The Value of Activity
By Brad Thomason, CPA
Dairy farmers in Belgium recently staged a protest to decry falling milk prices. Because of import bans in Russia (retaliation for the Ukraine/Crimea sanctions) and falling demand in China, EU exports are way down. Companies which supply oil field services in Texas and the Dakotas are going out of business, because with oil prices so low, many of the wells which were operational a couple of years ago are no longer profitable and have been shutdown. Hong Kong saw nearly a 10% drop in tourist traffic from China this summer. One effect is that real estate prices are falling: fewer people have money for a new apartment.
What do all of these things have in common? Activity, or more specifically, the lack there of.
The underlying pattern in all of these examples is similar. First a decrease in commercial activity leads to a drop in an asset price, and the drop in the asset price leads to more slowdown, whether in the original activity or another one.
A slowdown in buying activity among global energy users, especially in the face of increased supply, lead to a drop in oil prices. The drop in oil prices, in turn, lead to a slowdown in the rate at which oil services companies were getting hired. And so it goes.
As investors, we probably don’t spend a whole lot of time thinking about activity, per se. But maybe we should. We all have a vague sense that it’s important, but I don’t see that many investors engaged in purposefully tracking activity levels; either as a means to explain what’s going on, or as a means to look for the next solid investment idea.
In many areas of the physical world, nothing happens until x interacts with y. This goes for everything from chemical processes, to gravity relationships between things on the cosmic scale. Society is a function of activity, since if none of us ever had any contact with our neighbors, society wouldn’t even be a thing. Activity matters. A lot.
In asset markets, like stock exchanges, who sets the prices? The people who show up and buy or sell. Without that activity, there is no market. And if you have no market, having a market price becomes much tougher. If you don’t believe it, just ask your neighborhood CPA what kinds of hoops they have to jump through when a client has to mark an asset to fair value, and there’s no price published in the WSJ for that particular asset. It ends up being quite the task.
In Aldous Huxley’s novel Brave New World, there are several references to the idea that consumption was something of a civic responsibility in that society. In order for everything to stay strong for the good of all, people needed to be buying and using and buying replacements so there would be a strong premise for making more and keeping the plates spinning.
Why is war so disruptive to economic prosperity, at least for the area where the war is taking place? Because few people buy new TVs when bombs are falling. Activity. Retail activity drops, and everything else follows. Why are wars good for countries gearing up to go fight somewhere else? Same answer: increasing activity levels drive things in the favorable direction.
You get the point. Activity is sort of the leading indicator of leading indicators. Stable activity generally leads to stable conditions. Rising activity generally drives something(s) higher, and falling activity does the opposite.
It seems simplistic to approach investment analysis with rudimentary questions about basic activity levels. But you know, there’s an old adage in boxing that it’s important to watch the other guy’s feet because they may give you signals about what’s coming next. Simple or not, watching activity levels in lots of different arenas gives clues about which possible futures are becoming more likely. Pick up on them early enough and it could lead to better investment results – both from catching upswings, as well as dodging corrections. Next time you see a news article talking about something speeding up or slowing down, keep in mind that you may be holding a piece of information which could be important to your portfolio.