The article below is an excerpt from WhiteTree’s Q4 market commentary. If you would would like to receive our quarterly commentary, please email us at email@example.com.
“What important truth do very few people agree with you on.” – Peter Thiel
Michael Lewis’ The Big Short is out in theaters. The movie is a lightly fictionalized account of the hedge fund managers who were able to foresee the U.S. housing bubble and profit from it. One of the principal characters is Dr. Michael Burry, an autistic hedge fund manager from California who for most of the movie earns only the ire of his partners and investors for daring to make a large wager on a thesis that no one believed in.
Professional investors like Dr. Burry are paid to find situations where the there is more reward achieved relative to the amount of risk assumed. This is commonly referred to as an asymmetric risk reward scenario. If you can find enough of these you will be a successful investor given enough time. But asymmetries don’t just exist in financial markets, they happen in everyday life.
At least socially, being the bearer of bad news is an asymmetric scenario. If you are right and people lose, you are tainted by association. If you’re wrong, you’re just a fool like everyone thought anyway. Some people assume these thankless roles because they have courage; giving people potentially valuable information is more important to them than the adversity it entails. Other people do it for ego; being right is intrinsically more valuable than other people’s feelings about them.
There is another dimension through which distasteful ideas exhibit asymmetry. That is in the way in which these ideas posses great potential for financial gain or loss. Just as investments can become mispriced as a result of investors neglect, the intrinsic merit of an unpalatable truth is often magnified as a result of it’s being overlooked. In this respect at least, it is an investment advisors duty to give a nod in the direction of ideas which may have radical consequences.
I attended the College of Charleston in South Carolina. Charleston is located in a region of South Carolina known as the low country – due to its low elevation. I’ve heard it said that the highest elevation on the Charleston Peninsula is a mere six feet above sea level. I don’t know if that’s true but I do recall the rainstorms. The streets flooded even in the short summer afternoon thunderstorms. And it didn’t take much more rain before intrepid citizens were able to kayak down the streets. Perhaps because of this experience I was receptive to recent New Yorker article about the potential impact of rising sea levels in Miami Beach and South Florida generally.
The New Yorker piece titled The Siege of Miami is as is typical for that publication; a fluid and engaging narrative. Within that narrative there is an important thesis about the future of Miami and South Florida. What follows is our best effort to extract that thesis, accompanied by some germane passages from the piece itself:
1. Miami and South Florida generally, exists at a very low elevation relative to sea level:
“The regions troubles start with its topography. Driving across South Florida is like diving across central Kansas, except that South Florida is greener and a whole lot lower. In Miami-Dade County, the average elevation is just six feet above sea level… Broward County, which includes Fort Lauderdale, is equally flat and low and Monroe County, which includes the Florida Keys, is even more so.”
2. Rising global temperatures combined with ice-sheet collapse will make sea levels rise, perhaps significantly faster than people expect:
As temperatures climb again, so, too will sea levels. One reason for this is that water, as it heats up, expands. The process of thermal expansion follows well-known physical laws, and is relatively easy to calculate. It is more difficult to predict how the earth’s remaining ice sheets will behave and this difficulty accounts for the wide range in projections.
3. Historical evidence supports the thesis that sea levels rise more sporadically than gradually, meaning that if ice sheets are collapsing we could see a decade(s) of rapidly rising sea-levels:
“As the ice age ended and the planet warmed, the worlds coastlines assumed their present configuration. There’s a good deal of evidence – much of it now submerged – that this process did not take place slowly and steadily but rather, in fits and starts. Beginning around 12,500 B.C., during an event know as meltwater pulse 1A, sea levels rose by roughly fifty feet in three or four centuries, a rate of more than a foot per decade. Meltwater pulse 1A, along with pulses 1B, 1C and 1D, was, most probably, the result of ice-sheet collapse. One after another enormous glaciers disintegrated and dumped their contents into the oceans.”
4. South Florida cannot be helped by conventional seawater control methods such as barriers, pumping and levees. Because it sits on limestone that is porous; the water comes up from within the rock itself:
“But South Florida’s problems also run deeper. The whole region – indeed, most of the state – consists of limestone that was laid down over the millions of years Florida sat at the bottom of a shallow sea. The limestone is filled with holes, and the holes are, for the most part, filled with water…
I asked everyone I met in South Florida who seemed at all concerned about sea-level rise the same question: what could be done? More than a quarter of the Netherlands is below sea level and those areas are home to millions of people, so low-elevation living is certainly possible. But the geology of South Florida is peculiarly intractable. Building a dike on porous limestone is like putting a fence on top of a tunnel; it alters the route of travel, but not necessarily the amount.”
5. Regardless of people’s interest in living in the Miami area, insurance companies and banks could stop development and limit the availability of financing as a means of purchasing real estate:
“To cope with its recurrent flooding, Miami Beach has already spent something like a hundred million dollars. It is planning on spending several hundred million more. Such efforts are, in Wanless’s view, so much money down the drain. Sooner or later – and probably sooner—the city will have too much water to deal with. Even before that happens, Wanless believes, insurers will stop selling policies on the luxury condos that line Biscayne Bay. Banks will stop writing mortgages.”
Assuming that the preceding argument is not structurally flawed, the common response to this type of prediction is to seek refuge in the assumption that the relevant time-scale for sea-level-rise is decades if not centuries. Therefore this thesis, though perhaps valid, is so indefinite as to be meaningless to today’s investors. The common refrain is something along the lines of “Yes, but I’ll be dead by the time that happens.”
In response we would only offer that the real estate market, like all other markets, is forward looking by nature. The banks that lend people money to purchase homes expect those homes to be habitable for 25 years. If within the next 10 years, the forthcoming 25 years becomes at all precarious, prices will likely adjust rapidly. Like the stock market or holiday shopping, the only way to beat the crowd is to be there before everyone else.
Of course, the ideal outcome would be for our human economic activity and the world’s climate to achieve a stable and profitable harmony. It is our hope that Miami and South Florida enjoy a prosperous century to come. We would merely avoid taking out a mortgage based on that scenario.