On the Return of Peak Oil and Other Long-Term Forecasts

US shale oil production is peaking and will enter permanent, if gradual, decline. Stocks are set to deliver subpar long-term returns. US stocks are about to lag non-US for several years. These long-term forecasts have made the rounds in recent days, just as the Congressional Budget Office’s (CBO’s) US debt and deficit projections hogged headlines late last month. In our view, they all have something in common: They extrapolate present conditions far forward, which rarely mimics real life—a big reason why stocks don’t look further than 30 months or so ahead.

Any of these forecasts could probably merit a full article at some point—and have done so in the past. The oil production forecast is a retread of late 20^th and early 21^st century peak oil fears, which we spent plenty of pixels on before the Shale Boom put peak oil to bed for a spell. The CBO’s exercises with straight-line math have also gotten a regular workout on these pages. As have the follies of using valuations to forecast returns, which underpins those long-term projections of weak returns and perpetual US stock underperformance. Today, we will take a more general approach centering on the philosophical problem at play.

That problem: A lot will happen over the next 5, 10, 15 and 20-plus years. A lot of things that are utterly unknowable today. There is simply no way any long-term forecast, no matter the variables that underpin it, can account for this. Think of the aforementioned peak oil projections. Given oil is a finite natural resource, Peak Oil Theory stated that at some point US and global production would enter terminal decline. Many presumed the US was already in that stage—ditto natural gas production. But then came deepwater production—unimaginable to the first Peak Oil Theory proponents—followed by the shale boom. That brought US oil and natural gas output to new record highs. It defied forecasts because there was no way to know, in the 20^th century, that it would become economical and feasible to combine the techniques of horizontal drilling and hydraulic fracturing to release oil and gas trapped in shale rock formations. Is it so unrealistic to think today’s forecasts might be missing similar future innovations?

Long-term stock market forecasts suffer similar blind spots. Stocks, at their simplest, are stakes in companies’ future profits. How can we know now what technological advancements will drive earnings over the far future? How can we know how inventive users will apply those advancements to the vast range of goods and services we all consume today, never mind how they will bring new goods and services down the line? This will play a large role in determining long-term returns regardless of where valuations are today.

Or, try an even simpler logical path. Stock prices—like all prices—are functions of supply and demand. Hence, forecasting stock prices in the long term requires knowing what stock supply will be in the long term. We don’t recall anyone in the mid-1990s forecasting that US stock supply would nearly halve between its 1996 peak and 2019, but it did, falling from 8,090 to 4,266.^[i] To know future stock supply, you would have to nail every variable affecting it, including future IPOs, stock buybacks, stock-based mergers, cash-based mergers, private equity takeovers, nationalizations and failures. Which means you would have to nail all of the variables affecting these things, including technological advancement as well as economic trends, interest rates, regulations, tax policies and all the other incentives at work. Assessing these within the next year or two? Difficult, but feasible. In the long term, however, it is an ocean of question marks.

At a psychological level, we understand why long-term forecasts get so much attention. People want to know what will happen, and these analyses purport to offer a blueprint. But every projection is only as good as its inputs. If we know the future is ever-changing in unpredictable ways, then we must concede that it is illogical and inaccurate to base a long-term forecast on an extrapolation of one or two present conditions. To see it, just look at any of the CBO’s long-term forecasts. All rest on extrapolations of GDP growth, interest rates and government spending growth that use either present conditions or long-term averages. You will see the straight lines from year to year. But the real world never moves in a straight line. It is up and down. Messy. Volatile. The CBO is far from alone in using this methodology—central banks and finance ministries globally do it, too.

So for investors trying to navigate all of this, we suggest not letting far-flung forecasts dictate investment decisions today. Even if they come true, we fail to see how they would lead to better portfolio positioning in the here and now. Oil companies’ earnings are price-sensitive, not volume sensitive, so declining US production wouldn’t be auto-negative for earnings. The combination of synthetic fuel and cobalt-free long-range batteries could render dwindling oil supply moot. Stocks could deliver below-average returns over the next couple of decades simply due to the timing of the bull and bear markets that cycle through along the way—those bull markets would still probably be great times to own stocks, and long-term forecasts don’t tell you when they will occur. And yes, perhaps international stocks do finish ahead of US over some indeterminate long period. But leadership shifts often and irregularly even during long-term trends, which is why we think global investing is always the way to go regardless of which region looks set to lead.

Most importantly, remember to think like markets do. We have found that stocks tend to look at the next 3 – 30 months. Anything sooner than that is probably very widely known and priced in already. And anything further out is probably too hazy and full of unknowns to affect stock prices now. Narrowing your focus to 3 – 30 months is a handy way to filter out the noise, in our view.