathaway 

N Mahalakshmi & Rajesh Padmashali 

While he has always wanted to win and still does, Warren Buffett 

himself might not have visualised that he would end up creating the 

Berkshire Hathaway of today. He wrote in the 2014 annual report, 

“Berkshire now owns nine-and-a-half companies that would be 

listed on the Fortune 500 were they independent.” Last year, his 

https://www.outlookbusiness.com/specials/50-master-move…way/50-master-moves-that-shaped-berkshire-hathaway-900 

26/08/18, 10C43 AM 

Page 1 of 35

partner, Charlie Munger, had mused, “How the hell does this thing 

end up blowing past GE?” At last count, Berkshire had a market cap 

of $360 billion versus GEʼs $280 billion. 

Though Munger explained what he thought were the reasons for 

Berkshireʼs phenomenal success, he did also write, “Berkshireʼs 

better outcome was so astoundingly large that I believe that Buffett 

would now fail to recreate it if he returned to a small base while 

retaining his smarts and regaining his youth.” When this was 

pointed out at the 50th-year annual meeting, Buffett recalled the 

trifecta that was unlikely to happen again. The first was Lorimer 

Davidson spending four hours to explain the insurance industry to 

him when he was a 20-year-old. The second was Jack Ringwalt 

selling National Indemnity to him and the final one was Ajit Jain 

walking into his office in 1985. 

Left to Buffett, his list of master moves would only be these 

fortuitous three. But if one were to believe Munger, “If people 

werenʼt so often wrong, we wouldnʼt be so rich.” The fortuitous 

trifecta and Mungerʼs wisecrack aside, what they have achieved 

through Berkshire is the stuff of legend and the 50 master moves 

that you will read below is only in hindsight. 

1 Choosing to stay at Omaha 

The key to thinking independently is to shut out noise and not get 

carried away by it. Independent thinking and rationality has been 

central to Buffettʼs success and being away from Wall Street has 

helped.After graduating from Columbia and being turned down by 

Ben Graham for a job at his investment firm Graham and Newman, 

he returned to Omaha to become a stockbroker. Buffett didnʼt quite 


26/08/18, 10C43 AM 

Page 2 of 35

enjoy the brokerage business and pursued Graham, sending him 

stock ideas continuously till he relented. Buffett moved to New York 

for the love of the job in 1954, but returned to Omaha once Graham 

dissolved his partnership firm in 1956.Buffett ran his investment 

partnership firm in Omaha with extreme success till 1969. His next 

stint at New York was only when he stepped in at Salomon Brothers 

when it was embroiled in a crisis 

2 Winding up Buffett Partnership 

In the investment industry, itʼs not common for fund managers to 

wind down operations and return capital to clients if they have run 

out of ideas or are circumspect. Buffett did exactly that early in his 

career.After an extremely successful stint at the Buffett Partnership, 

delivering return of 29.5% compounded between 1956 and 1969, 

Buffett decided to close down the partnership and return the money 

to investors in 1969. Despite his fabulous performance, he took this 

bold decision, citing “inability to find bargains in the current market”. 

He liquidated all shares held by the partnership except Berkshire 

Hathaway, a textile company he had whimsically taken control of. 


26/08/18, 10C43 AM 

Page 3 of 35

3 Turning Berkshire into an investment company 

Buffett qualifies his Berkshire purchase as the "dumbest" stock he 

bought but then turned it into his famed investment vehicle. When 

he first bought into Berkshire, its textile business was ailing but he 

revived the company under CEO Ken Chace. Besides Chace's 

efforts to reduce inventory, sweat and sell assets, a temporary 

cyclical upturn generated substantial cash in the initial years. Buffett 

read correctly the winds of change affecting the textiles business, 

so he changed direction and invested its cash flows into more 

lucrative businesses. This decision forms the foundation for 

Berkshire's future. "Burlington Industries, the largest company in the 

textiles business (then and now) chose a different path, deploying 

all available capital into its existing business between 1965 and 

1985. Over the 20-year period, Burlington's stock appreciated at a 

paltry annual rate of 0.6 percent; Berkshire's compunded return was 

a remarkable 27 percent", notes William Thorndike in his book The 

Outsiders. 

4 Focusing on capital allocation 

Buffett figured out in his late 20s that investing had become his 

passion and thatʼs what he excelled at. His enormous reading list 


26/08/18, 10C43 AM 

Page 4 of 35

and legwork had led to a deep understanding of varied businesses 

and their economics, unlike most CEOs, who are constrained and 

blinkered because of the business they operate in. What 

differentiates Buffett from other successful CEOs is that he turned 

Berkshire into an investment company where he would take all 

investment decisions and let the operating managers take care of 

those businesses. Despite their phenomenal operating experience, 

the managers of Berkshire companies send their profits back to 

Omaha and Buffett decides on the allocation based on every 

businessʼ investment worthiness. There is no question of sinking 

money in declining businesses (textiles was shut down) but nothing 

stops him from allocating extraordinary capital to businesses that 

may hold outsized return potential. In recent history, capital 

intensive businesses such as BH Energy and Burlington Northern 

have received a bulk of the funding for acquisitions and expansion. 

5 Investment flexibility 

Through his career, he has dabbled in every financial instrument in 

the universe. Buffett has been asset-class agnostic, though now he 

is constrained by size. He still wants to own the best and says, “At 

Berkshire, we prefer owning a non-controlling but substantial 

portion of a wonderful company to owning 100% of a so-so 

business; itʼs better to have a partial interest in the Hope Diamond 

than to own all of a rhinestone. Our flexibility in capital allocation — 

our willingness to invest large sums passively in non-controlled 

businesses — gives us significant advantage over companies that 

limit themselves to acquisitions they can operate. Our appetite for 

either operating businesses or passive investments doubles our 

chances of finding sensible uses for Berkshireʼs endless gusher of 

cash.” 


26/08/18, 10C43 AM 

Page 5 of 35

6 Investing in long-term relationships 

Buffettʼs investment prowess apart, one of his greatest strengths is 

his ability to gauge character and competence in people, and 

cultivate them. Right from choosing Charlie Munger as his partner, 

to his close association with the chairperson of Washington Post 

Company, Katherine Graham, who aided in understanding the media 

business, where he made some remarkable bets, to the current 

partnership with 3G Capital. Buffettʼs secret to great long-term 

relationships is to first have a high entry barrier in terms of trust. 

Buffett works with trust and talk rather than confront and mock. His 

approach of “praise by name, criticise by category” also ends up 

winning him more friends than enemies. 

7 National Indemnity 

Buffettʼs likeability also resulted in many a great deal. Jack Ringwalt, 

the controlling shareholder of National Indemnity Insurance, came 

to Buffett in 1967 saying he would like to sell. Buffett did not ask for 

an audit, as he knew Ringwalt was honest but quirky, and would 

walk away if the deal became complicated.Buffett used a bulk of 

Berkshireʼs cash to acquire National Indemnity and sister company 

National Fire and Marine for $8.6 million. “Though that purchase 


26/08/18, 10C43 AM 

Page 6 of 35

had monumental consequences for Berkshire,” Buffett reveals in the 

2014 annual letter, “its execution was simplicity itself.” More 

importantly, it became an important pillar of the Berkshire structure. 

8 The power of float 

Using the insurance business to fuel his investment vehicle was 

Buffettʼs masterstroke, as it provided an implicit leverage without 

the firm having to actually borrow any money but bolstering overall 

return. This “float” is estimated to have added nearly a third to 

Berkshireʼs annual return. Buffett explains the power of float lucidly 

in his 2014 letter. “Property-casualty insurers receive premiums up 

front and pay claims later. This collect-now pay-later model leaves 

P/C companies holding large sums — money we call ‘floatʼ. 

Meanwhile, insurers get to invest this float for their benefit. 

Consequently, as our business grows, so does our float.” Besides, 

Buffett adds, the nature of Berkshireʼs insurance contracts is such 

that “we can never be subject to immediate demands for sums that 

are large compared to our cash resources. This strength is a key 

pillar in Berkshireʼs economic fortress”. 

9 Underwriting discipline 

Normally, insurance companies register an underwriting profit if 

premiums exceed the total of expenses and eventual losses that 

adds to the investment income the float produces. Buffett says the 

lure of this profit creates such intense competition that the industry 

actually ends up with a significant underwriting loss.But Berkshire is 

an exception, operating at an underwriting profit for 12 consecutive 

years, with pre-tax gain for the period having totalled $24 billion. 

The whole strategy of profitable underwriting and focus on float 

creation, as opposed to simply focusing on premium revenue, has 


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meant that Berkshire companies would avoid underwriting insurance 

when prices were unattractive, while underwriting large amounts 

when the prices were attractive.“In 1984, National Indemnity wrote 

$62.2 million in premium. Two years later, premium volumes grew an 

extraordinary six-fold to $366.2 million. By 1989, they had fallen 

back 73 percent to $98.4 million and did not return to the $100 

million level for 12 years. Three years later, in 2004, the company 

wrote over $600 million in premiums. Over this period, National 

Indemnity averaged an annual underwriting profit of 6.5 percent as a 

percentage of premiums compared with an average loss of 7 

percent for a typical property and casualty insurer,” points out 

Thorndike in The Outsiders. As for re-insurance, almost all bigticket 

underwriting lands up at Berkshire. “When major insurers 

have needed an unquestionable promise that payments of this type 

(where contracts entail substantial payments 50 years hence or 

more) will be made, Berkshire has been the party — the only party 

— to call,” says Buffett, adding that there have been only eight P/C 

policies in history that had single premium exceeding $1 billion and 

all eight were written by Berkshire; the highest ever was a 

transaction with Lloydʼs in 2007, where the premium was $7 billion. 

10 Geico 

Buffett bought into Geico when the firm lost more than 95% of its 


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value because of serious underwriting losses, but a new CEO was 

trying to revive the company, bringing back the underwriting 

discipline it was once known for. Between 1975 and 1980, Buffett 

invested about $45 million into Geico, raising his stake to 33%, as 

he knew the company had a low-cost structure (it directly sold 

insurance to customers and, hence, its operating cost was 15 cents 

a dollar compared with 24 cents for competition) and with the new 

management, it could do better.Over the next 15 years, by 1995, 

Buffettʼs investment had grown to $2.4 billion, a 51% stake, as the 

company also bought back shares. Berkshire finally bought the 

remaining 49% in January 1996 for $2.3 billion. In the 2014 annual 

letter, Buffett wrote, “It was clear to me that Geico would succeed 

because it deserved to succeed. No one likes to buy auto insurance. 

Almost everyone, though, likes to drive. The insurance consequently 

needed a major expenditure for most families. Savings matter to 

them — and only a low-cost operation can deliver these. Geicoʼs low 

costs create a moat — an enduring one — that competitors are 

unable to cross.” 

11 Conglomerate structure 

Charlie Munger loves spin-offs as a strategy and Buffett himself 

may feel that Berkshire is subject to a holding company discount, 

but they have favoured the conglomerate structure rather than split 

the company for a short-term pop. The conglomerate structure is 

abhorred by the market, usually because of the discretion it allows 

management to allocate — or misallocate — capital. With Buffett 

and Munger at the helm, the structure works beautifully, as they 

have perfected capital allocation. The biggest advantage is tax 

efficiency. Buffett has often advocated more taxes for the rich but 

has worked toward minimising tax outgo via deal structuring and 


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deferrals. “Thanks to its long-time horizon, Berkshire holds many 

assets acquired decades ago, resulting in deferred taxes now 

totalling $60 billion. These amount to interest-free government 

loans without conditions,” says Buffett watcher Lawrence 

Cunningham. 

12 Lean operation 

For a company of Berkshireʼs size and complexity with a turnover of 

nearly $200 billion and 340,000 employees, its headquarters is 

thinly staffed — and thatʼs an understatement. Berkshireʼs office at 

Farnam Street in Omaha houses 25 people, including Buffett. Adds 

Cunningham, “Most sizable American corporations use centralised 

procedures and departments, middle managers meeting regularly, 

along with consultants, directives, supervision and secondguessing. 

Berkshire has none of that — no centralised accounting, 

personnel, legal or technology departments; no hierarchies for 

reporting or budgeting; no middle managers or consultants. All such 

functions are handled in the individual units.” That cuts costs and 


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eliminates bureaucracy. 

13 Buying forever as centerpiece 

As Buffett graduated from Grahamʼs cigar butts strategy to one that 

emphasised quality stocks and fair prices, “buying forever” was 

probably a natural corollary. Implicit in the philosophy of buying for 

keeps are three considerations: 1) the power of compounding can 

do magic over long time periods, 2) there is cost associated with 

moving in and out of stocks, which erodes value over time, and 3) 

the reinvestment risk associated with winding down an existing 

holding. Barring IBM, which was purchased in 2011, his top four 

positions have been in his portfolio for over 20 years. 

14 See's Candies 

Seeʼs, a California-based candy company, was the landmark 

investment that marked the departure of Buffett from a pure 

quantitative process that Graham advocated to a quality-focused 

approach — the concept of ‘moatʼ in Buffett parlance. Buffett 

bought the company on Mungerʼs recommendation, at a price far 

higher than what he had paid for any stock till then. He paid $25 


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million, or 6X operating income, in 1972. To date, Seeʼs Candies has 

brought in pre-tax earnings of $1.9 billion, with its growth funded by 

investments of $40 million. Seeʼs competitive advantage was 

unleashed after Buffett initiated a more aggressive pricing strategy 

commensurate with its quality of products. Buffett has said, “If there 

was no Seeʼs, there would have been no Coke,” highlighting the 

significance of this investment. 

15 Coca-Cola 

Buffettʼs big bet on Coke had many tittering as they could not figure 

out why Buffett had taken such a massive bet on a century-old 

company. But the cold war was thawing and coupled with a massive 

distribution moat, Buffett could not see anything but a windfall of 

sugary profits from across the globe. The presence of one-time 

neighbour, the very competent Donald Keough, at the helm 

reinforced the comfort. Berkshire is now sitting on more than a 

twenty-fold gain on its investment, with the dividend fountain 

unlikely to run out of concentrate anytime soon. Coke is one of 

those dream investments for Buffett, high not only on nostalgia but 

also on return. 


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16 Washington Post 

This was one of those bargains of the century. Not only did he run a 

paper route as a teen, Buffett had also been buying regional 

newspapers and realised that sooner or later, the bulk of the 

advertising ends up with the market leader. The Washington 

Post was as strong as one could get in its market and given what it 

was trading at, Buffett loaded up enough to become the secondlargest 

shareholder in the holding company. If anything comes close 

to Coke, Washington Post Company must be it. The only difference 

is that he let go of it, but in a tax-effective manner that only Buffett 

could have envisaged. 

17 Capital Cities 

If The Washington Post was Buffettʼs initiation to national 


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newspapers, then Capital Cities and getting to know Tom Murphy 

was his gateway to national broadcasting. His earlier experience of 

investing in ad agencies and the template of advertising leadership 

was transplanted to a television network. Buffett financing Capital 

Citiesʼ acquisition of ABC resulted in a network that ran across the 

country, and then the eventual buyout by Disney. Again, like Keough 

at Coke, the formidable tag team of Tom Murphy and Dan Burke at 

Cap Cities made a big difference to how the return shaped up. 

18 Concentration as opposed to diversification 

Buffett and Munger have held the view that diversification does not 

reduce risk. “Diversification is protection against ignorance. It 

makes little sense if you know what you are doing,” Buffett has 

famously said. In the end, investing is about recognising everything 

that could go wrong and still being convinced about the upside. 

What this means is that your chances of striking it rich are higher if 

you bet on a few high-conviction ideas than across many where 

your conviction isnʼt as high. Currently, the top four positions in 

Berkshireʼs investment portfolio account for 60% of the total value. 

There have even been occasions when a single stock has 

accounted for more than 15% of the total value. 

19 American Express 

During his partnership days, Buffett made a big bet on American 

Express in 1965, when the company was battling the salad-oil crisis. 

He loaded up on Amex, building it to about 40% of his total portfolio 

— that amounted to more than 5% ownership in Amex at a cost of 

$13 million. That affection continues and Berkshire today holds 

nearly 15% in Amex, and that stake was worth $14 billion in end- 

December 2014.American Express' credit card business focuses on 


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encouraging higher spending by creating great reward schemes. 

While Amex has consistently widened its basket of offerings, it has 

been facing the heat recently because of a host of business 

challenges, including the end of its partnership with Costco, the 

largest US wholesaler. Buffett is unfazed, but his portfolio managers 

have already built positions in MasterCard and Visa, although that 

exposure is significantly smaller. 

20 Wells Fargo 

Buffettʼs traditional dislike of financial institutions was overcome by 

the valuation at play. During the collapse in banking stocks in 1990, 

Buffett reckoned that Wells Fargoʼs balance sheet had the depth to 

withstand the rot lending it had done. It was too good an 

opportunity to pass up and pretty soon, he was laughing all the way 

to the bank to buy more of its stock. So much so, that today, 

Berkshire holds about 10% of the bank in its investment portfolio. 

Given his earlier affirmation about “loading up on things that he likes 

best”, expect him to add more to the single-biggest holding in his 

portfolio. 

21 Moody's 

While he does make general statements, Buffett never goes to town 


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with his investment thesis on any of his holdings. However, many in 

town went after him for Berkshireʼs holding in Moodyʼs after the 

2008 crisis. Buffett, who was one of the ardent critics of those 

involved in the sub-prime crisis, always had a fat holding in 

Moodyʼs, one of the credit rating agencies, that was asleep at the 

wheel. Moodyʼs enviable regulatory moat aside, Buffett has reduced 

his holding over the years but the remainder is still worth over $2 

billion. This is probably one of the few stocks which has made him 

money but not given him much cause for cheer. 

22 Contrarian approach 

At the heart of investing are the emotions of greed and fear. The 

more depressed and fearful the market, the greater the potential for 

gains. And vice versa. While Buffett has bought into great 

businesses run by able managements, he timed his entry on several 

occasions when the stock was hit by a major scandal or crisis, 

which, in Buffettʼs assessment, did not damage the intrinsic value of 

the business to the extent that the market was reacting. Thorndike 

notes, “The majority of Berkshireʼs public market investments 

originated in some sort of industry or company crisis that obscured 

the value of a strong underlying business.” 

23 Strike only when cold 

Conventional fund managers say “time in the market is more 

important than timing the market.” While that statement may have 


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some merit, steering clear of a major catastrophe can result in very 

valuable dry powder. Buffett did so famously on two occasions — 

the first time in the late ʼ60s when he dissolved the Buffett 

Partnership and returned money to investors saying the markets 

were overvalued; and he did a repeat in 1987 ahead of the October 

market crash, when he sold all his stocks barring his core positions. 

Buffettʼs comfort with long periods of inactivity and spurts of peak 

activity is legendary and helps seize opportunities that offer 

superlative return. 

24 Smart acquisitions led by intrinsic value 

The key to maximising return is to buy businesses when the price is 

substantially lower than the intrinsic value. Buffettʼs acquisitions are 

not led by size or synergies but by the addition to intrinsic worth. 

Deeply cognisant of the intrinsic worth of Berkshire, barring the odd 

misstep with Dexter Shoes, he has largely abstained from making 

large acquisitions (BNSF is an exception) using shares. “The 

intrinsic value of the shares you give in an acquisition should not be 

more than the intrinsic value of the business you receive. Trading 

share of a wonderful business which Berkshire most certainly is for 

ownership of a so-so business irreparably destroys value,” said 

Buffett in his 2014 letter, adding that “Iʼve yet to see an investment 

banker quantify this all-important math when he is presenting a 

stock-for-stock deal to the board of the potential acquirer.” 


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25 Positioning BRK as a great place to sell 

Berkshire has, over time, earned itself a reputation of an ideal home 

for family businesses wanting to sell out. Firstly, itʼs easy to sell to 

Berkshire. No prolonged discussions or negotiations. Buffett has 

been listing his “acquisition criteria” in the Berkshire annual report 

for over three decades now, and any business-owner can approach 

Buffett directly if the acquisition criteria are met. Buffett is quick 

with deals and assures to give an answer usually in five minutes or 

less. But more than the ease of transaction itself is what comes 

after. Says Barnett Helzberg, who sold off his business Helzberg 

Diamonds to Berkshire Hathaway in 1995, “Promoters know Buffett 

is not going to change it, he is not going to sell it and he is not going 

to take it public. That is why he is the best person in the world to sell 

out to. That is also why Warren gets the opportunity to buy some 

very good family businesses.” 

26 Hire well, manage little 

Buffett may have said, “I try to buy stock in businesses that are so 

wonderful that an idiot can run them. Because sooner or later, one 

will,” but that grossly underplays the emphasis he lays on smart 

managers. His model of extreme de-centralisation would not work 

unless the operating managers delivered. A notable fact is that 

nobody at Berkshire is awarded stock options. Having hired well, 


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Buffett limits his interactions with his CEOs to the minimal, only to 

get involved in capex decisions. He allows 100% operating freedom 

to his managers, with full expectation that they will be 

conscientious. This tightrope walk has ensured that Berkshire has 

never lost a CEO to competition in all these years. It also 

demonstrates the fiduciary responsibility that is ingrained in the 

Berkshire culture. 

27 Trust-based model 

In May 2009, when the world was emerging out of the credit crisis, 

Buffettʼs partner Charlie Munger said something fundamental about 

Berkshire Hathaway that resonated with the 35,000 people present 

at the annual meeting: “Our model is a seamless web of trust thatʼs 

deserved on both sides. Thatʼs what weʼre aiming for. The 

Hollywood model, where everyone has a contract and no trust is 

deserved on either side, is not what we want at all.” To which Buffett 

had added, “We donʼt want relationships that are based on 

contracts.” It is this seamless web of deserved trust that is unique to 

Berkshire. 

28 Steering clear of institutional imperative 

Human beings and, by extension, companies find great comfort in 

herding. Hence, anything popular or even downright financially 

foolish gets copied if there are enough people doing it. That applies 

to sub-prime lending or the rush to underwrite insurance at low 

premium. It is then left to independent-minded contrarian leaders to 

ensure that their institution doesnʼt succumb to mindless fads or 

indulge in collective behaviour that borders on grey. Buffett was 

clear from the onset about doing the right thing both in letter and 

spirit and this was forcefully put forward when he stepped in to fix 

the breakdown at Salomon Brothers. All his operating companies 

are expected to toe the line. 


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29 No banker for deals 

In the earlier days, Buffett, unlike most CEOs, relied on his own 

research. And he didnʼt rely on investment bankers to do deals 

either. Bankers and brokers are driven by self-interest and for the 

hefty fees they charge, their advice often ends up being counterproductive. 

“Donʼt ask the barber if you need a haircut,” says 

Buffett. Apart from the deals that knock on his door, he relies on his 

network and previous sellers of businesses for deals. That has not 

deterred Wall Street from calling every now and then as Berkshire 

subsidiaries do a lot of bolt-on acquisitions through the year. 

30 Governance structure 

If Berkshire were some middling company, its board could have 

passed off as a coterie. Most of them have known Buffett for a long 

period of time but there is a big difference. The directors are 

personally invested in Berkshire and those shares have been bought 

with their personal money. Buffett champions the idea that directors 


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will be able custodians of shareholder interest when they have skin 

in the game. Unlike other American directors who are well-paid, 

Berkshire directors get paid almost nothing. They probably end up 

spending more attending the board meetings and are also not 

provided liability insurance cover. 

31 Direct communication with shareholders 

In line with the belief of not pandering to Wall Street, he does not 

give earnings guidance, spends no time on analyst calls or 

investment conferences but spends a full day answering questions 

at his legendary annual shareholder meetings in Omaha. His 

shareholder letters are a detailed account of all the major operating 

businesses of Berkshire, besides his take on important economic 

concepts and issues. Buffett and Munger have maintained that all 

shareholders should have access to new information that Berkshire 

releases simultaneously and should also have adequate time to 

analyse it. All financial data is thus released late on Fridays or early 

on Saturdays. The annual meeting is also always held on the first 

Saturday in May. Buffett and Munger do not talk one-on-one to 

large institutional investors or analysts, treating them as they do all 

other shareholders. 


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32 Not splitting shares and creating another class 

Managements often engineer stock splits to make the stock appear 

optically cheap and to create greater liquidity. Slicing a pizza does 

not make it any bigger, so Buffett has refrained from splitting the 

shares of Berkshire. Higher ticket size investments are often more 

thought through by investors and they tend to take a more longterm 

view. Still, Buffett created a new Class B, with fractional 

economic and voting rights, back in 1996 when two New York 

money managers designed a unit trust that would buy the stock and 

then issue fractional units designed to trade at a low price for a fee. 

“To knock out these meddling middlemen, Berkshire amended its 

charter to rename its existing common stock Class A and add a 

Class B, with fractional economic and voting rights. It vowed to offer 

as many shares as necessary to fill demand, which it did, thus killing 

off demand for the unit trust,” says Cunningham. 

33 No dividend policy 


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Over the past nearly 50 years, Berkshire has not paid a single dollar 

as dividend. In addition to its cash pile, Berkshire earned $20 billion 

in 2014 but all of that is retained for reinvestment. In his 1984 letter 

to shareholders, Buffett wrote, “Unrestricted earnings should be 

retained only when there is a reasonable prospect — backed 

preferably by historical evidence or, when appropriate, by a 

thoughtful analysis of the future — that for every dollar retained by 

the corporation, at least one dollar of market value will be created 

for owners. This will happen only if the capital retained produces 

incremental earnings equal to, or above, those generally available to 

investors…”For investors who are in need of cash, he suggests 

selling shares instead. “The sell-off policy lets each shareholder 

make his own choice between cash receipts and capital build-up.” 

The other advantage is that dividends attract a higher rate of tax 

compared with capital gains. The recent clamour for dividends from 

certain pockets was voted down overwhelmingly by the majority of 

shareholders. 

34 Integrity at all costs 

Buffettʼs values of integrity and humility were ingrained at an early 

age from his father Howard Buffett, a stockbroker who later ran 

successfully for Congress. Warren has carried that forward and 

carefully built Berkshire with trust and integrity as core values. 


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Breach of trust and integrity issues fall in the zero-tolerance zone 

for Buffett and Munger. After the Salomon Brothers episode, this 

was again apparent when Buffett took the tough decision to let go 

of David Sokol, after it came to light that he had bought shares of 

Lubrizol in his personal account ahead of Berkshireʼs acquisition of 

the company. David Sokol was one of his smartest managers, a 

trusted lieutenant and potential heir apparent. Despite that, or 

perhaps because of that, Buffett took the hard call. 

35 Surfing big trends 

Although Buffett underplays how much he looks at macros, his 

stock selection reveals a strong underpinning of the prevailing 

economic environment. Whether it be companies having pricing 

power when inflation was hurting or playing the private equity game 

at a time of near-zero interest rates or even investing in a business 

like wind energy because of the tax advantages it offers, Buffett has 

intelligently played macro trends as is visible in his portfolio. The 

beauty of his strategy is to pick stocks by quickly identifying 

structural trends but, at the same time, not lose sight of an 

opportunistic move that could hold significant gains. 


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36 Betting on management change 

Another strategy is betting on a new management and strategic 

change. Managements tend to destroy value when they diversify 

into businesses that promise lower returns than the existing 

“franchise-type” business that delivers high returns. A capable new 

management can add value by simply returning to the core business 

and doing away with mediocre businesses, and thatʼs a good 

opportunity to exploit. Thorndike presents evidence in his book The 

Outsiders. 

37 Saying no to dotcom darlings 

Even at the peak of the internet boom, when Buffett was 

underperforming and there was pressure and criticism about his 

abstaining from technology, he stuck to his circle of competence. 


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Although Buffett says he does not understand technology, the truth 

is that the pace of technology change makes predicting future cash 

flows next to impossible. Often, the longevity of the company also 

becomes questionable. Even though Buffett has largely refrained 

from technology, he bought into IBM in 2012 and has added to his 

position amid much cynicism. 

38 Widening circle of competence 

Sticking to his circle of competence has been Buffettʼs pet theory 

but the best part of Buffett and Munger is that they turned 

themselves into a life-long learning machine which has resulted in 

an ever-expanding circle of competence. The continuous learning 

— besides being intense readers, both devour balance sheets like a 

tabloid — ensures that they know what to look at and where not to 

waste time. In the recent annual meeting, Munger said, “We were 

always dissatisfied with what we already knew, and we wanted to 

know more. If Warren and I had stayed frozen in time, Berkshire 

would have been a terrible place.” 


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39 Cultivating China as an ally 

Outside the US, UK and Germany, the country with the most 

Berkshire fanatics has to be China, where he is looked upon as a 

god of investing. About 3,000 shareholders were in attendance from 

China for the 50 th -year annual meeting, and so were various 

Chinese media agencies. Buffett and Munger, too, are impressed by 

the way China has emerged as an economic power. And being the 

kind to have always looked around bends, they both believe that it is 

imperative for the US to nurture a cordial economic and political 

relationship with China. While there has been nothing recent, 

Berkshireʼs earlier investment in PetroChina was handsomely 

rewarding. 

40 PetroChina 

This was Buffettʼs first major investment in the Chinese market and 

seemed timed to cash in on a bottoming crude market and potential 

economic recovery in 2002. Buffett, until then, had not ventured 

outside the US market in such a major way, with a close to $500- 

million investment. The recovery in the world economy resulted in a 

higher crude price and Buffett exited the largest Chinese oil 

producer making seven times his original investment. In an earlier 


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interview, he had mentioned, “We bought it at a $35-billion market 

cap, but I thought the company was worth at least $100 billion. 

When we sold the stock, it was valued at probably $250 billion-275 

billion.” 

41 BYD 

Munger may have discussed and suggested a zillion investment 

ideas after Seeʼs Candies to Buffett, but it is the BYD investment 

that most recall as the recent one influenced by him. The BYD 

investment was suggested by Himalaya Capitalʼs Li Lu — who 

manages Mungerʼs money — and then became a part of the 

Berkshire portfolio. BYD is essentially a bet on the adoption of 

electric cars in China, and possibly around the world. The company 

is working on an efficiently rechargeable car battery and if it gets 

there before anybody else, there is another windfall awaiting 

Berkshire. That happening, BYD will indeed mean Build Your 

Dreams. 


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42 Berkshire Hathaway Energy 

Earlier known as MidAmerican, Berkshire Hathaway Energy supplies 

electricity and natural gas to about 12 million customers and 

generated $1.9 billion in net earnings in 2014. Buffett has 

traditionally stayed away from utilities, as they are capital-intensive 

businesses. The aggressive stance at BH Energy is not only driven 

by tax incentives but also the assurance of a steady return. In a way, 

it seems to be insurance against a turn in the current benign market 

environment. There is also a potential successor in the form of Greg 

Abel, who also sits on the board of Heinz. 

43 Impeccable deal structuring 

Buffett is great at identifying investment opportunities, as his buying 

spree during the 2008 crisis showed, but his prowess extends far 


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eyond in smartly structuring deals. Buffett invested in the late ʼ80s 

in convertible preferred securities of Salomon Brothers, Gillette, US 

Airways, and Champion Industries, wherein the dividends came with 

tax relief, which meant that not only could he earn higher post-tax 

yields but also benefit from any potential appreciation in stock price. 

In the deal struck with Bank of America post the crisis, Berkshire 

has the option of buying 700 million shares by 2021 at $5 billion. 

The market value of that stake today is $12 billion. Buffett is still 

sitting on the position and says he will “exercise the option closer to 

expiry”, even as he holds on to the cash. He has also frequently 

used a “cash-rich split-off” to maximise return. This play involves an 

exchange of cash and assets for stock and Buffett has used this 

tax-efficient mechanism very effectively in the case of the Duracell 

acquisition and to exit the Washington Post Company. 

44 Burlington Northern 

If there was a direct vote on the future of the US economy, this $44- 

billion deal was it. It is now in Buffettʼs words “Berkshireʼs most 

important noninsurance subsidiary”. Berkshire will spend $6 billion 

on capital expenditure to improve capacity and its network. This is 

one quarter of revenues, but this capex as well as that at BH Energy 

should lead to more deferred taxes and hence quasi float. Given the 

fear of mishaps, half the capex will be for improvement and 

maintenance of tracks. 

45 Iscar 

If PetroChina was the first major listed equity that Berkshire bought 

outside the US, then metalworks company Iscar was the first major 


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uyout of a private company outside the US for Berkshire. This 

buyout, again, reinforced Berkshireʼs position as a prized home even 

for private companies outside the US. The $6-billion transaction 

was done in two parts over 2006 and 2013, and the fact that 

Berkshire paid $2 billion for the last 20% implied that it was pretty 

satisfied with the way Iscar had grown since the acquisition. Given 

this favourable experience, it is likely that Berkshire could do more 

acquisitions in Israel. 

46 IBM 

The world takes its own time to come around and grasp the wisdom 

in Buffettʼs decisions. His call to invest in IBM might be another such 

case. It could well be that Buffett has not bought IBM for its 

technology. After having dissected it well over his lifetime, he might 

have bought it as a digital concrete company for its corporate moat, 

regular cash flows, share buy-backs and its capacity to pay regular 

dividends. Buy-backs are a regular theme wherever Buffett is 

involved, and so are dividends. Buffett likes dividends, it is just that 

he doesnʼt like to pay them. Then, given its legacy and standing in 

the corporate world, IBM is not something that will just go away. It 

can marshal enough resources to do an acquisition and tilt the 

playing field in services. 


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47 Partnering with 3G 

In a world of low interest rates, to juice up return, you need leverage. 

Debt has been anathema to Berkshire since its inception. So, the 

next best alternative in a 1%-interest-rate world is to do private 

equity with a partner that you are comfortable with. 3G Capital is 

that partner for Berkshire Hathaway and Jorge Paulo Lemann seems 

to be someone who Buffett is comfortable with. Getting into 

Berkshireʼs inner circle is a tough act, and that Buffett is taking the 

flak for 3Gʼs tough-love tactics is a reflection of the belief that he 

has in its capabilities. Look forward to more big elephant cohunting. 

48 Cash hoard 


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Buffett has been averse to leverage and loves cash because it 

comes handy when the best opportunities arise. That belief has only 

been strengthened over time, especially after the 2008 crisis, when 

there was great opportunity in the market and Buffett himself ended 

up buying early in the plunge. He considers cash a strategic 

advantage, and that was very evident in 2008. And even though 

Buffett may deliberately deemphasise macro fundamentals in his 

investment approach, his acute sense of timing has helped him 

make profitable decisions. Thatʼs probably the reason he is being 

judicious with his cash in the current times. 

49 Succession structure 

This has been the subject of endless speculation, and almost 

everybody associated with Berkshire was unusually tight-lipped this 

time around at the annual meeting. Buffett had earlier written, “Both 

the board and I believe we now have the right person to succeed me 

as CEO — a successor ready to assume the job the day after I die or 

step down. In certain important respects, this person will do a better 

job than I am doing.” Even Charlie Munger, who knows how much to 

speak and where, had everyone chattering after mentioning Greg 

Abel and Ajit Jain. The only hitch is that outside of Buffett and 

Munger, despite Berkshireʼs culture, very few seem assured that his 

successor will measure up. Given the tone of finality in the 2014 

letter, it is likely that a successor will be announced much sooner 

than is expected. 


26/08/18, 10C43 AM 

Page 33 of 35

50 Giving through Berkshire 

Over the years, Warren and Charlie have transferred planeloads of 

wisdom through their writing and annual meetings at Omaha and 

Los Angeles. They have not only been generous with their 

knowledge but also with their wealth. Like with most things, both 

Buffett and Munger are in sync here. “Those of us who have been 

very fortunate have a duty to give back. Whether one gives a lot as 

one goes along as I do, or a little and then a lot (when one dies) as 

Warren does, is a matter of personal preference,” says Munger. 

Buffett, on his part, has outsourced his giving to the Bill and Melinda 

Gates Foundation. He has been systematically giving Berkshire 

stock away and continues to nudge other billionaires to sign the 

Giving Pledge. The impact of this collective largesse will be felt after 

those who left it behind are long gone. 

You can read more about 50 Master Moves That Shaped Berkshire 

Hathaway by clicking on the link 

More from 50 Master Moves That Shaped Berkshire Hathaway 

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26/08/18, 10C43 AM 

Page 34 of 35

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26/08/18, 10C43 AM 

Page 35 of 35

A DECADE AFTER THE GLOBAL 

FINANCIAL CRISIS: WHAT HAS 

(AND HASN’T) CHANGED? 

BRIEFING NOTE 

SEPTEMBER 2018 

It all started with debt. 

In the early 2000s, US real estate seemed irresistible, and a heady run-up in 

prices led consumers, banks, and investors alike to load up on debt. Exotic 

financial instruments designed to diffuse the risks instead magnified and 

obscured them as they attracted investors from around the globe. Cracks 

appeared in 2007 when US home prices began to decline, eventually causing 

the collapse of two large hedge funds loaded up with subprime mortgage 

securities. Yet as the summer of 2008 waned, few imagined that Lehman 

Brothers was about to go under—let alone that it would set off a global liquidity 

crisis. The damage ultimately set off the first global recession since World War 

II and planted the seeds of a sovereign debt crisis in the eurozone. 1 Millions 

lost their jobs, their homes, and their savings. 

The road to recovery has been a long one since those white-knuckle days of 

September 2008. Historically, it has taken an average of eight years to recover 

from debt crises, a pattern that held true in this case. 2 The world economy 

has recently regained momentum, although the past decade of anemic and 

uneven growth speaks to the magnitude of the fallout. 

Central banks, regulators, and policy makers were forced to take extraordinary 

measures after the 2008 crisis. As a result, banks are more highly capitalized 

today, and less money is sloshing around the global financial system. But 

some familiar risks are creeping back, and new ones have emerged. In this 

article, we build on a decade of research on financial markets to look at how 

the landscape has changed. 3

GLOBAL DEBT CONTINUES TO GROW, FUELED BY 

NEW BORROWERS 

As the Great Recession receded, many expected to see a wave of 

deleveraging. But it never came. Confounding expectations, the combined 

global debt of governments, nonfinancial corporations, and households has 

grown by $72 trillion since the end of 2007 (Exhibit 1). The increase is smaller 

but still pronounced when measured relative to GDP. 

Underneath that headline number are important differences in who has 

borrowed and the sources and types of debt outstanding. Governments in 

advanced economies have borrowed heavily, as have nonfinancial companies 

around the world. China alone accounts for more than one-third of global 

debt growth since the crisis. Its total debt has increased by more than five 

times over the past decade to reach $29.6 trillion by mid-2017. Its debt 

has gone from 145 percent of GDP in 2007, in line with other developing 

countries, to 256 percent in 2017. This puts China’s debt on a par with that of 

advanced economies. 

Exhibit 1 

Global debt has continued to swell since the crisis but has remained stable relative to world GDP 

since 2014. 

Total debt outstanding 1 

$ trillion, constant H1 2017 exchange rate 

64 

Households 18 

Nonfinancial 

corporates 

Government 

Total debt 

to GDP 1 

% 

25 

21 

2000 

97 

31 

37 

29 

07 

105 

32 

41 

32 

08 

110 

33 

42 

36 

09 

117 

33 

43 

40 

10 

198 207 213 226 224 227 232 234 237 236 

1 Includes household, nonfinancial corporate, and government debt; excludes debt of the financial sector. Estimated bottom up using data 

for 43 countries from Bank for International Settlements (BIS) and data for eight countries from McKinsey’s Country Debt Database. 

NOTE: Figures may not sum to 100% because of rounding. 

139 

36 

52 

50 

13 

148 

38 

56 

54 

14 

157 

39 

61 

56 

15 

166 

42 

65 

59 

16 

169 

43 

66 

60 

H1 2017 

Change, 

2007–H1 2017 

Percentage 

points 

+11 

+29 

+31 

SOURCE: Bank for International Settlements (BIS); McKinsey Country Debt Database; McKinsey Global Institute analysis 

2 McKinsey Global Institute 

A decade after the global financial crisis: What has (and hasn’t) changed?

Growing government debt 

Public debt was mounting in many advanced economies even before 2008, 

and it swelled even further as the Great Recession caused a drop in tax 

revenues and a rise in social-welfare payments. Some countries, including 

China and the United States, enacted fiscal-stimulus packages, and some 

recapitalized their banks and critical industries. Consistent with history, a debt 

crisis that began in the private sector shifted to governments in the aftermath 

(Exhibit 2). From 2008 to mid-2017, global government debt more than 

doubled, reaching $60 trillion. 

Among Organisation for Economic Co-operation and Development countries, 

government debt now exceeds annual GDP in Japan, Greece, Italy, Portugal, 

Belgium, France, Spain, and the United Kingdom. Rumblings of potential 

sovereign defaults and anti-EU political movements have periodically strained 

the eurozone. High levels of government debt have set the stage for pitched 

battles over spending priorities well into the future. 

Exhibit 2 

Public debt increased rapidly after the crisis in advanced economies. 

Debt by sector in advanced economies 1 

% of GDP (Index: 100 = 2000) 

160 

150 

140 

130 

Pre-crisis 

Post-crisis 

Public 

Change in 

debt-to-GDP ratio 

Percentage points 

2000–07 

+2 

2007–H1 2017 

+35 

120 

110 

Private 2 

+20 

0 

100 

2000 2007 2009 2012 

2015 

2017 

1H 

Actual debtto-GDP 

ratio 

% 

Public 

Private 

69 

164 

105 

164 

1 Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Luxembourg, 

Netherlands, New Zealand, Norway, Portugal, Singapore, South Korea, Spain, Sweden, Switzerland, the United Kingdom, and 

the United States. 

2 Includes household and nonfinancial corporate sector debt. 

NOTE: Debt as percent of GDP is indexed to 100 in 2000; numbers here are not actual figures. 

SOURCE: BIS; McKinsey Country Debt Database; McKinsey Global Institute analysis 

McKinsey Global Institute 

A decade after the global financial crisis: What has (and hasn’t) changed? 

3

In emerging economies, growing sovereign debt reflects the sheer scale of 

the investment needed to industrialize and urbanize, although some countries 

are also funding large public administrations and inefficient state-owned 

enterprises. Even so, public debt across all emerging economies is more 

modest, at 46 percent of GDP on average compared with 105 percent in 

advanced economies. Yet there are pockets of concern. Countries including 

Argentina, Ghana, Indonesia, Pakistan, Turkey, and Ukraine have recently 

come under pressure as the combination of large debts in foreign currencies 

and weakening local currencies becomes harder to sustain. The International 

Monetary Fund assesses that about 40 percent of low-income countries 

in sub-Saharan Africa are already in debt distress or at high risk of slipping 

into it. 4 Sri Lanka recently ceded control of the port of Hambantota to China 

Harbour Engineering, a large state-owned enterprise, after after falling into 

arrears on the loan used to build it. 

Corporate borrowing in the era of ultra-low interest rates 

An extended period of historically low interest rates has enabled companies 

around the world to take on cheap debt. Global nonfinancial corporate debt, 

including bonds and loans, has more than doubled over the past decade to hit 

$66 trillion in mid-2017. This nearly matches the increase in government debt 

over the same period. 

In a departure from the past, two-thirds of the growth in corporate debt has 

come from developing countries. This poses a potential risk, particularly when 

that debt is in foreign currencies. Turkey’s corporate debt has doubled in the 

past ten years, with many loans denominated in US dollars. Chile and Vietnam 

have also seen large increases in corporate borrowing. 

China has been the biggest driver of this growth. From 2007 to 2017, Chinese 

companies added $15 trillion in debt. At 163 percent of GDP, China now has 

one of the highest corporate-debt ratios in the world. We have estimated 

that roughly a third of China’s corporate debt is related to the booming 

construction and real-estate sectors. 5 

Companies in advanced economies have borrowed more as well. Although 

these economies are rebalancing away from manufacturing and capitalintensive 

industries toward more asset-light sectors, such as health, 

education, technology, and media, their economic systems appear to run on 

ever-larger amounts of debt. 

In another shift, corporate lending from banks has been nearly flat since the 

crisis, while corporate bond issuance has soared (Exhibit 3). The diversification 

of corporate funding should improve financial stability, and it reflects 

deepening capital markets around the world. Nonbank lenders, including 

private-equity funds and hedge funds, have also become major sources of 

credit as banks have repaired their balance sheets. 



Exhibit 3 

Nonfinancial corporate bonds outstanding have increased 2.7 times over the past decade 

to $11.7 trillion. 

Global nonfinancial corporate bonds outstanding by region 1 

$ trillion, nominal exchange rate 

2007–17 

Global 

nonfinancial 

corporate 

bonds outstanding/GDP 

% 

11.7 

Other 

1.2 advanced 

economies 3 

1.2 Other 

2000 2003 2007 2010 2013 2017 2 

8.8 

1.1 2.0 

developing 

economies 4 

China 

0.9 

6.1 1.1 

Western 

2.6 

Europe 

0.7 

0.6 

4.3 0.4 2.1 

3.4 

1.6 

2.4 

1.1 

United 

0.9 

4.8 

States 

3.6 

0.6 

2.8 

2.3 

1.8 

1.3 

8 9 8 10 13 16 

Compound 

annual growth 

rate (CAGR) 

% 

+10.5 +7.4 

+7.9 

+0.6 

+14.0 

+39.9 

+8.6 

+7.8 

Change 

$ trillion 

+0.9 

+1.9 

+1.5 

+2.6 

1 Bond nationality is based on the location of the headquarters of the parent company of the company issuing bonds. 

2 Data as of December 4, 2017. 

3 Other advanced economies include Australia, Canada, Hong Kong, Japan, New Zealand, Singapore, South Korea, and Taiwan. 

4 Other developing economies include Argentina, Brazil, Chile, Colombia, Czech Republic, India, Indonesia, Israel, Kazakhstan, Malaysia, 

Mexico, Peru, the Philippines, Poland, Russia, South Africa, Thailand, and the United Arab Emirates. 


SOURCE: Dealogic; McKinsey Global Institute analysis 



5

HOUSEHOLDS HAVE REDUCED DEBT, BUT MANY ARE FAR FROM 

FINANCIALLY WELL 

Unsustainable household debt in advanced economies was at the core of the 

2008 financial crisis. It also made the subsequent recession deeper, since 

households were forced to reduce consumption to pay down debt. 

Mortgage debt 

Before the crisis, rapidly rising home prices, low interest rates, and lax 

underwriting standards encouraged millions of Americans to take out bigger 

mortgages than they could safely afford. From 2000 to 2007, US household 

debt relative to GDP rose by 28 percentage points. 

Housing bubbles were not confined to the United States. Several European 

countries experienced similar run-ups—and similar growth in household debt. 

In the United Kingdom, for instance, household debt rose by 30 percentage 

points from 2000 to reach 93 percent of GDP. Irish household debt climbed 

even higher. 

US home prices eventually plunged back to earth starting in 2007, leaving 

many homeowners with mortgages that exceeded the reduced value of 

their homes and could not be refinanced. Defaults rose to a peak of more 

than 11 percent of all mortgages in 2010. The US housing collapse was soon 

mirrored in the most overheated European markets. 

Having slogged through a painful period of repayment, foreclosures, and 

tighter standards for new lending, US households have reduced their debt 

by 19 percentage points of GDP over the past decade (Exhibit 4). But the 

homeownership rate has dropped from its 2007 high of 68 percent to 

64 percent in 2018—and while mortgage debt has remained relatively flat, 

student debt and auto loans are up sharply. 

Exhibit 4 

While households in the hard-hit countries have deleveraged, household debt has continued to grow 

in other advanced economies. 

Household debt to GDP 

% 

Change in household debt to GDP ratio, 2007–17 

Percentage points 

125 

100 

75 

50 

25 

United 

Kingdom 

United 

States 

Portugal 

Spain 

Germany 

Ireland 

-6 

-19 

-18 

-20 

-8 

-50 

125 

100 

75 

50 

25 

Australia 

Norway 

Canada 

South Korea 

Sweden 

Finland 

France 

Greece 

+14 

+28 

+22 

+23 

+23 

+16 

+12 

+6 

0 

2000 

2007 

2017 

0 

2000 

2007 

2017 

SOURCE: BIS; McKinsey Global Institute analysis 



Household debt is similarly down in the European countries at the core of 

the crisis. Irish households saw the most dramatic growth in debt but also 

the most dramatic decline as a share of GDP. The share of mortgages in 

arrears rose dramatically when home prices fell, but Ireland instituted a largescale 

mortgage-restructuring program for households that were unable to 

meet their payments, and net new lending to households was negative for 

many years after the crisis. Spain’s household debt has been lowered by 

21 percentage points of GDP from its peak in 2009—a drop achieved through 

repayments and sharp cuts in new lending. In the United Kingdom, household 

debt has drifted downward by just nine percentage points of GDP over the 

same period. 

In countries such as Australia, Canada, South Korea, and Switzerland, 

household debt is now substantially higher than it was prior to the crisis. 

Canada, which weathered the 2008 turmoil relatively well, has had a realestate 

bubble of its own in recent years. Home prices have risen sharply in its 

major cities, and adjustable mortgages expose home buyers to rising interest 

rates. Today, household debt as a share of GDP is higher in Canada than it 

was in the United States in 2007. 

Other types of household debt 

Looking beyond mortgage debt, broader measures of household financial 

wellness remain worrying. In the United States, 40 percent of adults 

surveyed by the Federal Reserve System said they would struggle to cover 

an unexpected expense of $400. 6 One-quarter of nonretired adults have no 

pension or retirement savings. Outstanding student loans now top $1.4 trillion, 

exceeding credit-card debt—and unlike nearly all other forms of debt, they 

cannot be discharged in bankruptcy. This cycle seems likely to continue, as 

workers increasingly need to upgrade their skills to remain relevant. Auto loans 

(including subprime auto loans) have also grown rapidly in the United States. 

Although overall household indebtedness is lower since the crisis, many 

households will be vulnerable in future downturns. 

BANKS ARE SAFER BUT LESS PROFITABLE 

After the crisis, policy makers and regulators worldwide took steps to 

strengthen banks against future shocks. The Tier 1 capital ratio has risen 

from less than 4 percent on average for US and European banks in 2007 to 

more than 15 percent in 2017. 7 The largest systemically important financial 

institutions must hold an additional capital buffer, and all banks now hold a 

minimum amount of liquid assets. 

Scaled-back risk and returns 

In the past decade, most of the largest global banks have reduced the scale 

and scope of their trading activities (including proprietary trading for their 

own accounts), thereby lessening exposure to risk. But many banks based in 

advanced economies have not found profitable new business models in an era 

of ultra-low interest rates and new regulatory regimes. 

Return on equity (ROE) for banks in advanced economies has fallen by 

more than half since the crisis (Exhibit 5). The pressure has been greatest 

for European banks. Their average ROE over the past five years stood at 

4.4 percent, compared with 7.9 percent for US banks. 



7

Exhibit 5 

Banks have posted weaker financial performance since the crisis. 

% 

Total developed country banks 

Total emerging economy banks 

Return on equity 

30 

25 

20 

15 

10 

5 

0 

2002 05 10 15 2017 

Price-to-book ratio 

4.0 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0 

2002 05 

10 15 2017 

NOTE: Analysis includes ~1,000 banks in 70 countries, each with total assets exceeding $2 billion. They account for ~75 percent of global 

bank assets. 

SOURCE: SNL; McKinsey Panorama; McKinsey Global Institute analysis 

Investors have a dim view of growth prospects, valuing banks at only slightly 

above the book value of their assets. Prior to the crisis, the price-to-book 

ratio of banks in advanced economies was at or just under 2.0, reflecting 

expectations of strong growth. But in every year since 2008, most advanced 

economy banks have had average price-to-book ratios of less than one 

(including 75 percent of EU banks, 62 percent of Japanese banks, and 

86 percent of UK banks). 

In some emerging economies, nonperforming loans are a drag on the banking 

system. In India, more than 9 percent of all loans are nonperforming. Turkey’s 

recent currency depreciation could cause defaults to climb. 

The best-performing banks in the post-crisis era are those that have 

dramatically cut operational costs even while building up risk-management 

and compliance staff. In general, US banks have made sharper cuts than 

those in Europe. But banking could become a commoditized, low-margin 

business unless the industry revitalizes revenue growth. From 2012 to 2017, 

the industry’s annual global revenue growth averaged only 2.4 percent, 

considerably down from 12.3 percent in the heady pre-crisis days. 



Digital disruptions 

Traditional banks, like incumbents in every other sector, are being challenged 

by new digital players. Platform companies such as Alibaba, Amazon, 

Facebook, and Tencent threaten to take some business lines, a story that 

is already playing out in mobile and digital payments. McKinsey’s Banking 

Practice projects that as interest rates recover and other tailwinds come 

into play, the banking industry’s ROE could reach 9.3 percent in 2025. But if 

retail and corporate customers switch their banking to digital companies at 

the same rate that people have adopted new technologies in the past, the 

industry’s ROE could fall even further. 8 

Yet technology is not just a threat to banks. It could also provide the 

productivity boost they need. Many institutions are already digitizing their 

back-office and consumer-facing operations for efficiency. But they can also 

hone their use of big data, analytics, and artificial intelligence in risk modeling 

and underwriting—potentially avoiding the kind of bets that turned sour during 

the 2008 crisis and raising profitability. 

THE GLOBAL FINANCIAL SYSTEM IS LESS INTERCONNECTED— 

AND LESS VULNERABLE TO CONTAGION 

One of the biggest changes in the financial landscape is sharply curtailed 

international activity. Simply put, with less money flowing across borders, the 

risk of a 2008-style crisis ricocheting around the world has been reduced. 

Since 2007, gross cross-border capital flows have fallen by half in absolute 

terms (Exhibit 6). 

Exhibit 6 

Global cross-border capital flows have declined 53 percent since the 2007 peak. 

Global cross-border capital flows 1 

$ trillion 

14 

12 

12.7 

10 

8 

6 

-53% 

5.9 

4 

2 

% of 

global 

GDP 

0 

1990 95 97 2000 03 07 10 14 

1990–2000 

5.3 

2000–10 

11.3 

2010–17 

7.1 

2017 

1 Gross capital inflows, including foreign direct investment (FDI), debt securities, equity, and lending and other investment. 

SOURCE: IMF Balance of Payments; McKinsey Global Institute analysis 



9

Global banks retrench 

Eurozone banks have led this retreat from international activity, becoming 

more local and less global. Their total foreign loans and other claims have 

dropped by $6.1 trillion, or 38 percent, since 2007 (Exhibit 7). Nearly half of the 

decline reflects reduced intra-eurozone borrowing (and especially interbank 

lending). Two-thirds of the assets of German banks, for instance, were outside 

of Germany in 2007, but that is now down to one-third. 

Exhibit 7 

European banks have reduced foreign claims. 

Foreign claims 1 

$ trillion, annual nominal exchange rates 

6.6 

1.2 

1.1 

1.7 

1.9 

0.8 

2000 

Other Western Europe 

United Kingdom 

Other Eurozone 

23.4 

3.6 

3.8 

7.8 

4.4 

3.7 

07 

-7.6 

15.8 

2.5 

3.5 

4.9 

2.2 

2.8 

2017 

Germany 

France 

Non- 

Eurozone 

-1.5 

Eurozone 

-6.1 

Decline in foreign claims of Eurozone banks, 

2007–17 

% 

100% = $6.1 trillion 

By type 

29 

By region 

17 

23 

8 

14 

62 

46 

Interbank 

cross-border 

claims 

Nonbank 

cross-border 

claims 

Local claims 

of foreign 

subsidiaries 

Intra- 

Eurozone 

To United 

Kingdom 

To United 

States 

Rest of 

world 

1 Foreign claims include cross-border claims and local claims of foreign affiliates. Claims include loans, deposits, securities, derivatives, 

guarantees, and credit commitments. 


SOURCE: BIS; McKinsey Global Institute analysis 



Swiss, UK, and some US banks have reduced their international business. 

Globally, banks have sold more than $2 trillion of assets since the crisis. The 

retrenchment of global banks reflects several factors: a reappraisal of country 

risk, the recognition that foreign business was often less profitable than 

domestic business, national policies promoting domestic lending, and new 

regulations on capital and liquidity. 

The world’s largest global banks have also curtailed correspondent 

relationships with local banks in other countries, particularly developing 

countries. These relationships enable banks to make cross-border payments 

and other transactions in countries where they do not have their own 

branch operations. These services have been essential for trade-financing 

flows and remittances and for giving developing countries access to key 

currencies. But global banks have been applying a stricter cost-benefit 

analysis to these relationships, largely due to a new assessment of risks and 

regulatory complexity. 

Some banks—notably those from Canada, China, and Japan—are expanding 

abroad but in different ways. Canadian banks have moved into the United 

States and other markets in the Americas, as their home market is saturated. 

Japanese banks have stepped up syndicated lending to US companies, 

although as minority investors, and are growing their presence in Southeast 

Asia. China’s banks have ramping up lending abroad. They now have more 

than $1 trillion in foreign assets, up from virtually nil a decade ago. Most of 

China’s lending is in support of outward foreign direct investment (FDI) by 

Chinese companies. 

Foreign direct investment is now a larger share of capital flows, a 

trend that promotes stability 

Global FDI has fallen from a peak of $3.2 trillion in 2007 to $1.6 trillion in 2017, 

but this drop is smaller than the decrease in cross-border lending. It partly 

reflects a decline in corporations using low-tax financial centers, but it also 

reflects a sharp pullback in cross-border investment in the eurozone. 

However, post-crisis FDI accounts for half of cross-border capital flows, up 

from the average of one-quarter before the crisis. Unlike short-term lending, 

FDI reflects companies pursuing long-term strategies to expand their 

businesses. It is, by far, the least volatile type of capital flow. 

Global imbalances between nations have declined 

Ben Bernanke pointed to the “global savings glut” generated by China and 

other countries with large current account surpluses as a factor driving interest 

rates lower and fueling the real-estate bubble. 9 Because much of this capital 

surplus was invested in US Treasuries and other government bonds, it put 

downward pressure on interest rates. This led to portfolio reallocation and, 

ultimately, a credit bubble. Today, this pressure has subsided—and with it, the 

risk that countries will be hit with crises if foreign capital suddenly pulls out. 



11

The most striking changes are the declines in China’s current account surplus 

and the US deficit. China’s surplus reached 9.9 percent of GDP at its peak in 

2007 but is now down to just 1.4 percent of GDP. The US deficit hit 5.9 percent 

of GDP at its peak in 2006 but had declined to 2.4 percent by 2017. Large 

deficits in Spain and the United Kingdom have similarly eased. 

Still, some imbalances remain. Germany has maintained a large surplus 

throughout the past decade, and some emerging markets (including Argentina 

and Turkey) have deficits that make them vulnerable. 

NEW RISKS BEAR WATCHING 

Many of the changes in the global financial system have been positive. Bettercapitalized 

banks are more resilient and less exposed to global financial 

contagion. Volatile short-term lending across borders has been cut sharply. 

The complex and opaque securitization products that led to the crisis have 

fallen out of favor. Yet some new risks have emerged. 

Corporate-debt dangers 

The growth of corporate debt in developing countries poses a risk, particularly 

as interest rates rise and when that debt is denominated in foreign currencies. 

If the local currency depreciates, companies might be caught in a vicious cycle 

that makes repaying or refinancing their debt difficult. At the time of this writing, 

a large decline in the Turkish lira is sending tremors through markets, leaving 

EU and other foreign banks exposed. 

As the corporate-bond market has grown, credit quality has declined. 

There has been notable growth in noninvestment-grade “junk” bonds. Even 

investment-grade quality has deteriorated. Of corporate bonds outstanding in 

the United States, 40 percent have BBB ratings, one notch above junk status. 

We calculate that one-quarter of corporate issuers in emerging markets are at 

risk of default today—and that share could rise to 40 percent if interest rates 

rise by 200 basis points. 

Over the next five years, a record amount of corporate bonds worldwide will 

come due, and annual refinancing needs will hit $1.6 trillion to $2.1 trillion. 

Given that interest rates are rising and some borrowers already have shaky 

finances, it is reasonable to expect more defaults in the years ahead. 

Another development worth watching carefully is the strong growth of 

collateralized loan obligations. A cousin of the collateralized debt obligations 

that were common prior to the crisis, these vehicles use loans to companies 

with low credit ratings as collateral. 

Real-estate bubbles and mortgage risk 

One of the lessons of 2008 is just how difficult it is to recognize a bubble while 

it is inflating. Since the crisis, real-estate prices have soared to new heights in 

sought-after property markets, from San Francisco to Shanghai to Sydney. 

Unlike in 2007, however, these run-ups tend to be localized, and crashes are 

less likely to cause global collateral damage. But sky-high urban housing 

prices are contributing to other issues, including shortages of affordable 

housing options, strains on household budgets, reduced mobility, and 

growing inequality of wealth. 



In the United States, another new form of risk comes from nonbank lenders. 

New research shows that these lenders accounted for more than half of 

new US mortgage originations in 2016. 10 While banks have tightened their 

underwriting standards, these lenders disproportionately serve lower-income 

borrowers with weaker credit scores—and their loans account for more 

than half of the mortgages securitized by Ginnie Mae and one-third of those 

securitized by Fannie Mae and Freddie Mac. 

China’s rapid growth in debt 

While China is currently managing its debt burden, there are three areas to 

watch. First, roughly half of the debt of households, nonfinancial corporations, 

and government is associated, either directly or indirectly, with real estate. 11 

Second, local government financing vehicles have borrowed heavily to fund 

low-return infrastructure and social-housing projects. In 2016, 42 percent 

of bonds issued by local governments were to pay old debts. This year, one 

of these local vehicles missed a loan payment, signaling that the central 

government might not bail out profligate local governments. Third, around 

a quarter of outstanding debt in China is provided by an opaque “shadow” 

banking system. 

The combination of an overextended property sector and the unsustainable 

finances of local governments could eventually combust. A wave of loan 

defaults could damage the regular banking system and create losses for 

investors and companies that have put money into shadow banking vehicles. 

Yet China’s government has the capacity to bail out the financial sector if 

default rates reach crisis levels—if it chooses to do so. Because China’s 

capital account has not been fully liberalized, spillovers to the global economy 

would likely be felt through a slowdown in China’s GDP growth rather than 

financial contagion. 

Additional risks 

The world is full of other unknowns. High-speed trading by algorithms can 

cause “flash crashes.” Over the past decade, investors have poured almost 

$3 trillion into passive exchange-traded products. But their outsized popularity 

might create volatility and make capital markets less efficient, as there are 

fewer investors examining the fundamentals of companies and industries. 

Cryptocurrencies are growing in popularity, reaching bubble-like conditions 

in the case of Bitcoin, and their implications for monetary policy and financial 

stability is unclear. And looming over everything are heightened geopolitical 

tensions, with potential flash points now spanning the globe and nationalist 

movements questioning institutions, long-standing relationships, and the 

concept of free trade. 



13

••• 

The good news is that most of the world’s pockets of debt are unlikely to pose 

systemic risk. If any one of these potential bubbles bursts, it would cause 

pain for a set of investors and lenders, but none seems poised to produce a 

2008-style meltdown. The likelihood of contagion has been greatly reduced by 

the fact that the market for complex securitizations, credit-default swaps, and 

the like has largely evaporated (although the growth of the collateralized-loanobligation 

market is an exception to this trend). 

But one thing we know from history is that the next crisis will not look like the 

latest one. If 2008 taught us anything, it is the importance of being vigilant 

when times are still good. 

This briefing note was authored by MGI partner Susan Lund; MGI chairman 

and director James Manyika; Asheet Mehta, a senior partner with McKinsey 

& Company’s financial services practice; and Diana Goldshtein, a McKinsey & 

Company knowledge specialist. 



Endnotes 

1 

Raghuram G. Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy, 

Princeton University Press, 2010. 

2 

Carmen M. Reinhardt and Kenneth S. Rogoff, “Recovery from financial crises: Evidence 

from 100 episodes,” American Economic Review: Papers & Proceedings 2014, Volume 104, 

Number 5. See also Reinhardt and Rogoff, Is this time different? Eight centuries of financial 

folly, 2009. 

3 

MGI’s body of research includes Debt and (not much) deleveraging, February 2015; The 

new dynamics of financial globalization, August 2017; and Rising corporate debt: Promise or 

peril? June 2018. 

4 

International Monetary Fund, Regional economic outlook: Sub-Saharan Africa, April 2018. 

5 

Debt and (not much) deleveraging, McKinsey Global Institute, February 2015. 

6 

Board of Governors of the Federal Reserve System, Report on the economic well-being of 

households in 2017, May 2018. 

7 

The Tier 1 capital ratio, a measure of financial health, is calculated by dividing a bank’s core 

capital by its risk-weighted assets. 

8 

McKinsey & Company Financial Services practice, Remaking the bank for an ecosystem 

world, October 2017. 

9 

“The global savings glue and the US current account deficit,” remarks by Ben S. Bernanke at 

the Sandridge Lecture, Virginia Association of Economists, March 10, 2005. 

10 

Liquidity risks in nonbank mortgages, Brookings Papers on Economic Activity, March 2018. 

11 

Debt and (not much) deleveraging, McKinsey Global Institute, February 2015. 

Further reading 

Bank for International Settlements, International capital flows and financial 

vulnerabilities in emerging market economies: Analysis and data gaps, August 

2016; and Economic resilience: A financial perspective, December 2016. 

International Monetary Fund, Global financial stability report: A bumpy road 

ahead, April 2018. 

Mian, Atif, and Amir Sufi, House of Debt: How They (and You) Caused 

the Great Recession, and How we Can Prevent it from Happening Again, 

University of Chicago Press, 2015. 

Rajan, Raghuram G., Fault Lines: How Hidden Fractures Still Threaten the 

World Economy, Princeton University Press, 2010. 

Reinhart, Carmen M. and Kenneth S. Rogoff, This Time is Different: Eight 

Centuries of Financial Folly, Princeton University Press, 2009. 

Turner, Adair, Between Debt and the Devil: Money, Credit, and Fixing Global 

Finance, Princeton University Press, 2016. 



15

McKinsey Global Institute | Copyright © McKinsey & Company 2018 

www.mckinsey.com/mgi @McKinsey_MGI McKinseyGlobalInstitute

GMO White Paper 

The Race of Our Lives Revisited 1 

Aug 2018 

Jeremy Grantham 

Introduction 1 

It was always going to be difficult for us – Homo sapiens – to deal with the long-term, slow-burning 

problems that threaten us today: climate change, population growth, increasing environmental 

toxicity, and the impact of all these three on the future ability to feed the 11 billion people projected 

for 2100. 

Our main disadvantage is that our species has developed over the last few hundred thousand years 

not to address this kind of long-term, slow-burning issue, but to stay alive and well-fed today and 

perhaps tomorrow. Beyond that we have a history of responding well only to more immediate and 

tangible threats like war. 

Ten thousand years ago, or even a hundred years ago, these problems were either mild or nonexistent. 

Today they are accelerating to a crisis. And at just this time, when of all times we could use 

a lucky break, our luck has deserted us. We face a form of capitalism that has hardened its focus to 

short-term profit maximization with little or no apparent interest in social good just as its power 

to influence government and its own fate has grown so strong that only the biggest most powerful 

corporations and the very richest individuals have any real say in government. To make matters 

worse, we have an anti-science administration that overtly takes the side of large corporations 

against public well-being, even if that means denying climate change and stripping the country of 

the very regulations designed to protect us. The timing could not be worse. It is likely we in the US 

will lose – indeed, we are losing already – the stable and reasonable society that we have enjoyed 

since The Great Depression. Beyond the US, the risks may be even greater, with the worst effects in 

Africa – threatening the failure of an entire continent. 

Our one material advantage is in the accelerating burst of green technologies, which has been better 

than anyone expected 10 or even 5 years ago and that may in the future be able to offset much 

of the accelerating damage from climate change and other problems. Yet despite these surprising 

technological advances, we have been losing ground for the last few decades, particularly in the last 

few years. Somehow or other we must find a way to do better. We must expand on our strengths in 

technology while fighting our predisposition toward wishful thinking, procrastination, and denial of 

1 

This paper uses much of the same material presented at this year’s Morningstar Investment Conference in Chicago 

in June and at London School of Economics in April 2018. Please make allowances for its conversational style. I have 

attempted to adapt and expand this version for the general public. And please remember you don’t have to read this 

in one sitting. The original “Race of Our Lives” is part of the GMO Quarterly Letter from April 26, 2013 and can be read 

at www.gmo.com. 

1

inconvenient long-term problems. We must also find inspirational leadership, for without it this race, 

possibly the most important struggle in the history of our species, may not be winnable. It is about our 

very existence as a viable civilization. We will need all the leadership, all the science and engineering, 

all the effort, and all the luck we can muster to win this race. It really is the race of our lives. 

Part I: Summary of the Argument 

I’m going to give you a broad overview of this topic first, then follow with considerable back-up data and 

supporting exhibits. 

You could call this the story of carbon dioxide and Homo sapiens. You may not know, but if we had 

no carbon dioxide at all, the temperature of the Earth would be minus 25ºC – a frozen ball with no 

life with the possible exception of bacteria. That crucial 200 to 300 parts per million of carbon dioxide 

has taken us from that frozen state to the pretty agreeable world we have today. CO2 is therefore, 

thank heavens, a remarkably effective greenhouse gas. The burning of fossil fuels, which is the main 

cause for increasing CO2 and warming the world, has played a very central role in the development 

of civilization. The Industrial Revolution was not really based on the steam engine – it was based on 

the coal that ran the steam engine. In a world without coal, we would have very quickly run through 

all our timber supplies, and we would have ended up with what I imagine as the great timber wars of 

the late 19 th century. The demand for wood would have quickly denuded all of the great forests of the 

world, and we would have returned to where we were at the time of Malthus, living at the edge of our 

capability, enduring recurrent waves of famine along with every other creature on the planet. A few 

good years, the population expands; a few bad years, we die off. 

A gallon of gasoline can do work equivalent to 400 hours of manual labor. This extraordinary advance 

meant that the ordinary middle class had the power that only kings had in the distant past. And what 

it did, this incredible gift of accumulated power from the sun over millions of years, was to create 

an enormous economic surplus that catapulted civilization forward in terms of culture and science. 

Above all, agriculture has benefited, allowing our population to surge forward. 

The sting in this tale, however, is that this has left us with 7.5 billion people today, going on a predicted 

11 or so billion by 2100. Such a large population can only be sustained by continued heavy, heavy 

use of energy. Fossil fuels will run out, destroy the planet, or do both. The only possible way to avoid 

this outcome is rapid and complete decarbonization of our economy. Needless to say, this will be 

an extremely difficult thing to pull off. It requires the best of our talents and innovation, which 

miraculously, it may be getting. It also needs much better than normal long-term planning and 

leadership, which it most decidedly is not getting yet. In theory, Homo sapiens can easily handle this 

problem; in practice, it will be a very closely run race. We should never underestimate technology but 

also never underestimate the ability of us humans to really mess it up. 

If the outcome depended on our good sense, if we had, for example, to decide in our long-term interest 

to take 5% or 10% of our GDP – the kind of amount that you would need in a medium-sized war – we 

would of course decide that the price was too high until it would be too late. It is hard for voters, and 

therefore politicians too, to give up rewards now to take away pain in the distant future, particularly 

when the pain is deliberately confused by distorted data. It is also hard for corporations to volunteer 

to reduce profits in order to be greener. Given today’s single-minded drive to maximize profits, it is 

nearly impossible. 

But technology, particularly the technology of decarbonization, has come surging in to help us. This 

is the central race. Technology, in my opinion, will in one sense win. If we were able to look ahead 

2 The Race of Our Lives Revisited 

Aug 2018

40 years, I’m confident that there would be a decent sufficiency of cheap green energy on the planet. 

In 80 years perhaps it’s likely we would have full decarbonization. Lack of green energy will not be 

the issue that brings us down. If only that were the end of the story. The truth is we’ve wasted 40 or 

50 years since the basic fact about manmade serious climate damage became known. We’re moving 

so slowly that by the time we’ve fully decarbonized our economy, the world will have heated up by 

2.5ºC to 3ºC, and a great deal of damage will have been done. A lot more will happen in the deeper 

future due to the inertia in the environmental system: if we no longer produce even a single carbon 

dioxide molecule, ice caps, for example, will melt over centuries and ocean levels will continue to 

rise by several feet. 

I don’t worry too much about Miami or Boston being under water – that’s just the kind of thing that 

capitalism tends to handle pretty well. The more serious problem posed by ocean level rise will be the 

loss of the great rice-producing deltas: the Nile, the Mekong, the Ganges, and others, which produce 

about a fifth of all the rice grown in the world. Agriculture is in fact the real underlying problem 

produced by climate change. Even without climate change, it would be somewhere between hard and 

impossible to feed 11.2 billion people, which is the median UN forecast for 2100. It will be especially 

difficult for Africa. 

With climate change, there are two separate effects on agriculture. One is immediate: the increased 

droughts, the increased floods, and the increased temperature reduce quite measurably the productivity 

of a year’s harvest. Then there’s the long-term, permanent effect: the most dependable outcome of 

increased temperature is increased water vapor in the atmosphere, currently up over 4% from the old 

normal. This has led to a substantial increase in heavy downpours. It is precisely the heavy downpours 

that cause soil erosion. In regular rain, even heavy rain, farmers lose very little soil. It is the one or 

two great downpours every few years that cause the trouble. We’re losing perhaps 1% of our collective 

global soil a year. 2 We are losing about a half a percent of our arable land a year. 3 Fortunately, it is the 

least productive half a percent. It is calculated that there are only 30 to 70 good harvest years left, 

depending on your location. 4 In 80 years, current agriculture will be simply infeasible for lack of good 

soil. We must change our system completely to make it sustainable, which, critically, involves reducing 

erosion to almost zero by using no-till or low-till farming combined with cover crops. Because these 

are significant changes for a conservative community, it will take decades and we’ve barely started. 

Happily, there are impressive advances in new technology in agriculture too. From intensive data 

management that tells us square meter by square meter exactly what is going on, where the nutrients 

are lacking and where more water is needed; to the isolation of every single micro-organism that 

relates to a plant. This race, too, is finely balanced. 

A separate thread also closely related to fossil fuels is that we’ve apparently created a toxic environment, 

not conducive to life, from insects to humans as we will see. We must respond by a massive and urgent 

move away from the use of complicated chemicals that saturate our daily life. 

A subtext to all of what I have to say here is that capitalism and mainstream economics simply cannot 

deal with these problems. Mainstream economics ignores natural capital. A true Hicksian 5 profit 

requires that the capital base be left completely intact and only the excess is a true profit. Of course, 

we have not left our natural capital base intact or anything like it. The replacement cost of the copper, 

2 

D.R. Montgomery, Dirt: The Erosion of Civilizations, University of California Press, 2007. 

3 

Pimentel and Burgess, “Soil Erosion Threatens Food Production,” Agriculture, August 2013. 

4 

2015 International Year of Soil Conference, UN Food and Agriculture Organization. 

5 

Sir John Richard Hicks is considered one of the most important and influential economists of the 20 th century. 


Aug 2018

phosphate, oil, and soil – and so on – that we use is not even considered. If it were, it’s likely that the 

last 10 or 20 years (for the developed world, anyway) has seen no true profit at all, no increase in 

income, but the reverse. 

Capitalism also has a severe problem with the very long term because of the tyranny of the discount 

rate. Anything that happens to a corporation over 25 years out doesn’t really matter to them. 6 

Therefore, in that logic, grandchildren have no value. Corporations also handle externalities very 

badly. Even the expression “handle badly” is flattering, for corporations typically don’t handle them 

at all, they’re just completely ignored. When they are not ignored it is usually because of direct or 

implied pressure from customers collectively. We deforest the land, we degrade our soils, we pollute 

and overuse our water, and we treat our air like an open sewer. All of this is off the balance sheet and off 

the income statement. Worse, any sensible response is deliberately slowed down by skillful programs 

of obfuscation, well-funded by fossil fuel interests and their allies. These deliberate obfuscators were 

known as the merchants of doubt when the problem was tobacco. (One of those merchants, MIT 

professor Richard Lindzen, actually went seamlessly from defending tobacco – where he famously 

puffed cigarettes through his TV interviews – to denying most of the problems of climate change.) 

This does not happen in China, India, Germany, or Argentina. This is unique to the English-speaking, 

oily countries – the US, the UK, and Australia – where the power of the fossil fuel interests is used to 

influence both politics and public opinion. 

I think I understand the capitalist argument. Milton Friedman, a patron saint of today’s brand of 

capitalism, famously said “There is only one social responsibility of business…to increase its profits 

(so long as it…engages in open and free competition without deception or fraud).” It makes for a 

simple enough world. But it is very different from the US I came to in 1964, which (except civil rights) 

was with hindsight perhaps at the sweet spot of the social contract. CEOs were content with 40 times 

the income of their average workers (as Japan still is) and not today’s 300 times. Corporations acted 

as if they really had obligations to the cities and states in which they operated. And, of course, to 

their country. This is true to a much smaller degree today. Corporations also acted as if they had real 

responsibility to their workers: to prove it they set about designing generous, i.e., expensive, wellmanaged 

defined benefit pension funds. Which they did not have to do. Today they claim, despite 

much higher profit margins, that they cannot afford them. The US as a whole also projected an idea 

of a global social contract – whenever the cold war would allow it – to promote the idea that ethical 

behavior had value (there were some miserable exceptions, but mostly it tried). It was always the US 

leading the way in promoting cooperative international trade, to enormous beneficial effect globally. 

Today both of these contracts appear to have been torn up and climate change is the epitome of 

what those who did the tearing up really hate: it occurs everywhere and very slowly. It is the ultimate 

Tragedy of the Commons: so it can only be dealt with by government leadership and regulation. 

All this is anathema to the new regime of maximizing an individual country’s advantage and shortterm 

corporate profits. Yet however much libertarians may hate regulation – and in general I am 

sympathetic – when it comes to climate change it is simple. There is no other way. 

As a footnote to the data provided, I will also examine the long and widely held view that any form of 

divestment is guaranteed to ruin performance. And together we will discover this view is completely 

inaccurate. 

6 

At a corporate discount rate of 15%, a common enough hurdle for new investments – today’s value of $1 earned 26 

years from now is two and a half cents. 


Aug 2018

Part II: Back-up Data 

Climate Change Damage Is Accelerating 

Exhibit 1 is the famous chart you might have seen used by Al Gore. It shows that for hundreds of 

thousands of years, the Earth’s atmosphere has had 180 to 300 parts per million of carbon dioxide. 

At 180 parts per million, we had ice ages (in the popular parlance) where, for example, 20,000 years 

ago New York was over a thousand feet deep in ice: enough to cover any building there today. At the 

previous highs of 280 parts per million, we had the interglacials, four of them, where our species 

benefited from the temperate and relatively stable environment we have enjoyed for the last few 

thousand years: a remission from cold that allowed for and facilitated the growth of civilization in the 

last 12,000 years. (Just for the record, 75% to 80% of the last 400 thousand years were spent in the “ice 

ages” and only 20% to 25% were in the warmer interglacials.) 

Exhibit 1: Historical CO2 Levels (Reconstruction from Ice Cores) 

In 1950, carbon dioxide levels were pretty much at the top of this historical range, and we were perhaps 

ready to slide into a new ice age in the next few thousand years. Then, bang, we added another 120 

parts per million in the blink of an eye! We have added the same amount that separates the bottom 

of glacial phases from interglacials, and we’ve added it in just 70 years. It is a dramatic and reckless 

experiment. The best word to describe it is feckless. We are going to add another 120 parts per million, 

I give you my personal guarantee. By the time we finish, we will have tripled the difference between an 

ice age and an interglacial. We must sincerely hope it is not worse than that. 

Exhibit 1: Historical CO2 Levels (Reconstruction from Ice Cores) 

Source: NOAA 

I’m proud to say I did Exhibit 2 about four and a half years ago because back then the scientists would 

not use the word “accelerate.” Scientists can be pretty chicken: not unreasonably given they are anxious 

to protect the dignity of science; they also desperately don’t want to be caught out exaggerating. With 

climate change they tend to underestimate and then are surprised by accelerating data. I sympathize 

with them – in science, overstatement is often dangerous – but in climate change work understatement 

on – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

can be very, very dangerous if it leads politicians to underreact in their policies. 


Aug 2018

Exhibit 2: Global Surface Temperature Compared to 1951-1980 Average 

Temperature Anomaly (°C) 

1.5 

1.0 

0.5 

0.0 

‐0.5 

+.007°C per year 

1958 



from peak to peak 

‐1.0 

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 

As of 8/31/16 

Source: NASA Goddard Institute for Space Studies, GMO 

ddard Institute for Space Studies 

18 

I have kept an informal check on the number of peer-reviewed articles where the conclusion is a change 

in the climate outlook – with much help from the “Carbon Brief ” and many others. My informal count 

is that about 80% conclude that, from the specialized work they have just done, the climate outlook 

is likely to be worse than consensus. The remaining 20% is either compatible with existing consensus 

or predicts a mitigating factor, a recent example of which would be that accelerating ice melting in 

Antarctica leads to an unexpectedly rapid rise in the bedrock from the reduced weight of the ice, 

which slows the rate of ice cap melting. But an 80-20 ratio in peer-reviewed science is pretty scary 

in itself. In stock market work – even economics – when a trend is systematically underestimated 

time after time models usually change to catch up. Climate science to date has been content to lag. 

What I must concede, though, is that since the US presidential election and the declaration of open 

war not just on climate science but science and research in general, the tone of climate research has 

toughened up considerably and become more realistic, and the term “acceleration,” almost overnight 

(and considerably overdue), has become commonplace. 

tion – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Still, the data in Exhibit 2 is clear. The trendline through the first 50 years of the last century is an increase 

of 0.007ºC per year. In the second half, the trend had doubled to 0.015ºC per year. Then between the 

two El Niños – climate events that cause a temporary surge in global heat – of 1998 and 2016 (like lining 

up the top of bull markets), the temperature increased at an average of 0.025ºC per year. 

Exhibit 3 shows what that looks like in color coded form from 1850 to 2017. Deep red goes up to 

+0.6ºC above long-term average and dark blue goes down to –0.6ºC below. This is an exceptionally 

clear way of showing data. Yes, there’s a little variability, but my, oh my, the dark red is all on the right. 


Aug 2018

Exhibit 3: Global Annual Temperatures, 1850-2017 – Color-Coded 

Source: Ed Hawkins, Climate Lab Book 

te Lab Book 

This exhibit reminds me of all the talk about pauses – the claim that 1998 was supposedly the top 

of the warming, which had then stopped, a favorite refrain of both deniers and “don’t worry-ers.” 

This argument was still remarkably in full force as late as 2013 and is repeated even now. Indeed, a 

famous British politician, former Chancellor of the Exchequer, Lord Lawson, said on BBC Radio 

4 this past April that the previous 10 years had not had any warming. He was not just wrong. The 

last 10 years were 10 of the hottest 11 years in history and contained the 3 hottest years ever. Please 

explain to me, if anyone knows, why these people say stuff like that. I have no idea. Perhaps they 

hate their grandchildren. 

Exhibit 4: Ocean Heat Content (in Joules) 

Exhibit 4 shows ocean temperature, which is accelerating even more than air temperature. The oceans 

absorb 93% of all the heat, with the rest spread between dry land and the air. 7 

for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

3 

Exhibit 4: Ocean Heat Content (in Joules) 

0‐2000 Meters 

1950 ‐ 1990 = 37 units/year 

1990 ‐ 2016 = 99 units/year 

GER 

GBR 

Source: “Improved Estimates of Ocean Heat Content from 1960 to 2015,” Cheng et al, Science Advances, March 10, 2017 

7 

D. Laffoley and J.M. Baxter (editors), “Explaining ocean warming: Causes, scale, effects and consequences,” IUCN, 

September 5, 2016. 


Aug 2018 

ed Estimates of Ocean Heat Content from 1960 to 2015,” Cheng et al, Science Advances, March 10, 2017.

Exhibit 5: Muir Glacier, 1941 and 2004 

The black line from the bottom left to the top right shows the heat energy of the ocean from the 

surface to 2,000 meters deep. From 1950 to 1990 it warmed at 37 heat units a year. From 1990 to 2016, 

the warming almost tripled to 99 units. Acceleration in something this dangerous should make the 

hair at the back of your neck prickle a bit. It does mine. 

Ice is melting even faster. Exhibit 5 is a view of a famous glacier valley in Alaska at the same time of 

year in each picture. It has just vaporized in 63 years. 

Exhibit 5: Muir Glacier, August 1941 1941 and 2004 

August 2004 

Exhibit 6: Annual 3”+ Rainfall Days in the US 

Source: USGS 

The most dependable effect of climate change, as I mentioned, is downpours. Exhibit 6 shows the 

annual number of three inches per day downpours in the US. 

Exhibit 6: Annual 3”+ Rainfall Days in the US 

not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

5 

Source: Climate Central 


Aug 2018

Last year in Houston, Hurricane Harvey dumped 10 inches of rain in a day, followed by 10 inches, 

followed by 10 inches. If you try to put a probability on that it just does not compute. Perhaps a 1-in- 

1,000-year event, perhaps almost impossible. It turns out that within the prior 18 months, Houston 

had already had a 1-in-200-year event. Within 18 months before that, a 50- to a 100-year event. In a 

terrible update from Japan just this month (July), almost 200 lives were lost and 2 million were asked 

to evacuate because of a downpour that was so far off the scale that it made Harvey look like a drizzle: 

23 inches of rain in 1 single day. 

Exhibit 7: Extreme Weather Events on the Rise 

Exhibit 7 is a quick survey of this kind of damage: the number of floods is up by 15 times from 1950, the 

deaths from droughts up by 10 times, wildfires by 7 times, and extreme temperature events by 20 times. 

Exhibit 7: Extreme Weather Events on the Rise 

Floods 

Drought Mortality 

No. of Floods 

3000 

2500 

2000 

1500 

1000 

500 

0 

x15 

1950‐1966 1967‐1983 1984‐2000 2001‐2017 

No. of Deaths in Droughts 

25000 

20000 

15000 

10000 

5000 

0 

x10 

1996‐2005 2006‐2015 

Wildfires 

Extreme Temperature Events 

400 

500 

No. of Wildfires 

300 

200 

100 

0 

x7 

1950‐1983 1984‐2017 

No. of Extreme 

Temperature Events 

400 

300 

200 

100 

0 

x20 

1950‐1972 1973‐1995 1996‐2017 

Source: EM-DAT database 

T database 

es_6-18 

Part III: Decarbonizing the Economy 

The good news is that greener technologies are also accelerating. This puts me in a very interesting 

position. I deal with green technologists and they have no idea how bad the situation is for the 

environment. Then I deal with environmentalists, who I must say are a gloomy lot, and they have no 

idea how rapidly the science is advancing in this area. Exhibit 8 is a bit dry, but it is absolutely vital. 

This is from the boss of one of the three largest utility companies in America, not one of our greens. 

This is a guy from the dark side, you might say, who is just telling it like it is. 

mation – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 


Aug 2018

Exhibit 8: From the Horse’s Mouth 

“Without incentives, wind is going to be a $0.02 or $0.03 product early in the next 

decade. Battery storage will be $0.01 on top of that. And when you look at (...) coal and 

nuclear, today, operating costs are around $0.03. New wind and new solar, without 

incentives and combined with storage, are going to be cheaper than the operating cost 

of coal and nuclear in the next decade. That is going to totally transform this industry. 

— James Robo, 06/22/2017 

CEO of NextEra Energy 

NextEra Energy controls Florida Power & Light, as well as the world’s largest trading unit for wind and 

solar. So he really should know what he’s talking about. And he says that without incentives, wind will 

be $0.02 to $0.03 per kilowatt-hour early in the next decade. Including a few hours of battery storage 

to carry that power into the evening surge will add another penny. What that means is that wind and 

solar are going to be cheaper than the operating costs of coal and nuclear, even the best coal and the 

best nuclear. 

Exhibit 9: Xcel Energy 2023 Solicitation –Median Levelized Cost per 

MWh 

Once again: you can receive a gift of a nuclear plant and just the cost of operating it is higher than the 

cost of building and operating a modern solar plant or a modern wind farm. This economic contest 

is therefore a done deal. Six months after that comment from Mr. Robo, Xcel Energy in Colorado 

wanted to close a couple of coal plants early and asked for bids for renewable energy. They were 

swamped by an amazing 850 bids. The median bid, the one in the middle, below which half were 

cheaper, was 2.1 cents per kilowatt-hour for wind including storage. The median bids they received 

for solar and wind power are shown in Exhibit 9. 

ation – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Exhibit 9: Xcel Energy 2023 Solicitation – Median Levelized Cost per MWh 

70 

Coal LCOE 

60 

50 

$/MWh 

40 

30 

20 

10 

New coal plants ‐ operating cost only* 

0 

Solar 

Wind 

With Storage Without 

Source: Xcel Energy, Lazard, EIA 

*Operating cost for new coal plants includes 30% CCS to comply with EIA New Source Performance Standards 

In June, we were all shocked when the Florida Power & Light boss said it would be 2 to 3 cents plus a 

penny for storage. Six months later, it was 2.1 cents including storage. These bids had median storage 

costs at only 0.3 cents / kilowatt-hour for wind, and 0.7 for solar, compared to the 1 cent from Mr. 

Robo’s estimate. Even solar, which was unexpectedly dearer than wind, came in at 3.7 cents with 

storage, which is similar to the operating costs of a new coal plant and well below the levelized cost, 

including capital, of a coal plant. 

Lazard, EIA 

new coal plants includes 30% CCS, to comply with EIA New Source Performance Standards 

n – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 


Aug 2018

Exhibit 10 shows the rate at which wind and solar prices have declined since 2009. Look at that – 

solar, from $400/MWh, screaming down to $55 in 2016 and soon to $25 or $30. The median coal 

plant has been completely outflanked. No one had this even as a gleam in their eye 10 years ago. 

Exhibit 10: Unsubsidized Levelized Cost of Renewable Energy over Time 

$400 

$/MWh (Log Scale) 

$100 

$50 

Utility Scale Solar 

Onshore Wind 

Coal 

2009 2010 2011 2012 2013 2014 2015 2016 

As of 12/31/16 

Exhibit 11: Giant Wind Turbines Illustrate the Speed of Change 

Source: Lazard 

An important word about wind. A two-megawatt wind tower is about the biggest wind tower you 

will have bumped into in your daily life. If you’re cycling through Holland, you will typically see twomegawatt 

wind towers. That’s the size of the Statue of Liberty. In Exhibit 11 I refer to that two-megawatt 

Newest version 

wind tower as a toy. The real monster is coming: since this exhibit was drawn up, GE actually offered 

for delivery in 2022 a 12-megawatt wind tower. 

Exhibit 11: Giant Wind Turbines Illustrate the Speed of Change 

ion – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

MONSTER 

TOY 

324 meters 

260 m 

195 m 

155 m 

111 m 

93 m 90 m 

Eiffel Tower 12MW 

Paris turbine 

2022 (est) 

MHI Vestas 

8MW turbine 

off Liverpool 

2016 

7MW 

turbine 

Planned 

St Paul’s 

Cathedral 

London 

Statue of 

Liberty 

New York 

2MW 

turbine 

Several locations 

2000 

Source: Reuters, GMO 


Aug 2018

Let me tell you about their 12-megawatt wind tower. It will stand 260 meters, or 284 yards, high. A 

single blade will measure 107 meters long. On its upswing, the blade would be nearly as high as the 

Eiffel Tower, where my wife and I had lunch last fall. It is almost impossible to imagine looking across at 

a wind tower from high up the Eiffel Tower. Let me tell you something else about windmills. The power 

generated goes up by the swept area, which means Pi R squared. When you take a 10-foot blade and 

make it 20, you do not get twice as much power, you get 4 times as much. As you go up near the top of 

the Eiffel Tower, you pick up more wind. Actually, it’s a rather disappointing fraction, but you pick up 

about 20% more wind. But this is the key: the wind factor is cubed. A hurricane with wind speeds of 

140 miles per hour does not have a modestly more damaging effect than one at 120. You cube 14 versus 

cubing 12. It is 60% more powerful. And that is why everyone dreads the 140-miles-per-hour hurricane. 

xhibit 12: Lithium‐ion Battery Pack Prices and Annual Decline 

It is the same here – that 20% higher wind speed at the top of the Eiffel Tower will generate 60% more 

power (less a few percent from mechanical inefficiencies), and the increased length of the blades will 

be squared. When 20- and 25-megawatt wind towers with new lightweight materials are built in the 

North Sea and the North Atlantic, possibly in the next 20 or 30 years, they may well generate the 

cheapest electricity on the planet. (Solar in deserts would likely be an honorable second.) 

The disappointing factor for green energy enthusiasts has always been battery costs. Indeed, batteries 

had been falling in cost for the 20 years prior to 2010 at less than half the rate of progress in solar. 8 

But just as the idea of that disappointment had become a cliché, Exhibit 12 happened. 

Exhibit 12: Lithium-ion Battery Pack Prices and Annual Decline 

‐20% ‐20% ‐7% ‐10% ‐35% ‐22% ‐23% ‐21% ‐52% to ‐76% 

Price ($/kWh) 

1000 

900 

800 

700 

600 

500 

400 

300 

200 

100 

0 

1000 

800 

642 599 

540 

350 

273 

209 165 

2010 2011 2012 2013 2014 2015 2016 2017 2018E … 2025E 

80 

40 

Source: Bloomberg New Energy Finance, GMO 

Low end of 2025 estimate range, at $40/kWh, assumes adoption of next-generation solid-state battery technology. 

In 2010, Tesla was looking at $1,000 per kilowatt-hour for battery storage. This year, the insiders say 

it’s down to nearly $150; we will use $165. It has dropped 85% in 8 years, faster than solar panels, wind, 

or anything else. Quite remarkable. This, though, is not the end of the game. When we’re building 

30 million electric cars globally, engineering and sheer scale will very likely cut the $165 in half to 

$80-odd by 2025 for current lithium ion batteries. When the next generation of solid-state battery 

technology is introduced, it will likely halve again. 

ergy Finance, GMO 

range, at $40/kWh, assumes adoption of next‐generation solid‐state battery technology. 

8 

for distribution. For Institutional N. Kittner, Use Only. F. Lill, Copyright and D.M. © 2018 Kamen, by GMO “Energy LLC. All storage rights reserved. deployment and innovation for the clean energy transition,” Nature 

Energy, July 2017. 


Aug 2018

I’m very pleased to say the Grantham Foundation is investing in a solid-state lithium-ion cell, which 

was delivered for testing to a major European car factory two months ago. It is half the weight, half 

the volume, half the materials, and, at scale, potentially half the price. It does not burst into flame, and 

it charges in five minutes. If we don’t get there first, there is a hotshot group at Tufts and another at 

MIT (go Boston, by the way) who are closing in, claiming similar properties for their new batteries. 

In addition, Mr. Dyson of hand dryer and vacuum cleaner fame, is also making progress – or at least 

investing heavily – on this in the UK. Solid-state will happen. It is only a question of whether we save 

a year or two in development time. Solid-state batteries will make electric cars much cheaper to build 

than gasoline-driven ones, and they are today already much cheaper to run and maintain with only 

15% of the moving parts of an internal combustion vehicle. Rapid charging will also largely remove 

range anxiety, with electric charging being similar to filling up at a gas station. 

Exhibit 13: World Annual Primary Energy Consumption by Source, 

1900‐2050 

So, you take all this optimism, all this progress in green technology, and where does it get us? 

Regrettably, it only gets us to Exhibit 13. 

Exhibit 13: World Annual Primary Energy Consumption by Source, 1900-2050 

TWh/year 

180000 

160000 

140000 

120000 

100000 

80000 

60000 

40000 

20000 

0 

1900 1920 1940 1960 1980 2000 2020 2040 

Coal 

Oil 

Gas 

Biomass 

Nuclear 

Renewables 

As of 9/30/17 

Source: OurWorldinData.org, Vaclav Smil, GMO 

Data from 2015-2050 is estimated or forecast. 

orldinData.org, Vaclav Smil, GMO 

15‐2050 is estimated or forecast. 

Lives_6-18 

The bad news is that although the renewables in green are surging, by 2050 over 50% of energy 

consumption is projected to still be driven by fossil fuels. What that means is even if fossil fuels were 

to peak in a couple of years, and I believe they certainly will peak by 2030 or 2035, the carbon dioxide 

in the atmosphere will continue to rise and rise. Climate change will not have been stopped. It will 

barely be slowing down, as shown in Exhibit 14. Bear in mind that the year with the single largest 

increase in CO2 levels was last year! 

rmation – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 


Aug 2018

Exhibit 14: Annual Energy Supplied by Fossil Fuels, and Cumulative CO2 Emissions 

Annual Energy Supplied 

by Fossil Fuels, TWh/year 

140000 

120000 

100000 

80000 

60000 

40000 

20000 

3500 

3000 

2500 

2000 

1500 

1000 

500 

Cumulative Anthropogenic 

CO2 Emissions, Gigatonnes 

0 

1900 1920 1940 1960 1980 2000 2020 2040 

Exhibit 15: Atmospheric CO2 and Temperature Increase since Pre‐ 

Industrial Era 

As of 9/30/17 

Annual Energy Supplied by Fossil Fuels, TWh/year (left axis) 

Source: OurWorldinData.org, Vaclav Smil, Carbon Dioxide Information Analysis Centre, GMO 

Data from 2015-2050 is estimated Cumulative or forecast. Anthropogenic CO2 Emissions, GT (right axis) 

0 

es_6-18 

This guarantees that we have no hope of limiting the world’s temperature increase to 1.5ºC. In all 

probability we will reach our 2ºC target by 2050, and we will be fighting tooth and nail – with any luck, 

with carbon taxes and an improved attitude – to keep it below 3ºC by 2100. We really will need luck, in 

technology and above all in political leadership: the need to stand up to the influence of the fossil fuel 

industry and manage the widely held dislike of the necessary regulations. The outlook for the world 

temperature to 2050, even in this optimistic scenario with accelerating progress in renewable energy 

and green technology, is shown in Exhibit 15. 

rldinData.org, Vaclav Smil, Carbon Dioxide Information Analysis Centre, GMO 

5‐2050 is estimated or forecast. 

mation – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Exhibit 15: Atmospheric CO2 and Temperature Increase since Pre-Industrial Era 

Atmospheric CO2Concentration, ppm 

480 

460 

440 

420 

400 

380 

360 

340 

320 

300 

280 

0.0 

1959 1969 1979 1989 1999 2009 2019 2029 2039 2049 

As of 9/30/17 

Source: National Oceanic and Atmospheric Administration, GMO 


2°C 2.0 

1.8 

Atmospheric CO2 Concentration, ppm (left axis) 

Global Temperature Increase Since Pre‐Industrial Era, °C (right axis) 

1.6 

1.4 

1.2 

1.0 

0.8 

0.6 

0.4 

0.2 

Global Temperature Increase Since 

Pre‐Industrial Era, °C 

ceanic and Atmospheric Administration, GMO 

50 is estimated or forecast. 



Aug 2018

Exhibit 16: Annual Global Renewable Energy Capex 

The necessary investment in decarbonizing the economy will be epic and is already well over $300 

billion a year. That’s the amount of money the world is spending annually to build out renewable 

energy. To put that in very relevant perspective, $300 billion is less than the amount of losses in the 

United States alone from weather and climate disasters in the single year of 2017: Hurricane Harvey, 

Hurricane Maria, wildfires, and so on, all exacerbated by climate change. Exhibit 16 shows forecast 

annual global renewable energy capex out to 2050. We will need, by 2050, $2 trillion per year in today’s 

money, to put in the transmission lines, the power plants, the storage facilities, the reengineered 

steel and cement factories, and everything else that is needed to completely decarbonize our society. 

Decarbonizing the economy is arguably the most important industrial change since the wholesale 

introduction of oil in the early 20 th century. 

Exhibit 16: Annual Global Renewable Energy Capex 

2500 

2000 

2.1 

Trillion 

Billions of 2015 USD 

1500 

1000 

500 

300 

Billion 

0 

2015 2020 2025 2030 2035 2040 2045 2050 

As of 9/30/17 

Source: DNV GL 


2050 is estimated or forecast. 

6-18 

Part IV: Climate Change and Feeding the 11.2 Billion 

So far we have at least had a balance between good technological surprises and the disheartening 

acceleration of climate damage. It is time now for the terrible news. Sorry about this. I tell you, it’s 

hard to live with for me, too. The issue is food sufficiency. Population growth and increasing wealth 

are driving up food demand, while climate change, soil erosion, and many other factors are impacting 

food supply. Exhibit 17 shows what the world population looks like since 1500. For the first few 

hundred years, it was stable. When Malthus wrote, it was only one billion. When I was born, it was up 

to about 2.3 billion. Today, just in my lifetime, the global population has tripled. (Whenever you see 

an exponential chart like this in investing, you know what to do: go short.) 

ation – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 


Aug 2018

Exhibit 17: World Population and Projections to 2100 

18,000,000,000 

16,000,000,000 

14,000,000,000 

12,000,000,000 

10,000,000,000 

8,000,000,000 

6,000,000,000 

4,000,000,000 

2,000,000,000 

0 

1500 1575 1650 1725 1800 1875 1950 2025 2100 

As of 1/25/18 

Source: UN World Population Prospects 

Actual 

Mid Projection 

1798: Malthus publishes 

Essay on the Principle of 

Population 

Low Projection 

High Projection 

1938: I was born 

Exhibit 18: Fertility Rates in the “Western World” 

1500 

X 

Y 

8 

World Population Prospects 

The good news that Malthus never dreamt about, our last best hope really, is declining fertility. 

In developed countries we’re all below replacement level, shown by the black dotted line across 

Exhibit 18. The irony here is it’s probably because we’ve discovered how incredibly expensive and 

inconvenient children are. This is my scientific reason. There are other more serious reasons, which 

we’ll get to, including waiting longer to have children and a side effect of toxicity. 

Exhibit 18: Fertility Rates in the “Western World” 

formation – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

ur Lives_6-18 

4.5 

Fertility Rate, Children / Woman 

4.0 

3.5 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

1960 1970 1980 1990 2000 2010 

France 

United States 

United Kingdom 

Canada 

Germany 

Italy 

As of 12/31/17 

Source: World Bank 

Fertility rates are dropping fast for many poorer countries too, as seen in Exhibit 19. Iran is my hero. 

It used to have seven children for each woman in 1960, and now it’s down to 1.6. My other hero is 

Bangladesh, dirt-poor then and now – unlike Iran, this country has no oil. It also had seven children, 

but today that number has dropped to 2.2. 

– not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 


Aug 2018

Exhibit 19: Fertility Rates Decline in Emerging Countries 

8.0 

Fertility Rate, Children / Woman 

7.0 

6.0 

5.0 

4.0 

3.0 

2.0 

1.0 

0.0 

1960 1970 1980 1990 2000 2010 

Egypt 

Morocco 

India 

Bangladesh 

Malaysia 

Iran 

As of 12/31/17 

Source: World Bank 

k 

It really is amazing. And all they’ve done is had a persistent program with some education and a little 

bit of training for the women involved. These women go out into the rural villages over and over again, 

and try very hard. It really can be done with limited resources and persistence. 

Exhibit 20: World Population to 2100 – Medium UN Estimate 

Exhibit 20 shows the real problem with population. In a word, Africa, where such persistent policies 

are sadly lacking. In most of Africa fertility rates are declining, but not rapidly, nor are they forecast to 

decline rapidly. Indeed, in several countries rapid population growth seems to be encouraged either 

overtly or by inference – the obvious lack of governmental interest in reducing it. The exhibit shows 

the midrange world population forecasts from the UN. The rest of the world, in dark blue, goes from 

6.2 billion today up to 7.2 in 2050 and then peaks out and drops back to 6.7 by 2100. The rest of the 

world is not the problem. Given a couple of hundred more years, that 6.7 may fall back down to 2. A 

fertility rate of 1.6, which is above Japan today, would take the whole rest of the world back to 2 billion 

in a few generations (six or seven generations would do it, about 200 years). 


Exhibit 20: World Population to 2100 – Medium UN Estimate 

2015 Population: 7.4 Billion 



Rest of 

World 

6.2 Bn 

Other 

Africa 

1.0 Bn Nigeria 

0.2 Bn 

Rest of 

World 

7.2 Bn 

Other 

Africa 

2.1 Bn 

Nigeria 

0.4 Bn 

Other 

Africa 

3.7 Bn 

Rest of 

World 

6.7 Bn 

Nigeria 

0.8 Bn 

Other Africa Nigeria Rest of World 

As of 9/30/17 

Source: UN World Population Prospects 


Aug 2018 

d Population Prospects

The problem, as you can see clearly, is Africa. Nigeria, the biggest country in Africa by population, is a 

perfect case. When I was born, there were 28 million Nigerians. Today, there are about 190 million: the 

precise number is not known. The midrange forecast for 2100 is 780 million! In recent surveys Nigerians 

say that seven children is the desired family size, so they are disappointed by their actual six. 9 Only 15% 

use contraception and 54% consider it immoral. 10 In a recent poll, 74% of Nigerians said they would 

love to emigrate if they could, and 38% said they actually plan to try to emigrate in the next 5 years, 

mostly to the US or Europe. 11 38% of 780 million – that’s 300 million who would love to go to the US 

and Europe, particularly the UK, which today can feed just half of its current 66 million people – the 

rest of its food is imported. (The only worse country is Japan, which feeds one-third. Everyone says 

how economically ludicrous it is for Japan to accept a declining population, but come serious, global 

food troubles, and they will come, the only way for Japan to even approach internal food sufficiency is 

to have a much smaller population.) Nigeria is just an example; the rest of Africa is forecast to nearly 

quadruple its population, or try to, to 3.7 billion people by 2100. When the UN makes these forecasts, 

we tend to assume they are on top of agricultural issues, but based on their conclusions I strongly doubt 

it. Another major problem is the sensitivity of the population issue. Not nearly enough time and thought 

and money is spent on population growth because it’s so politically sensitive. 

Exhibit 21: Grain Productivity and Population Growth: 

No Safety Margin! 

To get to the heart of the food problem, grain productivity, shown in Exhibit 21, is now barely keeping 

up with population. There is no safety margin. In the Green Revolution it was growing at 3.5% per year, 

and now on average since 1995 it’s come down to about 1.2%, with the world’s population growth also 

at 1.2%. A dead heat. We are producing as much grain as we produce people. There is simply no room 

for them to eat meat that takes 8 or 10 times the grain per calorie as eating bread directly. And yet, they 

intend to. This is going to be a very uncomfortable situation for the poor people who can’t afford to 

buy grain. (The population curve is, unsurprisingly, much less volatile than grain productivity, which 

is still influenced by the natural vagaries of annual weather. After three years of terrible grain-growing 

weather, we have had four excellent years through last season.) 

Exhibit 21: Grain Productivity and Population Growth: No Safety Margin! 

3.5% 

3.0% 

2.5% 

2.0% 

10‐Year Average 

Growth in Crop Yields* 

1.5% 

1.0% 

10‐Year Average 

Growth in Population 

0.5% 

0.0% 

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 

As of 12/31/17 

Source: Food and Agriculture Organization of the United Nations, GMO 

*For world’s three major staple crops: wheat, rice, and corn 

9 

National Demographic and Health Survey, Nigeria National Population Commission and ICF International, 2014; World Bank. 

10 

Pew Research Center, Spring 2013 Global Attitudes Survey. 

11 

Pew Research Center, Spring 2017 Global Attitudes Survey. 

Agriculture Organization of the United Nations, GMO 

e major staple crops: wheat, rice, and corn. 

tion – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

8 


Aug 2018

Part of this grain productivity problem is the inconvenient fact that as we progress in productivity 

we increasingly face diminishing returns. Every species has its limits. Humans will never be 12 feet 

tall. Let me point out they’ve been breeding race horses for thousands of years – the chief of the tribe 

always wanted to have the fastest horse – and they’re still breeding them today. Yet Secretariat still has 

the record for one and a half miles on dirt. Horses haven’t gotten materially faster for 45 years and 

they were barely getting faster for years before that. You can’t get blood out of a stone. You can get the 

horses to break more legs, but you can’t get them to run much faster because they are already close 

to their limit. Now grain, too, has diminishing returns. When looking for diminishing returns, go 

to the best grain producers on the planet per acre. (Not the US. The US is the best per person, say, a 

62-year-old farmer and his son and 6,000 acres.) If you want the best per acre, you go to rice in Japan 

and wheat in Germany, France, and the UK, as shown in Exhibit 22. Their grain yields were growing 

brilliantly forever – until the last 20 years, when their progress became very slow and erratic. It is what 

you expect. And in the US, the USDA’s data on multi-factor productivity shows little or no gain from 

corn in the last 12 years. 

Exhibit 22: 5‐Year Moving Average of Crop Yields in Leading Countrie 

Exhibit 22: 5-Year Moving Average of Crop Yields in Leading Countries 

100000 

70000 

Wheat Yields, Hg/Ha 

80000 

60000 

65000 

60000 

55000 

40000 

France (Wheat ‐– Left left axis) Axis) 

50000 

20000 

Germany (Wheat ‐ left axis) 

United Kingdom (Wheat ‐ left axis) 45000 

Japan (Rice ‐ right axis) 

0 

40000 

1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 

Rice Yields, Hg/Ha 

As of 12/31/17 

Source: Food and Agriculture Organization of the United Nations 

One of the reasons for this is that increased fertilizer use, the backbone of the Green Revolution, is also 

peaking out. You can use more in poor parts of the world, but the US and China, the two biggest users, 

already officially use too much – so much, it begins to be counter-productive as well as damaging to 

the health of waterways from excessive run-off of phosphorus and nitrogen. 

Exhibit 23 summarizes all of this, showing the growth in agricultural productivity in the US all the 

way back to 1930. Back then we were chugging along at a nice 1.5% a year. In the Green Revolution 

of the 50s and 60s, we accelerated for 20 years to 3.5% a year. Quite remarkable – every 3 years there 

was a 10% increase in the amount of crops grown on the same land. After that, not surprisingly, 

productivity growth dropped back then started to drop to new modern lows. Our 2010-2030 estimate, 

based on talking to scientists, is that productivity per acre would still continue to grow, other things 

being even, but at a slowly diminishing rate as we approach limits. 

griculture Organization of the United Nations 



Aug 2018

Exhibit 23: Diminishing Returns for Grain Productivity 

Average Annual Agricultural Productivity Growth in the United States, by 20‐year block 

Average of yield growth for corn, wheat, and rice 

Average Annual Yield Growth 

4.0% 

3.5% 

3.0% 

2.5% 

2.0% 

1.5% 

1.0% 

0.5% 

Green Revolution 

‐1.7% 

‐0.5% 

‐0.25% 

4: Gully Erosion 

0.0% 

As of 1/31/18 

Source: USDA NASS 

*GMO projection excluding future effects of erosion and climate change 

It turns out, however, that in the future of grain growing, other things will not be even. We face 

two increasing problems that seem likely to push productivity backwards: soil erosion and climate 

change. As we dug into these two problems, we quickly discovered a third: the giant seams that can 

run between different branches of science. Starting with erosion, we spoke to several soil scientists 

who specialized in erosion who were not aware that future climate change would materially affect 

erosion even though, as previously mentioned, the single most dependable feature of climate change 

is an increase in the very heavy downpours that do almost all the erosion damage – with 5- to 10-foot 

gullies sometimes appearing overnight in the great storms in Iowa and Kansas. Exhibit 24 shows the 

damage that more routine heavy rains can cause. 

S 

xcluding future effects of erosion and climate change. 

1930‐1950 

on – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Exhibit 24: Gully Erosion 

1950‐1970 

1970‐1990 

1990‐2010 

2010‐2030* 

Source: Katharina Helming, CC BY-SA 1.0, https://commons.wikimedia.org/w/index.php?curid=42387941 


Aug 2018

Exhibit 25: Effect of Erosion on Grain Production 

Exhibit 25 shows the effect of erosion on grain production going forward, according to the latest 

science. And what we did here is make a very, very modest assumption that the 10% damage to 

productivity that the erosion experts calculated we would get over the next few decades would increase 

to 13% because of the increase in heavy downpours. (We estimated this ourselves because, at least as 

far as we could find, no one else was doing it.) 

Exhibit 25: Effect of Erosion on Grain Production 

US Grain Yields, Historical and Projected 

Index averaging corn, wheat, soy, and rice yields, 2017 = 1 

1.6 

1.4 

1.2 

‐13% 

1.0 

0.8 

0.6 

0.4 

0.2 

0.0 

1970 1980 1990 2000 2010 2020 2030 2040 

Historic Data 

Projection only of historic productivity advances 

As of 4/30/18 

Source: USDA NASS; “Soil Erosion, Climate Change and Global Food Security: Challenges and Strategies,” Rhodes, 

Science Progress, 2014, GMO 

*GMO estimate 

Exhibit 26 is one of my horror show graphics actually. Pictured is an installation describing the topsoil 

of a particular farming county in Iowa. In 1850, this county had 14 inches of wonderful Midwestern 

topsoil. Ideally, you need only 4 inches and 3 will get you by. Fourteen inches is a luxury beyond belief 

for the rest of the world. But by 1900, it was 11.5”; by 1950, 9.5”; by 1975, 7”; by 2000, 5.5”. 


Projection including effect of soil erosion (Rhodes 2014) 

Projection including effect of increased flooding on soil erosion* 

Soil Erosion, Climate Change and Global Food Security: Challenges and Strategies,” Rhodes, Science Progress, 2014; GMO 


Aug 2018

Exhibit 26: Soil Depth in Iowa Has Halved Since Intensive Cultivation Began 

14.0” 

11.5” 

9.5” 

7.0” 

5.5” 

1850 1900 1950 1975 2000 

Source: Iowa Public Radio, “The Greatest Story Never Told,” installation in Adair County, Iowa, by David B. 

Dahlquist and RDG Planning & Design 

At considerable difficulty, we found the experts on soil 

in Iowa responsible for the data in this exhibit. We called 

them and asked what the number was for 2017. And they 

said, “Yes, erosion is recognized now as a major problem. 

People are trying much harder; the rate of erosion has 

come down by a lot, by nearly half.” But now, it’s 4.8”. Just 

think about that: 14” down to 4.8”. Our safety margin 

has gone from 11 inches to 1 or 2 inches. Yet there are 

still no signs of panic that reach the public or, apparently, 

the politicians. That may not scare you, but it certainly 

scares me. 

reatest Story Never Told,” installation in Adair County, Iowa, by David B. Dahlquist and RDG Planning & Design. 

ribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Now, we get to another disheartening finding from the last 

12 months. This is a report from the journal Proceedings 

of the National Academy of Sciences. When you get bad 

news, you don’t want it to come from one of the most 

prestigious scientific journals. This was a study done by a 

Although all the soil used for agriculture 

in the US is privately owned, it is in a 

real sense – an existential sense – a 

commons like the air and water, for 

without it none of us survive. We 

soil owners are all completely free to 

destroy our common good. Or as two 

former US Presidents put it: 

“While the farmer holds the title to 

the land, actually it belongs to all the 

people because civilization itself rests 

upon the soil.” - Thomas Jefferson 

“The nation that destroys its soil 

destroys itself.” - F.D. Roosevelt 

large team of a dozen or so top scientists, as usual for important studies these days, led by Dr. Liang. 

As I understand it, they studied what effect actual downpours, droughts, and increasing temperatures 

had on agricultural productivity in America over the last 50 years and they calculated the effect by 

each specific grain in each specific area. They put all that data into their model so that they captured 

the increasing incidence of floods and droughts from climate change. They then extrapolated the 

midrange of climate models into the future, building in the expected increases in heavy floods and 

severe droughts out to 2040, where the temperature increases also begin to really hurt (having had 

little effect up to now, with some areas gaining and some losing from temperature). They concluded 

26 


Aug 2018

that by 2040, if nothing else changed, the impact of climate change would be to take grain productivity 

all the way back to where it was in 1980, which is Exhibit 27. If this is true, it is incredibly bad news. 

This is the kind of data where your best hope is that the scientists have made a major error. 

Exhibit 27: Effect of Climate Change on Grain Production 



1.6 

1.4 

1.2 

1.0 

0.8 

0.6 

0.4 

0.2 

0.0 

1970 1980 1990 2000 2010 2020 2030 2040 

Historic Data 


Projection including effect of climate change (Liang et al 2017) 

As of 4/30/18 

Source: USDA NASS; “Determining Climate Effects on US Total Agricultural Productivity”, Liang et al, Proceedings 

of the National Academy of Sciences, GMO 

‐47% 

When we called Dr. Liang to ask him some questions, he seemed unaware that erosion had any 

important impact on the future of agriculture. It does seem to be a problem: climate scientists like him 

in one box and erosion scientists, with mud on their boots, in another, with very little communication 

or attempt to coordinate. It is a problem for most specialists – and one we can sympathize with – that 

to be on top of their fields they have to have a very tight focus. So the scary thing is that our crude 

attempt to put all these factors together is the first that you, dear reader, have ever seen! 

Determining Climate Effects on US Total Agricultural Productivity”, Liang et al, Proceedings of the National Academy of Sciences; GMO 

not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Exhibit 28 is, therefore, distinctly homemade. The lines show the various projections including all 

these factors one-by-one. At the top is the simple extrapolation of the historic productivity gains. 

The next line down shows what happens when you build in the diminishing marginal returns that we 

have seen in Japan, Germany, France, and the UK. Next is the effect of erosion, and the effect of more 

erosion from increased downpours. Then there’s the coup de grace from the climate change study. 


Aug 2018

Exhibit 28: Combined Effect of Climate Change and Soil Erosion 



1.6 

1.4 

1.2 

1.0 

0.8 

0.6 

0.4 

0.2 

‐38% 

‐56% 

0.0 

1970 1980 1990 2000 2010 2020 2030 2040 

As of 4/30/18 

Source: USDA NASS, Rhodes 2014, Liang et al 2017, GMO 

Rhodes 2014, Liang et al 2017, GMO 

We decided to give a one-third credit for 

adaptation to climate change: that farmers 

will be clever; they will change the crops 

they grow; they will work on building in 

more drought resistance or flood resistance. 

(By the way, you have to pick. You can’t do 

both drought and flood resistance at the 

same time.) Even with adaptation, grain 

productivity will fall a lot. Maybe in real life 

farmers will excel and deliver a two-thirds 

credit for adaptation. What we really need 

here is improved policy, very productive 

research, and an unusual willingness to 

change. But unfortunately, even with 

substantial adaptation, productivity will 

still be way down from the historic trend 

and very likely even down from where we 

are today. 

n – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

We also have bug and pathogen immunities 

to consider. Do you know we lose as much 

of our crop to weeds, bugs, and pathogens 

Historic Data 


Projection including diminishing marginal returns 

Projection including impact of soil erosion 

Projection including erosion after increased flooding 

Projection including effect of climate change 

Projection including 1/3 adaptation to climate change 

GMOs and Super Weeds 

As a semi technical aside, during the last few million 

years a few plants have stumbled by mutation into much 

more efficient ways of processing water, sun, and CO2 

and produce up to twice the mass of vegetation. They 

are called C4 and comprise a lowly 3% of all plants but 

account for around 25% of plant biomass thanks to 

their efficiency. In agriculture C4 plants include corn 

and sugar cane that compared to lowly wheat, barley, 

rice, and other C3 grains, are monsters of productivity. 

Well the good news is that one day we may torture the 

C3 grains into having more of the C4 characteristics to 

positive output effect. It is a difficult job that has been 

likened in complexity to nuclear fusion. The bad news 

is that 14 of the 18 most troublesome weeds are now C4 

(from 3% in nature to over three-quarters in modern 

US farming!). The whole point of genetically modified 

organism research – or 90% of the point – is to produce 

seeds that can withstand much-increased doses of specific 

pesticides, most commonly glyphosate. And which weeds 

do you think are going to better withstand this chemical 

onslaught, C3 or C4? We have in fact designed a system 

to produce C4 super weeds that now compete with our 

lowly C3 crops like wheat and rice. Whoops! 


Aug 2018

today, as a percentage, as we did in 1945 before we declared chemical war on these organisms? 12 

If we pull back from the chemicals now, the bugs and weeds, which have turned into super bugs 

and super weeds, will eat our lunch, breakfast, and dinner. Had we never done it, we would be 

losing approximately the same amount as we are now, but saving impressive amounts of money – 

approximately as much as for feed or fertilizer. 

xhibit 29: Global Distribution of Phosphate Reserves 

Before we finish on farming, I’d like to touch on the global distribution of phosphate reserves. We 

cannot grow any living thing without potassium (potash) and phosphorus (phosphate). We mine 

these elements, which are very, very finite. We dig these essential fertilizers out and we scatter them 

in excess around our farms because they are cheap (where the heavy rains often carry them off and 

pollute the streams and rivers and the Gulf). Exhibit 29 is the problem: 75% of all the high-grade 

phosphorus reserves in the world are in Morocco and Western Sahara (which Morocco controls). 

Exhibit 29: Global Distribution of Phosphate Reserves 

Annual Production and Reserves (millions of metric tons) 

Production (2010) 

Reserves 

Morocco and Western Sahara 26.0 50,000 

World 176.0 65,000 

As of 12/31/10 

Source: USGS 

This share of reserves makes OPEC and Saudi Arabia look like absolute pikers, and phosphate is much 

more important even than oil. Phosphorus, the key ingredient in phosphate, is an element and cannot 

be made or substituted for. If ISIS takes over Morocco, I give you my second personal guarantee that 

within a week the military of China or the US or both will have intervened. We simply cannot manage 

for long under currently configured agriculture without Morocco’s reserves – perhaps 35 to 40 years. 

This section began with the premise that food sufficiency will prove to be our civilization’s greatest 

future challenge. If the UN population forecast presented in Exhibit 17 actually happens – even if we 

stay on that flight path for another decade or two – we will be looking at a failing continent, in my 

opinion, with some of the damage caused by the need to maintain political correctness. The process 

may well have started already. Five countries, in my view, have failed already in Africa, five more or 

so are possibly in the process of failing. Food problems there will put incredible pressure on Europe 

through immigration, and the scale will be far too great for Europe to handle well. I wrote five years 

ago that the first casualty of this African (and near Eastern) problem would be the liberal traditions 

of Europe. Well, it happened a whole lot faster than I feared! Just an accumulated couple of million 

refugees are already providing political propaganda that is empowering right-wing groups everywhere 

in Europe. Imagine if Europe were to try and take 100 million, and 100 million isn’t even a down 

payment on the billion and a half or so that will want to emigrate if the population keeps growing like 

this. Europe will need to get its act together and form a joint policy that is as gentle and as firm and as 

reasonable as it can possibly be. It simply will not be able to take and absorb nearly as many food and 

climate refugees as would be required to solve the problem. (I am not speaking as someone with fascist 

tendencies – on income equality for example, I am left of the Scandinavian countries. Sometimes the 

truth is politically very incorrect indeed.) 

r distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

29 

12 

M. Yudelman, A. Ratta, and D. Nygaard, “Pest Management and Food Production: Looking to the Future,” International 

Food Policy Research Institute, 1998. 


Aug 2018

We have a growing population who want to eat meat, diminishing agricultural returns, and worldwide 

erosion taking 1% a year of the global soil and half a percent of our arable land. Then there is urban 

expansion, which is nearly always in fertile river plains, taking the best arable land and concreting it 

over – calculated to be about two and a half million acres a year. 13 Plus, there are water availability 

problems from hell that I could spend half an hour on, or an expert could spend a week on. Reservoirs 

in South Africa, in Morocco, in Spain, in Nevada, are all shrinking, all suffering from the increased 

heat. We’re depleting our aquifers: in heavily irrigated areas such as Las Vegas or the Central Valley of 

California, well water levels have fallen by hundreds of feet. In China, parts of Beijing are sinking by 

four inches a year – that’s how fast they’re pumping out the water. 14 Over half a billion people globally 

totally depend on underground, very finite aquifers for their water and food. 

For all these many reasons, agriculture is the key to our future success or failure. It is also where 

climate change has its most consequential effects. But, sadly, it is not the only problem: 

Part V: Toxicity, Biodiversity, and the Deficiency of Capitalism 

Now, we come to the next piece of very bad news: the 75% loss of flying insects. This was from a report 

done by German insect fanatics, amateurs who love insects. 15 They went out every year to a different 

selection from 63 forest preserves. They put out the same nets in the same places at the same time of 

year. They took all the bugs that they caught, and they laid them out and they counted them. Germans 

are unbeatable at this type of thing! And to everyone’s shock and horror, over 27 years there has been 

more than a 75% decline in the total quantity of flying insects. These are our pollinators. They have 

just gone missing. Why isn’t this a dramatic item in our news? One-third of all the food plants that we 

eat need pollination, every flower needs a pollinator. What we’ve done is created a toxic world, which 

is apparently not conducive to life as we know it. 

This toxicity together with climate change and population pressure form an unprecedented threat to 

biodiversity. We are, as you probably know by now, in the sixth great extinction. The first five were 

caused by meteorites and by great shifts in the climate caused by the sun. This sixth one is caused by 

us, the people. And we, too, are part of the biodiversity that is threatened: the last piece of very bad 

news science has for us (at least in this paper) is that in the developed world there’s been over a 50% 

loss of sperm count. This is from a recent meta-study 16 of almost 200 individual sperm count studies 

from different parts of the world: it’s hard to imagine how they could get the data that badly wrong. 

Although I hope they have. One Danish study said that healthy young men in Copenhagen today 

have lower sperm quality than men visiting infertility clinics 70 years ago! 17 In China, coming from 

way behind us, they have a 25% loss in the last 15 years. 18 And no one is concerned! Will we worry at 

75%? How about 87%? This very well may be contributing already to the declining fertility rate of the 

Western world, along with delayed marriage. (So, oddly, we may face the problem of low fertility in 

the long term in the developed world while we face the problem of too-high a fertility rate in Africa.) 

13 

Bren d’Amour et al., “Future urban land expansion and implications for global croplands,” Proceedings of the National 

Academy of Sciences, August 2017. 

14 

M. Chen et al, “Imaging Land Subsidence Induced by Groundwater Extraction in Beijing (China) Using Satellite Radar 

Interferometry,” Remote Sensing, 2016, 8(6) 468. 

15 

C. Hallmann et al., “More than 75 percent decline over 27 years in total flying insect biomass in protected areas,” PLOS 

One, October 2017. 

16 

H. Levine et al., “Temporal trends in sperm count: a systematic review and meta-regression analysis,” Human 

Reproduction Update, November 2017. 

17 

N. Jørgensen et al., “Human semen quality in the new millennium: a prospective cross-sectional population-based 

study of 4867 men,” BMJ Open, Volume 2, Issue 4, 2012. 

18 

C. Huang et al., “Decline in semen quality among 30,636 young Chinese men from 2001 to 2015,” Fertility and Sterility, 

January 2017. 


Aug 2018

I think toxicity and the chemicals causing it will turn out to be a hotter button than climate change. 

Climate change is regrettably a bit like the story of boiling the frog in the pot. (Speaking of which, 

frogs are going extinct too – scientists say the total amphibian population is falling 4% every year. 19 ) 

Toxicity, sperm counts, insects going missing, and birds and frogs going with them is something that 

I think can excite people to action. Europe has turned unexpectedly serious, for example, on the risks 

of plastics in the last year, banning some single-use plastics. The EU has also banned three incredibly 

important neonicotinoids that are alleged to kill bees. And very probably do, along with all other 

flying insects that come near them. This is the problem though: in the EU, if regulators have some 

doubt, a company must prove its chemical is clean. But in the US, if there’s doubt, how could anyone 

interfere with the capital rights of a chemical company to its chemicals? We will take the side, at least 

for the next few years, of the chemical companies because there is a lot of doubt. This is a complicated 

soup we are dealing with – it is hard to impossible to positively prove which chemical is contributing 

precisely what damage. Have we in the US, inadvertently or otherwise, adopted an ultra-corporatefriendly 

standard that will produce so toxic an environment before we act that the consequences – 

totally avoidable on paper – will be extreme? 

Exhibit 30: Prevalence of Autoimmune Disorders in Western World 

(1940‐2012) 

In any case in the US, the chemical companies will get the benefit of the doubt – not our sperm count, 

or flying insects, or life in general. At least until we are more obviously on the ropes. An interesting 

choice to make. 

Exhibits 30 and 31 show some of the apparent effects of toxicity. Healthwise in the West, things 

are going so well in many areas, but autoimmune diseases are just exploding. They have to do with 

chemicals – endocrine disruptors – in all probability, especially exposure to them during pregnancy. 

There’s the same rise with certain cancers, for which there is no other obvious explanation. 

Exhibit 30: Prevalence of Autoimmune Disorders in Western World (1940-2012) 

Incidence Rate 

12 

10 

8 

6 

4 

Type 1 Diabetes 

per 100,000 

(RHS) 

Celiac Disease 

per 1,000 

Asthma 

per 100 

2 

Multiple Sclerosis 

Autism 

per 100,000 

per 1,000 

0 

1940 1950 1960 1970 1980 1990 2000 2010 

25 

20 

15 

10 

5 

0 

Incidence Rate 

Source: Boström et al 2012, Rubio-Tapia et al 2009, Autism Speaks, National Center for Health Statistics, Gale 2002 

19 

M.J. Adams et al., “Trends in Amphibian Occupancy in the United States,” PLOS One, May 2013. 

l 2012, Rubio‐Tapia et al 2009, Autism Speaks, National Center for Health Statistics, Gale 2002 



Aug 2018

Exhibit 31: Age-Standardized Incidence Rate of Cancers in Scandinavia* 

Age‐Standardized Incidence per 100,000 

18 

16 

14 

12 

10 

8 

6 

4 

2 

Breast (RHS) 

Melanoma (LHS) 

Testis (LHS) 

0 

0 

1953 1962 1971 1980 1989 1998 2007 

As of December 2007 

Source: World Health Organization International Agency for Research on Cancer 

*Average of Denmark, Finland, and Norway. (Countries chosen for having longest available data.) 

90 

80 

70 

60 

50 

40 

30 

20 

10 

Age‐Standardized Incidence per 100,000 

There’s a cheerful professor at Harvard, Dr. Steven Pinker, who’s come out with a couple of books 

saying how wonderful things are. On the data he uses, he’s absolutely accurate. Yes, we do live longer. 

Yes, we have fewer wars, fewer murders, and fewer this and fewer that. But what it doesn’t account 

for is sustainability and toxicity: that we’re using up our resources and threatening our biosphere. It’s 

a bit like the guy who falls off the top of the Empire State Building, and as he passes each floor on the 

way down he is heard to say, “So far, so good.” “14 inches of soil, life expectancy increases, so far so 

good.” “12 inches of soil, 8 inches, 4 inches, so far so good.” “80% of our sperm count, 50%, so far so 

good.” “80% of our flying insects, 50%, 25%, so far so good.” We’re simply not accounting for the real 

underlying damage. Without that accounting, things can indeed be construed as looking pretty good. 

It’s seductive. Right up to the edge of the cliff most of the numbers look better and better and just a few 

look worse and worse. But how super critical those few worse numbers are. 

Organization International Agency for Research on Cancer 

k, Finland, and Norway. (Countries chosen for having longest available data.) 


The greatest deficiency of capitalism is its complete inability to deal with any of these things that we are 

talking about even though it can handle the millions of more mundane factors that go into producing 

a workable economy, far better than planned economies. Let me tell you my story once again of the 

devil and the farmer. The devil goes to a Midwestern farmer and he says, “OK, if you sign this contract 

and give me your soul, I will triple your profits, your meager profits that have always been a struggle 

for you. And I will do it for 100 years for you and your descendants.” The farmer is desperate, so he 

signs. The profits are tripled and all is well. 

Now footnote 21 of the contract – there are always footnotes with the devil – says the farmer will lose 

1% of his soil every year. Because that’s what farmers are all losing anyway, big deal. So he signs, and 100 

years later there’s no soil at all left for his great-great-grandchildren. He has given up soil as well as his 

soul. Exhibit 32 shows what happened. The expected value of the deal with the devil was $5.5 million. 

The no-deal farmer up the road who stuck it out the hard way had a present value of only $2 million. 


Aug 2018

Profits per year under deal and no deal 

Exhibit 32: The Devil’s Deal: Your Soil and Your Soul! 

350,000 

Annual Profits 

300,000 

250,000 

200,000 

150,000 

100,000 

50,000 

0 

Source: GMO 

"Deal" present value (5% discount rate): 

$5,583,000! 

"No deal" present value (5% discount rate): 

$2,000,000 

0 20 40 60 80 100 

Year 

As I’ve noted before, at least when the starving crowds arrive from Chicago, the farmer dies rich. As 

currently configured, every MBA ever produced would sign that contract, or fail the course. That is 

capitalism. Ask Milton Friedman once again. A corporation’s responsibility is to maximize profits, not 

to waste money attempting to guess how to save our soil. There’s simply no machinery in today’s world, 

which has gone all Milton Friedman on us, to get this job done: to reach a sustainable agriculture 

system, and a stable temperature that we can live with – ideally close to the one we have enjoyed for 

the last few thousand years. 


Part VI: Investing and the Environment 

Exhibit 33 is our portfolio at GMO of climate change opportunities, which has been around for a year. 

What we’re trying to do is understand, a little ahead of the market, these powerful and complicated 

new crosswinds as we decarbonize. I hope we are helped in this task by the deliberate propaganda 

that has been aimed at downplaying the current speed and long-term importance of climate change. 

Unsurprisingly, the portfolio has lots of clean energy stocks, copper (which is 5 times more heavily 

used by electric cars than conventional cars), masses of energy efficiency opportunities, and around 

20% in agriculture. I can say that I have a very high-confidence belief that these industries collectively 

will have higher top-line revenue growth than the balance of the economy. 


Aug 2018

Exhibit 33: Illustrative Climate Change Portfolio (Global Equities) 

Exhibit 33: Illustrative Climate Change Portfolio (Global Equities) 

Segment 

Exposure 

Clean Energy 39.4% 

Solar 9.7% 

Wind 8.5% 

Other Clean Energy 1.3% 

Clean Power Generation 6.1% 

Batteries & Storage 14.0% 

Smart Grid 6.2% 

Copper 8.4% 

Energy Efficiency 16.8% 

Transportation 6.6% 

Buildings 0.4% 

Diversified Efficiency 6.0% 

Technology 1.9% 

Lighting 1.4% 

Recycling 0.5% 

Agriculture 19.1% 

Farming 3.8% 

Farm Machinery 1.6% 

Timber 0.7% 

Eco‐Chemicals/Seeds 1.5% 

Fertilizer 5.5% 

Fish Farming 5.9% 

Water 4.4% 

Cash 5.6% 

Source: GMO 

Part VII: The Alleged Perils of Divestment 


It should be pretty clear from this discussion that if you’re messing around with oil stocks, you’re taking 

the serious risk of ending up with stranded assets, and if you’re messing with chemical companies 

of the toxic kind, you are taking some risks also. Oil companies are being sued everywhere because 

they’ve been caught red-handed. They were writing for peer-reviewed journals in the late 1970s, 

proving that carbon dioxide was dangerous and that the ocean levels would rise. They took advantage 

of their knowledge: they took it into account to drill in the Arctic and to site their refineries. And 

they have misrepresented the damage they knew their products would cause. They are vulnerable 

and face many legal battles as we speak. Yet investment committees, the most conservative groups on 

the planet as we know – I have spoken to perhaps 3,000 or so of them – maintain that if they divest 

from oil it will ruin their performance. And that in any case, ethics, à la Friedman, should not come 

into it. If they accept any constraint at all, they feel, it will ruin their performance. I’m sympathetic 

up to a point: you don’t want everyone with a bee in his bonnet to come marching in. But this issue – 

climate change – is the mother and father of all exceptions. It is about our survival. Exhibit 34 shows 

what we did to test this long-held divestment hypothesis. We took out each of the 10 major groups 

in the market for 30 years, leaving only 9 of the 10 groups in each portfolio, and what we found was 


Aug 2018

Exhibit 34: You Can Divest from Oil – or Anything Else – Without 

Consequence 

that it didn’t make any difference. The entire range from best to worst was only 50 basis points. The 

return you get without Energy is highlighted – you make 3 bps more without Energy. Look at the 

graph. Taken together, other than IT in the 2000 bubble, they look like a single series. Even the 2000 

deviation settled back as if the bubble had never occurred. 

Exhibit 34: You Can Divest from Oil – or Anything Else – Without Consequence 

Annualized Absolute Returns (Nominal Terms): 1989‐2017 – Range: 50 bps 

12% 

8% 

4% 

0% 

9.44% 9.54% 9.56% 9.66% 9.71% 9.74% 9.75% 9.77% 9.84% 9.90% 9.94% 

Ex Health 

Care 

Ex Consumer 

Staples 

Ex IT Ex Industrials S&P 500 Ex Energy Ex Consumer Ex Utilities 

Discretionary 

Ex Materials Ex Telecom Ex Financials 

Absolute Returns 

(Nominal Terms, Logarithmic Scale) 

3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 

‐0.5 

Sep‐90 Mar‐95 Sep‐99 Mar‐04 Sep‐08 Mar‐13 Sep‐17 

As of 9/30/17 

Source: S&P, GMO 

Ex Cons. Discr. 

Ex Cons. Staples 

Ex Energy 

Ex Financials 

Ex Health 

Ex Industrials 

Ex IT 

Ex Materials 

Ex Telecom 

Ex Utilities 

S&P 500 

9/30/17 

ce: S&P, GMO 

ngstar_Race of our Lives_6-18 

After I first showed this exhibit I had a suspicion that we had picked a lucky time period. My conscience 

nagged me for a while. So, we went back in history, first to 1957, and then with some considerable 

effort all the way back to 1925, as shown in Exhibit 35. Look at 1925: the range between missing the 

best group and the worst has soared from plus or minus 50 basis points to plus or minus 56 basis 

points. When you divest from oil or chemicals, the starting assumption must be that it will cost you a 

few tiny basis points of deviation, and it’s just as likely to be positive deviation as negative. These are 

the facts – not the hearsay of investment committees that have managed to maintain an erroneous, but 

perhaps convenient, consistency over decades on this issue. 

ietary information – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

3 


Aug 2018

Exhibit 35: Divestment Back to 1925 

1989‐2017 Range: 50bps 

12% 

8% 

4% 

0% 

9.44% 9.54% 9.56% 9.66% 9.71% 9.74% 9.75% 9.77% 9.84% 9.90% 9.94% 

Ex Health 

Care 

Ex Consumer 

Staples 

Ex IT Ex Industrials S&P 500 Ex Energy Ex Consumer Ex Utilities 

Discretionary 

Ex Materials Ex Telecom Ex Financials 

1957‐2017 Range: 61bps 

12% 

8% 

4% 

0% 

10.04% 10.12% 10.18% 10.25% 10.28% 10.28% 10.34% 10.34% 10.34% 10.39% 10.65% 

Ex Consumer 

Staples 

Ex Health 

Care 

Ex Energy S&P 500 Ex Consumer 

Discretionary 

Ex IT Ex Industrials Ex Telecom Ex Utilities Ex Financials Ex Materials 

1925‐2017 Range: 54bps 

12% 

8% 

4% 

0% 

11.37% 11.39% 11.44% 11.48% 11.51% 11.51% 11.51% 11.53% 11.54% 11.57% 11.91% 

Ex Consumer 

Staples 

Ex Health 

Care 

Ex Consumer 

Discretionary 

Ex Energy Ex IT Ex Telecom Ex Utilities S&P Index Ex Financials Ex Materials Ex Industrials 

ace of our Lives_6-18 

As of 9/30/17 

Source: S&P, GMO 

Prior to March 1957 the S&P 500 is represented by the S&P 90 Index. 

0/17 

S&P, GMO 

March 1957 the S&P 500 is represented by the S&P 90 Index. 

There are two quick points to be made before we leave this exhibit. The first is on the power of 

compounding. In the 92 years since 1925 the S&P 500 would have turned a single dollar – not allowing 

for inflation and taxes – into $22,911! Not bad is it? (Without Energy you would have had 4.3% less, 

or $21,984.) The second point is to admire how well the market mechanism did this particular job. I 

have always made a lot of fuss at how incompetent the market mechanism has been in dealing with 

bubbles, allowing through momentum and career risk for crazy overvaluations followed by dangerous 

collapses. But here the market has been amazingly efficient at pegging the long-term prospects of these 

10 major groups. It has taken away any possible free lunches from buying, say, appealing high-growth 

technology and selling dopey utilities by pricing technology higher and utilities lower to compensate. 

Impressive. Who knew? Not me anyway. 

ry information – not for distribution. For Institutional Use Only. Copyright © 2018 by GMO LLC. All rights reserved. 

Now we can put a more accurate price on divestment and ethics. For example, if you were to consider 

it unethical to own these oil companies whose scientists wrote, as mentioned, about the serious 

dangers of climate change in the 1970s only to have management later ignore it all and fund deniers 

and obfuscators, you can believe the cost of your ethics is about +/- 20 basis points! 

There is, however, one more economic argument in favor of divestment: that the Energy sector will be 

the first example of much more significant mispricing than any sector in the past due to oil companies 

not bending with the economic winds but fighting them all the way. And why would the market not do 

its usual remarkable job of forecasting this? Because this is the first time in history, I believe, where a 

significant chunk of the US investment community does not believe in the most important factor that 

will affect this sector – climate change. Why? Because we have had a 30-year, well-funded program 

to make the problem of climate change seem vague, distant, and problematic, the end result of which 

35 


Aug 2018

is that we have a Republican Party wherein 60% of the people don’t believe a word of the facts I have 

showed you. Some of them, presumably, are in the stock market. How many of these deniers does it 

take to distort the price? How can this not affect the market’s probabilities of carbon taxes, energy 

regulations, and other important factors? There certainly should be more mispricing than normal 

and that might just allow for unexpected long-term underperformance of Energy (and perhaps some 

chemicals). Certainly the governor of the Bank of England, Mark Carney, has been telling everyone 

that they are bitterly underestimating the future troubles facing the oil industry and I agree. 

(The short-term prospect for oil, however, is a very different story and there exists a probability, in my 

opinion, of a near-term squeeze on oil prices before the electric cars kick in fully.) 

Part VIII: What Should Investors Do About Climate Change? 

Let me finish this with some recommendations. What I’m hoping you will do, first of all, is vote for 

green politicians. I don’t care what party they belong to. It might surprise you to learn that all the great 

environmental law of the past 100 years came from Republicans. Second, lobby your investment firms 

to be a bit greener and encourage them to lean on their portfolio companies to do the same. Push them 

hard. Cash in some of your career risk units. You will at least be able to look your children in the eye. 

You may even feel better. And your firms may be able to attract more of the best kind of young recruits 

who are beginning to care very much more about these issues than we older folk collectively do. 

We’re racing to protect more than our portfolios from stranded assets and other climate change impact. 

That I believe is easy enough. But for those portfolio managers who happen to be human, we have a 

much more important job. We’re racing to protect not just our portfolios, not just our grandchildren, 

but our species. So get to it. 

Postscript 1: What Should We All Do? 

Of course, the first recommendation is the same: vote for green politicians. Especially support 

those who are pushing for a carbon tax, or a “cap and trade” program that sets limits for total CO2 

production but allows for trading and therefore more directly encourages efficiency and promotes 

CO2 sequestration – reforestation, improved soil management, and direct CO2 recovery from the 

air – that in a pure tax would probably be missed. Be aware that a direct carbon tax must be high 

to change consumer behavior enough to reach our goal of holding to less than 2ºC warming – one 

estimate is $200-$300/ton by 2050. 20 I would point out, though, that economic sensitivities are much 

higher for electricity generation than for gasoline. Taxes on gasoline in European countries average 

over $300/ton and they certainly have not made London or Paris free of traffic! Nor have these taxes 

crashed their respective economies. What they have done is created a market for energy-efficient cars 

that on average get almost twice the miles per gallon as do US vehicles. 

In contrast to transportation, $40/ton is more than enough to get rid of all coal-fired electricity 

generation in a couple of decades. A ton of coal for generation costs about $40/ton and generates 

2.8 tons of CO2. In addition, as discussed above, the costs of wind and solar plus a few hours’ 

storage are already substantially cheaper. A $40/ton tax on coal and natural gas would be an 

enormous incentive to design new generations of larger scale and cheaper storage. 

One thing to watch out for is that the major oil companies are all in favor of a modest carbon tax if it 

comes with immunity to the damage they have caused. That would indeed be a great bargain for them, 

for they know through their European subsidiaries that gas taxes are simple “pass-throughs.” They 

20 

Environment Canada, 2018. 


Aug 2018

act as tax collectors and pass on the several dollars per gallon tax immediately to the government. It 

absolutely does not affect their return on equity. 

But should they get immunity? In a world in which we all benefited from using fossil fuels – which 

we certainly did – and all were ignorant of the damage CO2 caused, there would be no unethical 

behavior, in my opinion, by oil companies or others, nor any possible breaking of consumer disclosure 

laws. But this is not the case. The oil companies did know of future damage. Better than all but a 

handful of scientists. And they deliberately hid this data, as mentioned above, after about 1982, having 

previously reported it in detail. Worse, they funded propaganda that has delayed our progress on 

decarbonization, perhaps by several years, and recklessly endangered us. For this part there should be 

no immunity any more than for any other dangerous activity. 

So let us all lobby as best we can for taxes high enough to be effective or equivalent programs that 

encourage sequestration and give immunity only for behavior that represents ignorance, acted on in 

good faith. 

Other than this main agenda item, what should we do? There are several small household 

improvements we can make, many of which, like LED lighting, high-efficiency furnaces, washing 

machines, refrigerators, and insulation, actually save money. At a larger scale, we can buy electric 

vehicles as their price comes down: the full lifetime costs, including much cheaper maintenance and 

running costs, are already cheaper for a $45,000 vehicle and, as mentioned, will be much cheaper 

yet in the next 10 years. At an even larger scale we can take fewer jet flights and do more video 

conferencing. One or two fewer flights a year will dwarf all the other savings. But at the highest 

level of savings of all we should consider having one less child, which is several times more effective 

than all the above added together as it represents one complete lifetime of carbon footprint plus that 

person’s descendants forever, or at least until we reach a zero net carbon equilibrium. Tough, but true. 

Postscript 2: Just Heat Waves or Climate Change? 

The current heat wave covers most of the Northern hemisphere so I swelter in Boston along with my 

sisters in London – who have less air conditioning. But in places as varied as Canada, Greece, India, 

and Japan it is far more serious as people are dying from the heat directly and the unprecedented 

fires they cause – including, remarkably, fires inside the Arctic Circle. Of course, global climate is 

far too complicated for any single incident to be explained with certainty, but these occurrences 

have in general been predicted for several decades: that we would have more long and dangerous heat 

waves than normal along with more prolonged heavy downpours. (Pity Japan that had both within a 

month.) And the accumulating number of new record high temperatures leaves new record lows in 

the literal dust: as of July 25 th , weather stations around the world have reported 122 record highs in 

the last month, versus only 2 record lows. The hottest overnight minimum temperature ever recorded 

anywhere – 108.7ºF in Quriyat, Oman – was on June 26, 2018. Imagine surviving that without air 

conditioning! Not only is the base temperature of the planet 1ºC or 1.7ºF hotter than it used to be, 

added on to both peaks and troughs, but some climate scientists have predicted 21 that the flow of 

weather has been changed so that longer spells of heat and rain should be expected. And both of these 

are exactly what we have been getting. Outside the US and the UK this new work is discussed and it 

is taken for granted that climate change is part of it. The discussion is only about which part and how 

much. Here in the US, as a testimonial to the effectiveness over the years of the denialist propaganda, 

there is hardly a peep. When people make up their minds based on politics and the clan they belong 

to, there is perhaps no weather extreme enough to convince them of the obvious. 

21 

J.A. Francis and S.J. Vavrus, “Evidence linking Arctic amplification to extreme weather in mid-latitudes,” Geophysical 

Research Letters, March 2012. 


Aug 2018

Thirty years ago the dire predictions of leading climate scientists were laughed at. Now we watch 

these predictions coming true and ignore the data or pretend to. So, as the world starts to burn up, we 

twiddle our thumbs and talk about “just another heat wave!” God help us. For we appear incapable of, 

or are at least unwilling to, help ourselves, and our great scientific skills increasingly appear insufficient 

on their own. 

Jeremy Grantham. Mr. Grantham co-founded GMO in 1977 and is a member of GMO’s Asset Allocation team, serving as the firm’s chief 

investment strategist. He is a member of the GMO Board of Directors and has also served on the investment boards of several nonprofit 

organizations. Prior to GMO’s founding, Mr. Grantham was co-founder of Batterymarch Financial Management in 1969 where he 

recommended commercial indexing in 1971, one of several claims to being first. He began his investment career as an economist with 

Royal Dutch Shell. Mr. Grantham earned his undergraduate degree from the University of Sheffield (U.K.) and an M.B.A. from Harvard 

Business School. He is a member of the Academy of Arts and Sciences, holds a CBE from the UK and is a recipient of the Carnegie Medal 

for Philanthropy. 

Disclaimer: The views expressed are the views of Jeremy Grantham through the period ending August 2018, and are subject to change 

at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should 

not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and 

should not be interpreted as, recommendations to purchase or sell such securities. 

Copyright © 2018 by GMO LLC. All rights reserved. 


Aug 2018

8/20/2018 The Case for a 50-Year Bull Market - Barron's 

This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit 

http://www.djreprints.com. 

https://www.barrons.com/articles/the-case-for-a-50-year-bull-market-1534550401 

ADVISOR GUIDE 

The Case for a 50-Year Bull Market 

Andy Sieg, Head of Merrill Lynch Wealth Management PHOTO: JARED SOARES 

By Steve Garmhausen 

Aug. 17, 2018 8:00 p.m. ET 

As head of Merrill Lynch Wealth Management, Andy Sieg oversees the so-called thundering herd of 

14,820 financial advisors, the second-largest workforce among the big brokers. 

Barron’s: What advice would you give investors to get the most out of an advisor? 

Andy Sieg: We encourage clients to be very specific about what success means to them, and even more 

specifically what their intent for their wealth is. In many cases, clients have thought about this, but may not 

have articulated it. When we encourage clients to be more specific about their intentions for their wealth, 

it produces clarifying conversations—not just with the advisor but also between the members of a couple, 

or across generations in a family. 

Deep into this bull market, where does Merrill see investment opportunities? 

It’s very easy right now to talk yourself into a sense that we’re in the late innings of the bull market. We 

think a much better perspective is to take a step back and say that we’re probably only 10 years into 

another 50-year bull-market cycle. 

The drivers of this bull market are a very powerful extension of the baby boomers’ productive lives, the 

silver economy, which is powering a lot of economic activity in the U.S. and around the world, and the rise 

of the millennial generation, which is a larger and even more economically powerful cohort than the 

boomers. The growth of the middle class in emerging markets around the world will be a lasting, 

sustained growth engine. And supercharging all of this is the technology innovation cycle, which we see 

https://www.barrons.com/articles/the-case-for-a-50-year-bull-market-1534550401 1/4


year after year. 

ALSO IN FINANCIAL ADVISOR GUIDE 

How to Find Income: Top Advisors Share Their Best Ideas 

Fire Your Hedge Fund; Hire an Advisor 

Barron’s Top Advisors Methodology 

Making It Easy To Find a Top Financial Advisor 

Over the last 50-year bull cycle, almost every year 

there was a reason that people worried. The big 

risk for individuals is that they become paralyzed by 

the bears and the negative news at the moment. By 

not being in the equity market, they’re not 

participating in the global economic expansion. 

That’s the real risk that families have. 

What is your advice for graduates entering the 

workforce this fall? 

Barron’s Financial Advisor Guide 

My first advice is to take a careful look at the wealth 

management industry. It’s a growth industry, and it 

promises tremendous careers for those who have 

what it takes. For grads entering wealth 

management, my most important advice is to remember that this business begins and ends with clients— 

everyone’s success in the financial industry broadly comes from their ability to serve clients well. The 

combination of a tremendous work ethic, rock-solid integrity, and an ability to build relationships with 

people around you are the three ingredients to long and successful careers. 

The industry is graying. Are there going to be enough financial advisors to go around 20 years 

from now? 



Yes is the short answer. There’s an awareness that we are in a golden age for wealth management or, as 

we like to say, a bull market for advice. With boomers moving into retirement, there’s a need for sound, 

long-term financial planning at a scale we’ve never seen before, and it’s causing ever-greater interest in 

wealth management as a career path. 

We’re sensing much more interest on campus around careers in wealth management, and more 

universities with degree programs around financial planning. And when people predict a shortfall of 

advisors, I think they’re very much underestimating how many advisors are eager to extend their careers. 

There is no such thing as 65 as the normal retirement age for our advisors. I think that is going to help 

ensure that we have the ranks of advisors we need. 

NEWSLETTER SIGN-UP 

Advisor Center 

Barron’s scans the world’s major publications 

each day to find news that helps financial 

advisors serve their clients better. 

SIGN UP 

What should investors make of the unusual climate 

in Washington, D.C.? 

You need to avoid getting wrapped up in the day-to-day 

noise and focus on fundamentals. The fundamentals 

are that U.S. economic growth is strong. This is a more 

pro-business climate than we’ve seen in quite some 

time. The benefits of last year’s tax bill are real and 

lasting. Our midsize- and small-business-owner clients 

are very optimistic about what they’re seeing in their 

local markets. The eternal risk to investors is to be 

distracted from fundamentals by the day’s headlines or 

the day’s tweets. My strong advice is to focus on the 

long term. A bullish perspective has been the right 

perspective for a long time in America, and I don’t thing 

that’s changing anytime soon. 

Thanks, Andy. 

Email: editors@barrons.com 

JOIN NOW 

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August 21, 2018 04:11 AM GMT 

Diversified Financials 

Exploring global cryptocurrency 

regulations 

EU regulators are increasingly concerned about retail client 

exposure to cryptocurrency trading. Whilst so far, there is no 

explicit ban on trading of these products, warnings and limits 

have been imposed. Our latest thoughts highlight the key 

evolution in the sector. 

Rising regulatory spotlight on cryptocurrency trading in Europe. The European 

Securities and Markets Authority (ESMA) amongst other EU regulators have 

expressed strong concerns on the exposure of unsophisticated retail clients to 

the trading of cryptocurrencies (Bitcoin, Ripple, Ether) and cryptocurrency 

contracts for difference (CFDs). In fulfilling their mandate on investor protection, 

we have seen a number of warnings, restrictions on trading and in some cases 

bans imposed on the advertising of such products. New EU CFD regulations are 

in force from August 1, 2018 where leverage on retail client crypto CFD trades 

has been capped at 2:1. We expect negative impact on total cryptocurrency CFD 

volumes in Europe as a result. However, we are yet to see any explicit ban on 

trading these products. 

Global cryptocurrency regulations. The regulatory environment continues to 

evolve as countries assess the benefits and risks of permitting/promoting 

cryptocurrencies domestically. International bodies like the International 

Monetary Fund have called for increased collaboration as countries assess both 

the potential benefits of improved market efficiency with the risks if used with 

leverage and without appropriate safeguards. Increased lobbying efforts and 

significant investor losses are likely to keep regulation top of mind, given the 

large amounts of capital at stake. 

Crypto regulations are increasing at a measured pace in the US. The fragmented 

structure of the US financial regulatory system has led to a patchwork of crypto 

regulations, making it harder for market participants to navigate. 3 federal 

agencies are leading the charge - the SEC, CFTC and FinCEN. There has been a 

push for a more coordinated response among regulators. The Financial Stability 

Oversight Council (FSOC), headed by Treasury Secretary Mnuchin, has set up a 

working group. A more coordinated response should lead to more rule clarity 

and less duplication, a positive for crypto markets in the long run. 

Limited exposure to crypto trading in our European coverage. CMC Markets is 

the only stock under our EU coverage with a direct exposure to cryptocurrency 

trading, though this is nascent having launched CFD trading (of crypto) in March 

2018. As such, the product's share of revenues is currently immaterial. Other 

players such as IG Group and Plus 500 (both uncovered) have launched similar 

offerings with Plus 500 having the largest exposure, we believe. 

MORGAN STANLEY & CO. INTERNATIONAL PLC+ 

Adedapo O Oguntade, CFA 

EQUITY ANALYST 

Adedapo.Oguntade@morganstanley.com 

Anil Sharma, CFA 


Anil.K.Sharma@morganstanley.com 

Jacqueline W Ho 

RESEARCH ASSOCIATE 

Jackie.Ho@morganstanley.com 

MORGAN STANLEY & CO. LLC 

James E Faucette 


James.Faucette@morganstanley.com 

Betsy L. Graseck, CFA 


Betsy.Graseck@morganstanley.com 

MORGAN STANLEY & CO. INTERNATIONAL PLC+ 

Sheena Shah 

STRATEGIST 

Sheena.Shah@morganstanley.com 

Diversified Financials 

Europe 

IndustryView 

+44 20 7677-9026 

+44 20 7425-8828 

+44 20 7677-7412 

+1 212 296-5771 

+1 212 761-8473 

+44 20 7677-6457 

In-Line 

Morgan Stanley does and seeks to do business with 

companies covered in Morgan Stanley Research. As a 

result, investors should be aware that the firm may have a 

conflict of interest that could affect the objectivity of 

Morgan Stanley Research. Investors should consider 

Morgan Stanley Research as only a single factor in making 

their investment decision. 

For analyst certification and other important disclosures, 

refer to the Disclosure Section, located at the end of this 

report. 

+= Analysts employed by non-U.S. affiliates are not registered with 

FINRA, may not be associated persons of the member and may not 

be subject to NASD/NYSE restrictions on communications with a 

subject company, public appearances and trading securities held by 

a research analyst account. 

1

Regulatory position on cryptocurrency trading and distribution in 

Europe 

Adedapo Oguntade, Anil Sharma 

We have published a number of reports assessing ESMA's CFD regulations in Europe, 

including: 

ESMA update on CFDs and binary options, 18th December, 2017 

ESMA publish measures on CFDs and binary options, March 27, 2018 

CMC Markets: Risk reward less appealing; downgrade to Equal-weight, May 1,2018 

ESMA adopts final product intervention measures on CFDs, June 1, 2018 

ESMA publishes update on upcoming measures, July 12, 2018 

CMC markets is currently the only stock under our EU coverage with a direct exposure 

to cryptocurrency trading. ‘Currency Management Corporation’ (CMC Markets) is a 

contract for difference (CFD) and spread betting firm specialising in financial products 

(e.g. shares, FX, and indices). Revenues are generated predominantly from the bid-offer 

spread, with the bulk coming from CFD transactions. The firm has a global footprint 

with >50k customers in 70 countries. 

CMC launched its cryptocurrency CFD offering in March 2018 and as such this currently 

accounts for an immaterial portion of revenues. Other players such as Plus 500 

(uncovered) have realised greater benefits as early industry movers - Plus 500 indicated 

cryptocurrency CFDs trading represented less than 15% of 2017 revenues. 

We have received a number of enquiries / investor questions on the position of EU 

regulators on cryptocurrency CFDs and similar derivative products with a focus on 

which European countries have banned cryptocurrency CFDs, if any. We explore this in 

the light of the various regulatory pronouncements we have seen thus far. To be clear, 

CMC's exposure here is not material and we do not make any changes to our forecasts 

on the back of this note. 

Investor protection concerns at the top of regulatory focus. Consumer protection is a 

growing concern for regulators, particularly as complaints have increased and poor 

practices have been uncovered in the retail CFD & spread betting industry. Over the last 

two to three years, we have seen intense regulatory scrutiny on the distribution of CFD 

products in Europe. In Dec 2016, the UK regulator (FCA) proposed introducing leverage 

limits, enhancing disclosure and prohibition on bonus payments, which arguably 

heralded the start of greater pan European legislation. In June 2018, the European 

Securities and Markets Authority (ESMA) published wide ranging temporary measures to 

address these concerns with a focus on: (i) prohibiting the marketing, distribution or sale 

of binary options to retail clients; and (ii) lower leverage limits and defining the nature of 

trading accounts that can be offered to retail clients (see note). These measures took 

2

effect from 2 July/1 August 2018. 

We see rising regulatory spotlight on cryptocurrency trading. Given the surging 

popularity of cryptocurrencies (i.e Bitcoin, Litecoin, Ethereum) over the last 18 -24 

months, ESMA and a number of National Competent Authorities (NCAs) have expressed 

concerns on the exposure of unsophisticated retail investors to trading these products. 

Several examples: 

1. The French regulator, Autotite des marches Financiers (AMF), has also published a 

release on cryptocurrency derivatives advertising while in the UK, the FCA issued 

warnings on the product. 

2. Belgium, the Financial Services and Markets Authority (FSMA) warned on 

fraudulent cryptocurrency trading platforms publishing a list of firms where 

indications of fraud were established. 

3. The German regulator, Bafin, published an advisory note on the regulation of Initial 

Coin Offerings (ICO) identifying which laws could be triggered in an ICO and on a 

case by case basis, when such ICOs can be regarded as financial securities. In terms 

of trading, the Bafin has focused on identifying and banning cryptocurrency 

exchanges which have not been properly authorised. 

4. In Cyprus, the Cyprus Securities and Exchange (CYSEC) in a 2017 release permitted 

trading in these products when certain conditions are satisfied. Subsequently, 

CYSEC has published new rules governing derivatives on virtual currencies which 

are in line with ESMA measures. 

Notably, three key European regulators - The European Securities and Markets 

Authority (ESMA), the European Banking Authority (EBA) and the European Insurance 

and Occupational Pensions Authority (EIOPA) - issued a joint warning statement on 

cryptocurrencies highlighting why they were risky for consumers including amongst 

others: (i) extreme volatility (ii) absence of protection (iii) lack of exit options (iv) lack of 

price transparency and (v) operational disruptions. Following on from the warning, 

ESMA restricted the leverage limit on cryptocurrency CFDs to 2:1 for retail clients as 

part of its temporary CFD industry measures. 

Which EU countries have banned cryptocurrencies? Amongst the NCAs, Belgium placed 

a ban on the distribution of OTC Forex, CFDs and binary options in August 2016 on firms 

authorised in Belgium. This ban affects all CFDs including crypto CFDs; This does not 

extend to other variations of cryptocurrencies such as spot, futures or options contracts. 

In France, the AMF has determined that cash-settled cryptocurrency contracts qualify as 

a derivative, irrespective of the legal qualification of a cryptocurrency. In line with 

provisions under Safin II legislation, the AMF has banned the electronic adverts of 

derivatives such as binary options and forex contracts with cryptocurrency as 

underlying. Adverts of cryptocurrency CFDs to retail clients where there is no negative 

balance protection are also banned. 

FCA issue warning on trading cryptocurrency CFDs. Cryptocurrencies do not fall under 

the regulatory scope of the FCA (See link). However firms that offer cryptocurrency 

derivatives need to be authorised by the FCA. In November 2017, the FCA issued a 

warning to consumers highlighting the risks in investing in cryptocurrency CFDs. The 

body noted these products were extremely high-risk speculative products and expressed 

3

the following concerns: 

1. Price volatility - vulnerability to sharp movement in price with the possibility for 

>20% movement in value in a single day. 

2. Leverage: The possibility for leverage to multiple losses with some firms offering 

leverage of up to 50:1 

3. Charges and funding costs: Spread fees, funding charges and commissions on 

cryptocurrencies tend to be higher than other products. 

4. Price transparency: There is greater risk that consumers will not receive a fair and 

accurate price for the underlying cryptocurrency when trading. 

The FCA has not issued any bans on cryptocurrencies with no indication of any plans to 

carry out additional studies on the product. 

Cryptocurrency adverts are banned on major social media platforms. Major social media 

networks like Google and Twitter have placed bans on all cryptocurrency and initial coin 

offering (ICO) adverts on their platforms in an effort to enhance consumer protection. 

In similar fashion, Google has indicated advertisers offering online trading of 

instruments such as CFDs and financial spread bets will need to be both licensed by 

national regulators in the countries they are targeting and certified by Google to make 

use of the company's advertising service. Facebook initially instituted a ban earlier in the 

year but this has now been rescinded. 

4

Global trading of cryptocurrency 

Sheena Shah 

It is well known that the retail investor has been a participant in cryptocurrency 

markets. The volatility in prices and the ever increasing number of tokens to trade has 

caught the attention of regulators and central banks. Overall, the thinking has been that 

cryptocurrencies are not a financial stability risk because the volume of flows are low vs 

the broader financial market. We have written in more detail in prior notes, below we 

summarise the key ideas. 

- Why a Country May Be Interested in Digital Currency (8 May 2018) 

- Where Are Exchanges Based? (25 Apr 2018) 

-Features of a Bitcoin Bear Market (19 Mar 2018). 

Exhibit 1: Where are exchanges located? 

1,200 

1,000 

800 

600 

400 

200 

0 

Cryptocurrency trading volume by legal location of exchange (USDmn) 

Allocations as of April 2018 

Volumes as of August 2018 

Malta 

Belize 

Seychelles 

Hong Kong 

British Virgin Islands 

USA 

South Korea 

Samoa 

Canada 

UK 

Estonia 

Japan 

Scam 

Russia 

Singapore 

Turkey 

Poland 

Armenia 

Cayman Islands 

Vanuatu 

Argentina 

N/A 

Luxembourg 

Mongolia 

Bahamas 

Singapore 

Ukraine 

Australia 

Brazil 

Indonesia 

Thailand 

New Zealand 

Switzerland 

Netherlands 

Decentralised N/A 

Taiwan 

Mexico 

Panama 

India 

Isle of Man 

Chile 

Denmark 

Israel 

Norway 

Bulgaria 

Finland 

Source: CoinMarketCap.com, company websites, Morgan Stanley Research. Originally published here. 

Exhibit 2: Bitcoin major trading currencies 

Bitcoin trading by currency (14-Aug-18, 1m av) 

Others, 

EUR, 2.2% 7.2% 

XMR, 2.8% 

DASH, 

5.0% 

USD, 

13.9% 

Source: CryptoCompare, Morgan Stanley Research 

USDT, 

33.3% 

JPY, 35.7% 

Changing regulation has caused cryptocurrency exchanges to reconsider which country 

they are located in. In April when we ran our analysis, the largest cryptocurrency 

volumes were traded via one exchange called Binance, which had announced that it will 

move operations from Hong Kong to Malta. From around 200 other exchanges we 

analysed, the next favoured locations are South Korea, Belize and Seychelles (Exhibit 1). 

The United Kingdom ranked particularly highly on the number of exchanges located 

there, but only saw 1% of trading volume. 

Defined but also attractive regulation makes an exchange decide to choose one country 

over another – a set of laws for companies to follow when handling digital tokens, 

customer assets, AML policies, taxes, etc. Regulatory certainty is part of the 

attractiveness for the companies so they can plan for the future as they know what to 

expect. Low taxes are a benefit. 

The country where bitcoin is traded is unknown but the fiat currency that is exchanged 

for bitcoin can be used as a proxy. The major trading currency on exchanges has changed 

over time (Exhibit 3). Exhibit 2 shows that most recently, most trading is still versus the 

Japanese Yen (36%) but a crypto-token USD Tether (USDT) is still taking an increasing 

share of volumes. That has occurred because the biggest exchanges only allow trading 

5

etween cryptocurrencies. As cryptocurrency prices have been falling correlations 

between coins stayed high so traders looked for a way to come out of the market, with 

USDT being relatively stable around 1 USD, providing that avenue. Cryptocurrencies 

make up about 60% of all trading vs bitcoin, while fiat currencies around 40%. 

Exhibit 3: Bitcoin Trading by Currency 

Source: CryptoCompare, Morgan Stanley Research 

6

Global Cryptocurrencies Regulation 

James Faucette 

The degree of regulation varies widely. Governments have taken multiple approaches 

to regulating cryptocurrencies. Some jurisdictions have kept the space less regulated, in 

part to attract crypto investment (e.g. Malta), and others are using it as part of a push 

for improved efficiency for their financial services industries. Others countries, like the 

US, have a wide range of regulatory reviews underway regarding cryptocurrencies. In the 

US, financial regulators have their own unique and evolving views on crypto. For 

example, the IRS' opinion is that cryptocurrencies are assets and therefore investors 

need to disclose gains for short and long term capital gains taxes, the SEC recently 

stated that initial coin offerings (ICOs) can be construed as securities and can be subject 

to securities law, several Federal Reserve Governors have highlighted that 

cryptocurrency is not legal tender. Reviews are ongoing and we should expect the 

regulatory regime to continue to firm up. 

Exhibit 4: Degrees Regulation of ICOs and Cryptocurrencies Globally 

Note: Green area represents country where government has provided limited guidance on regulation. Red area indicates that country has prohibited 

cryptocurrencies in some capacity. Yellow indicates progressing toward greater regulation. This is intended to offer a visual representation of varying 

levels of regulation at a point in time and may not accurately reflect more recent developments. Source: Business Insider, Morgan Stanley Research 

Meanwhile, large sums of money raised from ICOs are funding lobbying efforts. 

Associations are engaging with investors (e.g. venture capital firms) who have invested 

heavily in ICOs and cryptocurrency technology to push pro-cryptocurrency legislation. 

Coinbase, the largest US-based cryptocurrency exchange platform, recently formed a 

PAC (political action committee) in the US, and Fidelity is lobbying on behalf of bitcoin 

and other digital assets, according to the FEC and Politico. Associations like ACCESS in 

Singapore and Bitcoin Association Switzerland are also said to be lobbying and 

educating interested parties. We expect lobbying to increase in countries that are moving 

toward stricter regulations, given the large amounts of capital at stake. 

Significant investor losses may lead to regulation. ICOs have raised over $5bn in capital 

YTD, nearly as much as the total for 2017. However, as we highlighted in our note, 

Update: Bitcoin, Cryptocurrencies and Blockchain, 2/3 

rd 

of potential ICOs in 2017 failed 

before/after their ICOs, a much higher failure rate vs. startups in their first year. Reports 

7

of fraudulent ICOs have also surfaced, with the WSJ reporting that some active ICOs, 

currently raising over $1bn, have missing/fake executive teams and are using plagiarized 

investment documents. Cryptocurrency exchange hacks have also hurt investors, with 

$801mn in coin losses resulting from just 5 hacks in 2018 (Exhibit 5). Earlier this year, the 

South Korean government inspected 21 cryptocurrency exchanges and found that no 

firm met all 85 inspection standards, according to the WSJ. Meaningful losses with no 

recourse may spur tighter regulation. If it increases, we believe cryptocurrency 

transactions will migrate to less-regulated jurisdictions. As an example, when China 

increased its restriction on bitcoin mining in 2017 and then banned trading, we saw 

global bitcoin trading move away from the CNY (Exhibit 3). 

Exhibit 5: Some of the Largest Hacks on Cryptocurrency Exchanges/Platforms 

Exchange/Platform Date of Hack Value in Coin Losses ($mn) 

Bancor (Israel) Jul-18 $24mn 

Coinrail (South Korea) Jun-18 $40mn 

Bithumb (South Korea) Jun-18 $32mn 

BitGrail (Italy) Feb-18 170 

Coincheck (Japan) Jan-18 535 

NiceHash (Slovenia) Dec-17 70 $70mn 

Parity (UK) Jul-17 $32mn 

Youbit (South Korea) Apr-17 $35mn 

Bitfinex (Hong Kong) Aug-16 77 $77mn 

DAO (Germany) Apr-16 55$55mn 

Mt. Gox (Japan) Jan-14 450 

Source: WSJ, Morgan Stanley Research 

$170mn 

$450mn 

$535mn 

8

Exhibit 6: Regulators Globally are Watching Cryptocurrencies Closely 

Regulator/Event 

Jay Clayton, SEC Chairman 

(USA) 

Brian Bussey, Director of CFTC’s 

Clearing and Risk division 

(USA) 

Raphael Bostic, President, Federal 

Reserve Bank of Atlanta 

(USA) 

Valdis Dombrovskis, the EU’s Financial 

Chief 

(Europe) 

Mike Carney, Bank of England 

Governor 

(Europe) 

Andrea Enria, Chairperson, European 

Banking Authority 

(Europe) 

Ashley Alder, Chief Executive, 

Securities and Futures Commission, 

Hong Kong 

(Asia) 

The Monetary Authority of Singapore 

(Asia) 

Comments 

“ (I am) very optimistic that developments in financial technology will help facilitate capital 

formation,” but “many promoters of ICOs and cryptocurrencies are not complying with our 

securities laws and, as a result, the risks are significant.” SEC staff has been instructed “to be 

on high alert for approaches to ICOs that may be contrary to the spirit of our securities 

laws.” (Jan/Feb 2018) 

The CFTC has issued new guidance to exchanges and other trading platforms that are 

interested in listing bitcoin futures and other cryptocurrency derivatives products. “CFTC 

staff is providing this information, in part, to aid market participants in their efforts to design 

risk management programs that address the new risks imposed by virtual currency 

products.” (May 2018) 

“They (cryptocurrencies) are speculative markets. They are not a currency. If you have 

money you really need, do not put it in these markets.” (March 2018) 

“This (cryptocurrency) is a global phenomenon and it’s important there is an international 

follow-up at the global level. We do not exclude the possibility to move ahead (by regulating 

cryptocurrencies) at the EU level if we see, for example, risks emerging but no clear 

international response emerging.” (Feb 2018) 

Cryptocurrencies do not threaten “financial stability” at the moment, but they could after 

more consumers get involved. It is time to incorporate the cryptocurrency ecosystem into 

the rest of the financial system, applying to it the same regulatory approach and the same 

“rigorous standards.” (Mar 2018) 

Suggested it could be more efficient to prohibit banks and other financial institutions from 

holding and selling cryptocurrencies, than to directly regulate crypto, according to FT. (Mar 

2018) 

“Some complainants claimed that cryptocurrency exchanges had misappropriated their 

assets or manipulated the market, or that technical breakdowns of the exchanges’ platforms 

had caused them significant losses. Several complaints against ICO issuers alleged unlicensed 

or fraudulent activities. We will continue to police the market and enforce when necessary. ” 

(Feb 2018) 

“When it comes to money laundering or terrorism financing, Singapore’s laws do not make 

any distinction between transactions effected using fiat currency, virtual currency or other 

novel ways of transmitting value. ” MAS will seek to impose anti-money laundering and antiterrorist 

financing requirements on intermediaries that exchange fiat for virtual currencies – 

such as exchanges and brokers. (Jan 2018) 

Jose J. Kattoor, Reserve Bank of India 

Chief General Manager 

(Asia) 

“Virtual Currencies (VCs)... raise concerns of consumer protection, market integrity and 

money laundering, among others. Reserve Bank has repeatedly cautioned users, holders and 

traders of virtual currencies, including Bitcoins, regarding various risks associated in dealing 

with such virtual currencies.” Entities regulated by RBI shall not deal with or provide services 

to any individual or business entities dealing with or settling VCs. Regulated entities which 

already provide such services shall exit the relationship within a specified time. (Apr 2018) 

Source: Morgan Stanley Research 

9

Regulatory landscape in the US 

Betsy Graseck 

Different agencies, different jurisdictions, different rules...The fragmentation in the US 

financial regulatory system has led to a patchwork of crypto regulations, making it 

tougher for market participants to navigate. 3 federal agencies are currently leading the 

efforts, in our view. The Securities and Exchange Commission (SEC) has been focused on 

the ICO market, looking for any potential fraud or other misconduct. The Commodity 

Futures Trading Commission (CFTC) has oversight of the crypto futures market. 

Meanwhile, the Financial Crimes Enforcement Network (FinCEN) has said that any 

businesses exchanging virtual currencies are "money transmitters" meaning that they 

have to register with FinCEN and are subject to AML/BSA compliance. While the three 

agencies focus on different aspects of crypto, they shared the same goal of providing 

more investor protection, in particular for retail investors. 

What does the SEC care about? ICOs. The SEC has said that certain ICO tokens are 

securities and therefore fall under its jurisdiction. Whether or not a token is deemed a 

security depends on the specific facts and circumstances of the offerings, as determined 

by the Howey test. Those that are securities will need to be registered with the SEC 

unless exempted. The SEC is also looking to apply securities law to exchanges and 

digital asset storage companies that deal with securities token. In 2018 YTD, the SEC has 

brought 7 enforcement actions against ICOs that allegedly violated federal securities 

law. Note that the SEC has previously said that bitcoin and ethereum are not considered 

securities. 

Another area that has been gaining attention is crypto ETFs. The SEC has not to date 

approved for listing and trading any ETFs holding cryptocurrencies or other related 

assets. The SEC has recently rejected a second attempt by Cameron and Tyler 

Winklevoss, founders of crypto exchange Gemini, to list the first crypto ETF on a 

regulated exchange, citing issues with high volatility and funds' liquidity. The market is 

now watching for the SEC's decision whether to approve for listing the VanEck/SolidX 

bitcoin ETF proposal. The SEC has set a deadline for September 30 to make a decision. 

Crypto derivatives fall under the purview of the CFTC. The CFTC has designated crypto 

as a commodity, giving it oversight of the crypto derivatives markets. In late 2017, the 

CFTC has allowed the CBOE and CME to launch bitcoin futures products on their 

exchanges. The CFTC believes that the bitcoin futures markets will provide them with 

greater visibility into the underlying spot markets that they would not otherwise have. It 

is worth highlighting that the two bitcoin futures products are cash-settled contracts, 

which means that buyers do not have to hold bitcoin itself. Additionally, clearing 

members have the ability to impose trading or exposure limits on their clients, as well as 

increase margin requirements. 

Cryptocurrencies are assets for federal tax purposes, as per the IRS. This means that 

crypto is subject to capital gain taxes, just like stocks, bonds or other investment 

properties. Further, the IRS has recently launched the Joint Chiefs of Global Tax 

Enforcement (J5) with four other countries, namely Australia, Canada, the Netherlands 

10

and the UK, to investigate cryptocurrency crimes like tax fraud and money laundering. 

What about the Fed? Former Fed Chair Janet Yellen has called crypto a "highly 

speculative asset" that "doesn't constitute legal tender." While the Fed does not have a 

direct jurisdiction over cryptocurrencies, it is responsible for ensuring that the banking 

organizations under its supervision are appropriately managing their risk exposure to 

crypto market participants. 

Building a more coordinated regulatory response to crypto. The Financial Stability 

Oversight Council (FSOC) has formed a cryptocurrency working group comprising the 

SEC, CFTC, the Fed and the FinCEN. Further, the SEC and CFTC have issued a 

memorandum of understanding in June to ensure a continued coordination and 

information sharing between the two agencies, in particular on cryptocurrencies. We 

think that a more concerted effort to regulate crypto will lead to more rule clarity and 

less duplications, a positive for the development of crypto markets in the long run. 

11

WWRR Vol.2.008

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