In response to last week’s blog, a long term and very perceptive reader from a country that is also wrestling with the size of government asked whether I favor large or small government. I believe that size does matter. The single biggest determinate as to whether any current government eventually stays in power is the size of the perceived services it delivers to its people. There is a line that is attributed to a Roman poet that chronicled the need for “bread and circuses.” What went without saying were the primary needs of protection against foreign and domestic enemies. In the current era, the bread and circus line can be translated more simply to “finding and filling satisfying jobs.” I suggest that the size that matters is the size of the demands placed on the current political leaders.
Today’s appropriate size is governed by two constraints, the willingness to pay and the skills to deliver. With the exceptions of some small populations with large amounts of easily delivered but scarce natural resources, deficit production is threatening the current leadership of governments around the world. Whether the government is freely elected or not, it does not seem to matter much. The size of the current deficit is the widening gap between spending and revenue generation. Spending is for the aggregate services provided by the government to fill the perceived needs of the people that tolerate the political leaders. As discussed in last week’s blog, each of us acts as our own special interest group advocating for spending to fit our needs to be added to those of others. This is another size that matters. ‘Austerity’ is the government’s reason for not fulfilling all those current needs. Many societies are at the point that if large scale revenues are increased, it will force the private sectors to cut back their spending, reinforcing the downward spiral of austerity. While the need to sharply curtail spending is increasingly apparent and unpopular, there is some practical recognition that could save the day.
“Too big to fail?”
The first recognition is that there is little to no multiplier effect when government is the direct employer. Job leverage is much better supplied by the private sectors that are likely to bring all sorts of capital and management skills to bear on satisfactory job creation. The second recognition should have come as a result of the whole discussion regarding “Too Big to Fail.” That misplaced focus was on the potential irreparable harm that would have come from the financial failure of some 700 banks, two large American iconic auto companies, and the largest casualty and financial insurer in the world. At the time when poor decisions were made, I believe these groups had begun to manage successfully. If these companies were too big to manage, I suggest that governments, at many levels have become too large to manage. (This is particularly true when most governments cannot count on successfully recruiting the most qualified people at various levels.) Coming from these recognitions is the realization that many activities conducted by the government could and likely would be done better by customer-oriented private companies.
Thus, the answer to my reader’s inquiry: I am in favor of reduced size and scope of activities by various levels of government, but by no means am I advocating a cottage industry government.
Commitments
As a long-term investor in funds with Asian securities, I have been concerned with the financial/investment news media echoing various investment and economic leaders about the prospects for Asia. These opinions are largely based on too-similar views as to the progress of China. As an analyst, any time I find too much agreement on a topic, I get nervous. I do not like to be in crowded trades.
While it is too early to have a well-defined view of the future, I am happy to share some thoughts prior to reaching any conclusions. These thoughts are about current commitments. On the positive side, in discussions with a couple of managers I learned how they are investing in their own businesses, which are showing their commitment to investing client money in Asia for the long-term. I have been visiting Hong Kong over many years, and with my previous firm, had a fund data and marketing office there. I used to think that in many ways Hong Kong was like a suburb of London. Investment leadership appeared to be plugged into “the great and good” UK investment houses; with some minor leadership from a handful of US firms, often hiring UK ex-pats. This week I learned of one investment house having a dozen local analysts, including three in Shanghai, plus global industry analysts. What was most encouraging for me was the use of a number of business intelligence agencies to verify what many Chinese companies are saying or reporting to shareholders. With this firm’s commitment to investing in consumer goods companies, for the local market, a feel for what is actually happening as distinct from reading and believing press releases becomes critical to produce good relative performance. A second firm, in this case mid-sized, with only twelve investment people, has opened an office in Mumbai and staffed it with four analysts. The leader of this firm believes that this is the best investment that the firm has made, even though they currently have only about 8% invested in India. These two firms are making significant investments with their own operating money, being able to produce “long horizon” investment returns for their clients.
The other set of commitments are even longer-term and much more difficult to produce satisfactory results. Governments in China have not lost power from battles with foreign invaders, but from large-scale social disruptions. With over 50% of the current population living in the cities, with more wanting to live and work in the cities, China's urban development is critical to social stability. The government is particularly focused on the inland cities. With their lower wages, they could become major job creators and socially stabilizing forces. The government has a desire that many of these cities should be able to ship their manufactured product and natural resources to coastal ports within five hours travel time. There is, at least, one problem with the execution of this desire. Most existing railroads generally run in a north-south direction, however east-west routes are needed to bring merchandise to the ports. The recent series of crashes of the “bullet trains” has led to major changes in China’s infrastructure planning, including rail speed and management. To the extent that the central government’s change in emphasis in favor of consumer spending as contrasted to the prior focus on exports, there could be some relief beneath the social surface. The pace of development will need to keep pace with the speed of electronic communication to prevent an increase in the reporting of social disruption.
We need to do more research. What happens in China will impact the rest of the world.
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Sunday, January 29, 2012
Sunday, January 22, 2012
When it Comes to Taxes, We All Have Special Interests
A few days ago, I was asked my views on taxation fairness and was provided with two opposing views of tax policy for comment; one from a New York Times columnist and the other a Wall Street Journal opinion piece. My response follows.
The biggest unanswered question facing all nations with deficits is, “What are we paying for on an individual basis?” In the matter of tax policy each of us, in effect, forms a special interest group. Those of us living in suburbia are in favor of money to be spent on roads and possibly suburban transportation. Our urban friends would prefer that money be spent on mass transit in their cities. When we, our close family and friends are healthy, excessive spending on public health is overdone. However, when any of us are ill, we want the best healthcare available. Only those of us who fear future wars and terrorism are supporters of national defense spending etc., etc. Since we are not able to order our services à la carte, our next problem is how to pay for all the services that we want and pay for the sometimes wasteful spending for others that might have more votes than us. Governments pay for these services through taxes, fees, sale of assets, and borrowing. In the end, borrowing is self-defeating, but perhaps acceptable to many who do not have grandchildren.
One of the lessons from history is that the ability to levy taxes leads a society into certain actions. Think of taxes as the price we pay for services. If the price becomes too high, we will modify our behavior. If we tax income or capital at too high a rate, we will generate less income or capital. Since we have not successfully developed wide scale revenue-generating user fees, we will need to use taxes to pay for all those wanted and unwanted goods and services. Each of us has very good reasons to believe that someone else should pay our share of the expenses. As I believe that as a society we spend too much, I would favor various forms of consumption taxes with an appropriate carve-out for life sustaining items and the poor. Unfortunately the remaining purchases would probably be too small to be a good base for tax generation. There is another risk; that if legitimate user fees get to be too high, we will create a black or grey market with all its socially undesirable characteristics. There are other victims from an imposed tax on “luxury goods.” When we decided to tax large yachts, the yacht building business left the US for friendlier locations.
Because every inhabitant of this great country benefits from our collective government services, each person should pay something. Otherwise, we will continue the situation whereby people who do not pay taxes will want additional services to be paid by others. Thus, I am afraid we need a graduated tax rate approach. My own view is that income should be taxed and deployed capital should not until the capital is producing dividends. The more we adjust these principles to take into consideration legitimate needs of people, or the society as a whole, the more we will create special interest groups who not only want their needs taken care of, but who are willing to trade their votes to support other people’s needs on a reciprocal basis. (If you think sorting out US Federal taxes is difficult, attempt to do it for state and local taxes which have dramatic impact on the attractiveness of local communities. From our standpoint, there is one advantage at the state level: in most cases states are required to have balanced budgets. Thank you, Alexander Hamilton.)
We have often been told that the only certain things in life are death and taxes. Over time, we can learn to deal with those realities. However, there is a third constant in modern society which has caused more upset and bad decisions. The third item, perhaps the third rail, is tax changes, both in terms of rates and application. While I hope the debate between the Wall Street Journal and the New York Times is useful, I am concerned that it will lead to annual tax changes that will retard both social and economic progress.
Investing implications
As mentioned above, from a credit concern viewpoint, General Obligation bonds issued by highly-rated US states make more sense than US Treasury and Agency paper. However, because of the temptation on the part of the politicians (including those at the US Federal Reserve), one needs to be wary about inflation. Thus, in general I would restrict my fixed-income purchases to a portfolio of bonds with current maturities less than twelve years. For many of us who do not have sufficient experience in selecting and owning individual municipal bonds, or don’t have a highly competent advisor, one can use a package approach with (Open End) Mutual funds, Closed End funds (non-leveraged), and possibly Unit Investment Trusts (UITs). The keys in selecting these are restricting the choices to those that indicate that they are intermediate in maturity and have one of the lower current gross yields of the available products. As markets generally price risk into the yields offered, a lower yield may be less risky. The distinction between gross and net yield is the expense ratio on the fund. Other things being equal, a fund with a high total expense ratio (TER) will appear to have a lower yield than a fund with a lower TER.
For those who wish to add to their stock positions, and this may not be a bad time to do so, I would focus on investments in countries with relatively low deficits compared with their Gross Domestic Product (GDP). A number of these are found in Asia, particularly in southern Asia. Very recently, Indonesia has had its credit rating raised back to investment grade, many years after having suffered a downgrade. One must be cautious in using credit rating changes, as most often they are recognition of a change that has happened some time ago. In a forthcoming blog I will share my views as to these Asian opportunities.
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
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The biggest unanswered question facing all nations with deficits is, “What are we paying for on an individual basis?” In the matter of tax policy each of us, in effect, forms a special interest group. Those of us living in suburbia are in favor of money to be spent on roads and possibly suburban transportation. Our urban friends would prefer that money be spent on mass transit in their cities. When we, our close family and friends are healthy, excessive spending on public health is overdone. However, when any of us are ill, we want the best healthcare available. Only those of us who fear future wars and terrorism are supporters of national defense spending etc., etc. Since we are not able to order our services à la carte, our next problem is how to pay for all the services that we want and pay for the sometimes wasteful spending for others that might have more votes than us. Governments pay for these services through taxes, fees, sale of assets, and borrowing. In the end, borrowing is self-defeating, but perhaps acceptable to many who do not have grandchildren.
One of the lessons from history is that the ability to levy taxes leads a society into certain actions. Think of taxes as the price we pay for services. If the price becomes too high, we will modify our behavior. If we tax income or capital at too high a rate, we will generate less income or capital. Since we have not successfully developed wide scale revenue-generating user fees, we will need to use taxes to pay for all those wanted and unwanted goods and services. Each of us has very good reasons to believe that someone else should pay our share of the expenses. As I believe that as a society we spend too much, I would favor various forms of consumption taxes with an appropriate carve-out for life sustaining items and the poor. Unfortunately the remaining purchases would probably be too small to be a good base for tax generation. There is another risk; that if legitimate user fees get to be too high, we will create a black or grey market with all its socially undesirable characteristics. There are other victims from an imposed tax on “luxury goods.” When we decided to tax large yachts, the yacht building business left the US for friendlier locations.
Because every inhabitant of this great country benefits from our collective government services, each person should pay something. Otherwise, we will continue the situation whereby people who do not pay taxes will want additional services to be paid by others. Thus, I am afraid we need a graduated tax rate approach. My own view is that income should be taxed and deployed capital should not until the capital is producing dividends. The more we adjust these principles to take into consideration legitimate needs of people, or the society as a whole, the more we will create special interest groups who not only want their needs taken care of, but who are willing to trade their votes to support other people’s needs on a reciprocal basis. (If you think sorting out US Federal taxes is difficult, attempt to do it for state and local taxes which have dramatic impact on the attractiveness of local communities. From our standpoint, there is one advantage at the state level: in most cases states are required to have balanced budgets. Thank you, Alexander Hamilton.)
We have often been told that the only certain things in life are death and taxes. Over time, we can learn to deal with those realities. However, there is a third constant in modern society which has caused more upset and bad decisions. The third item, perhaps the third rail, is tax changes, both in terms of rates and application. While I hope the debate between the Wall Street Journal and the New York Times is useful, I am concerned that it will lead to annual tax changes that will retard both social and economic progress.
Investing implications
As mentioned above, from a credit concern viewpoint, General Obligation bonds issued by highly-rated US states make more sense than US Treasury and Agency paper. However, because of the temptation on the part of the politicians (including those at the US Federal Reserve), one needs to be wary about inflation. Thus, in general I would restrict my fixed-income purchases to a portfolio of bonds with current maturities less than twelve years. For many of us who do not have sufficient experience in selecting and owning individual municipal bonds, or don’t have a highly competent advisor, one can use a package approach with (Open End) Mutual funds, Closed End funds (non-leveraged), and possibly Unit Investment Trusts (UITs). The keys in selecting these are restricting the choices to those that indicate that they are intermediate in maturity and have one of the lower current gross yields of the available products. As markets generally price risk into the yields offered, a lower yield may be less risky. The distinction between gross and net yield is the expense ratio on the fund. Other things being equal, a fund with a high total expense ratio (TER) will appear to have a lower yield than a fund with a lower TER.
For those who wish to add to their stock positions, and this may not be a bad time to do so, I would focus on investments in countries with relatively low deficits compared with their Gross Domestic Product (GDP). A number of these are found in Asia, particularly in southern Asia. Very recently, Indonesia has had its credit rating raised back to investment grade, many years after having suffered a downgrade. One must be cautious in using credit rating changes, as most often they are recognition of a change that has happened some time ago. In a forthcoming blog I will share my views as to these Asian opportunities.
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com
Sunday, January 15, 2012
Do Something Now
to Make Money Later
Introduction
Unfortunately, some people have the habit of remembering what I say even if I don’t. In order to protect me, I am trying to write down what I think I say in various conversations. This week I had four discussions that separately focused on what investors and managers should be doing. In thinking about these communications, my point of view was they should be doing something now, to make money in the future.
The two portfolio approach
In a discussion with an organized group of sophisticated investors who travel behind a cloak entitled OFIC, much of the conversation was about the various concerns that were preventing them from investing. In reaction, in part due to my reading about naval warfare, I suggested that they immediately do something. In a naval battle, a ship that is not moving is a much better target for the enemy than one that is in motion, particularly if the motion leads to rapid changes of direction and speed. For my National Football League-oriented friends, this is advocating the use of broken field plays to keep the defense off guard. My suggestion was that each investor create, at least in his or her mind, if not in fact, two portfolios. The first portfolio is to hold the investor’s maximum need for liquidity. The first would have not cash (yielding nothing) but mostly munis and other income producing paper. With the need for liquidity addressed, the second portfolio could be aggressively invested. The aggressive portfolio should be focused on the reasonable extremes of the myriad of opportunities that are available today. We should keep in mind that even during the Depression there were some fantastic up-market moves.
There are two keys to this strategy, the first is get out of the middle where everyone else is, and the second, like a broken field runner, be prepared to change courses rapidly.
Essential elements of information
I spend a lot of time with analysts and portfolio managers trying to understand how they make investment decisions. I get worried when they express their decisions based on the complete confidence that they have all the information on a company, stock, or market. This confidence belies what I learned in the US Marine Corps as well as my own analytical endeavors on individual stocks. In the military intelligence world (perhaps it’s an oxymoronic statement), one needs to identify what are the critical facts needed to make a decision. These facts are called the essential elements of information. Further, each element was graded on the likely accuracy and the quality of the source of the information. In the heat of battle, did the Marines, and I suspect other forces, have complete knowledge of the situation that faced them? As an analyst, I used to lay out what I wanted to know about a company and a stock. (They are very different for the long-term.) In both cases, in the military and on the analyst desk, did we ever have 100% of the essential information? Due to time pressure, we frequently had to make decisions having only 60% of the needed elements. Rarely did we get to 75%. When the battle is on (or when the stock is recommended or bought), some of the missing elements become known, plus new unanticipated factors surface. When properly processed and communicated, the additional information can cause changes in direction. With this as a background, I am less likely to buy a fund where the manager and/or responsible analyst feel that they know everything. A level of doubt is an important additional attribute that is a positive for me.
Precision vs. accuracy
Recently I was in communication with a very bright law school student who was entering his last semester with a very good record. I suggested that it is possible that at the end of his last term some professor could ask a question whose answer was not in his books but in his evolving understanding of the practice of law. I used as an example that, I believe 50% of my last Asset Accounting exam was to answer the question as to what was wrong with accounting. What the professor was asking was, in essence, what value was all this work? (The same question could and perhaps should be asked at the final term of all professional schools.)
There is a significant difference between accurate bookkeeping and accounting. Bookkeeping requires the capture of all the financial information and displaying it in an acceptable format. Good accounting takes the product of bookkeeping and colors it for other factors based on experience, regulation, and tax management. A bookkeeper can capture the cost of an asset and assign it to an expense or asset account. The bookkeeper can charge against the asset an agreed depreciation, so that the balance sheet reflects how much of the asset has been paid for through the income statement. The accountant needs to determine whether the asset is overstated or the property is materially not worth its carrying cost. While the bookkeeping is precise, the accounting is making a judgment as to the accuracy of the numbers. As a portfolio manager and investor in financial services securities, I am offended by the argument in the press and by some managers and analysts that many banks and other financial companies are holding large amounts of assets, particularly loans, that are selling at ridiculous low valuations. They scream that these stocks are selling at prices that approximate book value. These same stocks are not only not going up, they are going down. They have mathematical precision to buttress their argument. The market is not buying it. The imprecise market is looking for accuracy. Accuracy as to what the assets are really worth. One could take the attitude that instead of being cheaply valued, that these securities are in fact, expensively priced. The assets could, for example, be worth 50% of their carrying value and thus these stocks are selling at 2X their realistic book value. On this basis, I am suspicious of many so-called value managers who assert that their portfolios are statistically cheap based on published book values. There are, undoubtedly, a number of stocks that are selling at substantially below what a knowledgeable buyer would pay for the company. When we see a pickup in M&A deals for already public companies, there will be more verification of values in the market.
Hire a good pro
One of the observations that I make in interviewing CEOs of private investment management organizations is to see whether they hiring people. During most periods one of the constraints on future growth of a business is the lack of good people to hire at reasonable wages. I believe that eventually we will see high stock market levels and that there are an inordinate number of good investment people that are either out of work or for the first time in their careers, would be willing to jump to a better opportunity. Thus, I think this is a good time to hire. As a matter of fact, if any member of this blog community knows of an experienced analyst of US mutual funds who is looking for an investment employment opportunity, there is a good chance we should talk directly (not through any intermediary).
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com
Unfortunately, some people have the habit of remembering what I say even if I don’t. In order to protect me, I am trying to write down what I think I say in various conversations. This week I had four discussions that separately focused on what investors and managers should be doing. In thinking about these communications, my point of view was they should be doing something now, to make money in the future.
The two portfolio approach
In a discussion with an organized group of sophisticated investors who travel behind a cloak entitled OFIC, much of the conversation was about the various concerns that were preventing them from investing. In reaction, in part due to my reading about naval warfare, I suggested that they immediately do something. In a naval battle, a ship that is not moving is a much better target for the enemy than one that is in motion, particularly if the motion leads to rapid changes of direction and speed. For my National Football League-oriented friends, this is advocating the use of broken field plays to keep the defense off guard. My suggestion was that each investor create, at least in his or her mind, if not in fact, two portfolios. The first portfolio is to hold the investor’s maximum need for liquidity. The first would have not cash (yielding nothing) but mostly munis and other income producing paper. With the need for liquidity addressed, the second portfolio could be aggressively invested. The aggressive portfolio should be focused on the reasonable extremes of the myriad of opportunities that are available today. We should keep in mind that even during the Depression there were some fantastic up-market moves.
There are two keys to this strategy, the first is get out of the middle where everyone else is, and the second, like a broken field runner, be prepared to change courses rapidly.
Essential elements of information
I spend a lot of time with analysts and portfolio managers trying to understand how they make investment decisions. I get worried when they express their decisions based on the complete confidence that they have all the information on a company, stock, or market. This confidence belies what I learned in the US Marine Corps as well as my own analytical endeavors on individual stocks. In the military intelligence world (perhaps it’s an oxymoronic statement), one needs to identify what are the critical facts needed to make a decision. These facts are called the essential elements of information. Further, each element was graded on the likely accuracy and the quality of the source of the information. In the heat of battle, did the Marines, and I suspect other forces, have complete knowledge of the situation that faced them? As an analyst, I used to lay out what I wanted to know about a company and a stock. (They are very different for the long-term.) In both cases, in the military and on the analyst desk, did we ever have 100% of the essential information? Due to time pressure, we frequently had to make decisions having only 60% of the needed elements. Rarely did we get to 75%. When the battle is on (or when the stock is recommended or bought), some of the missing elements become known, plus new unanticipated factors surface. When properly processed and communicated, the additional information can cause changes in direction. With this as a background, I am less likely to buy a fund where the manager and/or responsible analyst feel that they know everything. A level of doubt is an important additional attribute that is a positive for me.
Precision vs. accuracy
Recently I was in communication with a very bright law school student who was entering his last semester with a very good record. I suggested that it is possible that at the end of his last term some professor could ask a question whose answer was not in his books but in his evolving understanding of the practice of law. I used as an example that, I believe 50% of my last Asset Accounting exam was to answer the question as to what was wrong with accounting. What the professor was asking was, in essence, what value was all this work? (The same question could and perhaps should be asked at the final term of all professional schools.)
There is a significant difference between accurate bookkeeping and accounting. Bookkeeping requires the capture of all the financial information and displaying it in an acceptable format. Good accounting takes the product of bookkeeping and colors it for other factors based on experience, regulation, and tax management. A bookkeeper can capture the cost of an asset and assign it to an expense or asset account. The bookkeeper can charge against the asset an agreed depreciation, so that the balance sheet reflects how much of the asset has been paid for through the income statement. The accountant needs to determine whether the asset is overstated or the property is materially not worth its carrying cost. While the bookkeeping is precise, the accounting is making a judgment as to the accuracy of the numbers. As a portfolio manager and investor in financial services securities, I am offended by the argument in the press and by some managers and analysts that many banks and other financial companies are holding large amounts of assets, particularly loans, that are selling at ridiculous low valuations. They scream that these stocks are selling at prices that approximate book value. These same stocks are not only not going up, they are going down. They have mathematical precision to buttress their argument. The market is not buying it. The imprecise market is looking for accuracy. Accuracy as to what the assets are really worth. One could take the attitude that instead of being cheaply valued, that these securities are in fact, expensively priced. The assets could, for example, be worth 50% of their carrying value and thus these stocks are selling at 2X their realistic book value. On this basis, I am suspicious of many so-called value managers who assert that their portfolios are statistically cheap based on published book values. There are, undoubtedly, a number of stocks that are selling at substantially below what a knowledgeable buyer would pay for the company. When we see a pickup in M&A deals for already public companies, there will be more verification of values in the market.
Hire a good pro
One of the observations that I make in interviewing CEOs of private investment management organizations is to see whether they hiring people. During most periods one of the constraints on future growth of a business is the lack of good people to hire at reasonable wages. I believe that eventually we will see high stock market levels and that there are an inordinate number of good investment people that are either out of work or for the first time in their careers, would be willing to jump to a better opportunity. Thus, I think this is a good time to hire. As a matter of fact, if any member of this blog community knows of an experienced analyst of US mutual funds who is looking for an investment employment opportunity, there is a good chance we should talk directly (not through any intermediary).
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com
Sunday, January 8, 2012
Two Levels of Investing:
For Progress and for Preservation
Wealthy individuals and governments face similar problems dealing with today’s and tomorrow’s issues. One of the major tools for dealing with these issues is through wise and contemplative investments. Eventually, choices have to be made that will result in major influences to future actions of the general population as well as to those near and dear to us. While the processes to reach critical investment decisions by governments/politicians and those of wealth are similar, the advisors to the decision makers are different as well as the critical time frames. Today’s blog will seek to initiate discussions as to the investment implications for both sets of long-term investors.
The big picture
There is hardly any government in the world, no matter at what level, that is truly popular. Governments are tolerated because the various political forces, be it in the ruling family or other power bases, cannot find much better alternatives. Those in power, unless they are truly statesmen or stateswomen, want to stay in power whether or not they have completed their perceived missions. In effect, they are striving for preservation of power. (For some wealthy, this requirement translates to preservation of capital.) Both governments and individuals are prisoners of past decisions, made by ourselves and others. These prior decisions force us to deal with situations as they are, not what we would like them to be. Only governments that are in a constant state of surplus are not in the deficit production and control business. The whole legitimizing concept of government is that individuals are willing to give up certain actions and other assets in exchange for a third party providing required services. The deficit creation comes from our collective desire not to pay full price for the services acquired. The way the political process works is that one can stay in power by promising to provide more services to more people. Just raising revenues either through taxes or fees, in many cases is similar to pouring oil on a fire; it just leads to more expenses. The sudden cessation of spending, some call it austerity, can panic a society into massive curtailment of discretionary spending, which in turn could produce lower tax revenues. From our provincial vantage point here in the US, this is what we perceive in Europe and Japan.
In the US we see a different pattern, where governments are laying off and/or not hiring workers at the same time that the private sector is ever so slowly adding jobs. Having had to deal with corporate and institutional cutbacks, I recognize that most of the time layoffs at the low end do not produce enough savings to bring the books into balance. Only when some of the senior executives and whole departments are made redundant can sufficient savings be generated. While this is painful in the private and non-profit sectors, it is almost impossible to meaningfully accomplish in government. For example, when a senior employee of the State of New Jersey receives notice of being laid off, he/she can “bump off” (replace) a more junior employee almost anywhere within the state government. Yes, there is a decline in total salaries, but the state is stuck with the senior’s productivity or lack thereof. We have not yet begun to shrink the number of cabinet departments or members of various legislative bodies. Nevertheless, in the US, we are doing something to recognize the deficit problems mostly at the state level. This is being driven by the legal requirement that most of our states must produce a balanced budget. From an investment point of view, this could suggest that a number of our states could be more reliable credit risks than our federal government. This abhorrence of owning most federal debt is reinforced by the belief that it is only a matter of time until the US will join other countries in debasing their currency/debts through inflation. Further, I wonder whether all governments will lose some of their attraction as counterparties in a commercial transaction. I suspect that some governments will try to get out of paying their trade obligations in full and on a timely basis. Thus I am approaching a view that the corporations that have large government contracts should carry a lower valuation than a pure corporate counterparty.
The important picture for the wealthy
With the possible exception of the pharaohs, most wealthy have shown an interest in how their worldly goods are passed on to various heirs. I have written about this topic in my book, MONEYWISE (St. Martin’s Press). Today, I am returning to the critical discussion of multi-generational wealth transfer using a Linkedin Group to promote discussion, and as a resource for all who wish to think about and contribute their thoughts.
After observing families up close and personal as well as from afar, I can say that there is no single expert on all of the aspects of transferring wealth to your heirs. But a number of different kinds of experts are needed to give critical advice to the source of significant wealth, often called the grantor.
Most wills and trusts are developed with the initial assistance of competent attorneys with lots of trusts and estate experience. Their main function is to develop the document that captures the intent of the grantor as nearly as possible. Unfortunately, this is where many people end their search for advice. Tax accountants familiar with federal and state tax laws and regulations are essential, particularly for the wealthy with numerous and complex assets. Further, those who have assets outside of their home country will need competent local accountants and lawyers in each location of the wealth. Again, all too many wealthy individuals stop their transfer thinking process here. In my opinion, there are five other experts that are needed. Future blog discussions will address each expert need in detail.
Wealthy families around the world have these challenges in common. Through the mechanism of a Linkedin group titled Multi-Generational Wealth Transfer, I hope to explore many of the aspects of successful wealth transfer, and respond to your questions and comments. My goal is to assist in the optimum multi-generational wealth transfer.
_________________________________________________
Did you miss Mike Lipper’s Blog last week? Click here to read.
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The big picture
There is hardly any government in the world, no matter at what level, that is truly popular. Governments are tolerated because the various political forces, be it in the ruling family or other power bases, cannot find much better alternatives. Those in power, unless they are truly statesmen or stateswomen, want to stay in power whether or not they have completed their perceived missions. In effect, they are striving for preservation of power. (For some wealthy, this requirement translates to preservation of capital.) Both governments and individuals are prisoners of past decisions, made by ourselves and others. These prior decisions force us to deal with situations as they are, not what we would like them to be. Only governments that are in a constant state of surplus are not in the deficit production and control business. The whole legitimizing concept of government is that individuals are willing to give up certain actions and other assets in exchange for a third party providing required services. The deficit creation comes from our collective desire not to pay full price for the services acquired. The way the political process works is that one can stay in power by promising to provide more services to more people. Just raising revenues either through taxes or fees, in many cases is similar to pouring oil on a fire; it just leads to more expenses. The sudden cessation of spending, some call it austerity, can panic a society into massive curtailment of discretionary spending, which in turn could produce lower tax revenues. From our provincial vantage point here in the US, this is what we perceive in Europe and Japan.
In the US we see a different pattern, where governments are laying off and/or not hiring workers at the same time that the private sector is ever so slowly adding jobs. Having had to deal with corporate and institutional cutbacks, I recognize that most of the time layoffs at the low end do not produce enough savings to bring the books into balance. Only when some of the senior executives and whole departments are made redundant can sufficient savings be generated. While this is painful in the private and non-profit sectors, it is almost impossible to meaningfully accomplish in government. For example, when a senior employee of the State of New Jersey receives notice of being laid off, he/she can “bump off” (replace) a more junior employee almost anywhere within the state government. Yes, there is a decline in total salaries, but the state is stuck with the senior’s productivity or lack thereof. We have not yet begun to shrink the number of cabinet departments or members of various legislative bodies. Nevertheless, in the US, we are doing something to recognize the deficit problems mostly at the state level. This is being driven by the legal requirement that most of our states must produce a balanced budget. From an investment point of view, this could suggest that a number of our states could be more reliable credit risks than our federal government. This abhorrence of owning most federal debt is reinforced by the belief that it is only a matter of time until the US will join other countries in debasing their currency/debts through inflation. Further, I wonder whether all governments will lose some of their attraction as counterparties in a commercial transaction. I suspect that some governments will try to get out of paying their trade obligations in full and on a timely basis. Thus I am approaching a view that the corporations that have large government contracts should carry a lower valuation than a pure corporate counterparty.
The important picture for the wealthy
With the possible exception of the pharaohs, most wealthy have shown an interest in how their worldly goods are passed on to various heirs. I have written about this topic in my book, MONEYWISE (St. Martin’s Press). Today, I am returning to the critical discussion of multi-generational wealth transfer using a Linkedin Group to promote discussion, and as a resource for all who wish to think about and contribute their thoughts.
After observing families up close and personal as well as from afar, I can say that there is no single expert on all of the aspects of transferring wealth to your heirs. But a number of different kinds of experts are needed to give critical advice to the source of significant wealth, often called the grantor.
Most wills and trusts are developed with the initial assistance of competent attorneys with lots of trusts and estate experience. Their main function is to develop the document that captures the intent of the grantor as nearly as possible. Unfortunately, this is where many people end their search for advice. Tax accountants familiar with federal and state tax laws and regulations are essential, particularly for the wealthy with numerous and complex assets. Further, those who have assets outside of their home country will need competent local accountants and lawyers in each location of the wealth. Again, all too many wealthy individuals stop their transfer thinking process here. In my opinion, there are five other experts that are needed. Future blog discussions will address each expert need in detail.
- The first expert required is someone wise enough to evaluate the current potential heirs as to their needs, prudence and experience in handling investment activities. As difficult as this task is, they or their successors need to update their views as various heirs mature, marry, divorce, get permanently sick, and leave their own estates and possibly trusts.
- The next expert is the supervisor of the administration of complex instruments and relationships. Details that are not properly executed can thwart the intent of the grantor. The ability to supervise is particularly critical in this era of mergers of law firms, accounting firms, banks and trust companies.
- Many wealthy believe that they have obligations to their definition of society, and at the same time do not want to make some or all of their other heirs too wealthy and destroy their fruitful life styles. In this case an expert is needed to review not just requests from various charities, but also their operations and leadership
- The next to last expert needed is one that can appropriately make corrections for unexpected changes including any of the heirs, supporting experts, laws and regulations. I have often seen in beautifully drawn, long-term trusts, some need to adjust the then-new reality that was not in the mind of the grantor when he/she approved the document. Too often the only recourse to get changes are the courts who will be guided by the written law and the specific trust language, not the current cast of characters and current thinking as to the natures of well-being, investment structure changes, etc.
- The final person that is needed for a successful wealth transfer plan is the investor advisor. Actually he/she should be involved all the way along the process. The grantor needs advice as to what is going to be the composition of the transferred assets which may include operating and financial liabilities. Often investment organizations want you to put all the money in one big pool and have each heir get a designated slice at a specific time. This is the easiest way to administer the pot of wealth. It may not be the best as different heirs, including charities have different needs for current income, “real” income, tax adjusted income, long-term capital production, collateral for other obligations, etc.
Wealthy families around the world have these challenges in common. Through the mechanism of a Linkedin group titled Multi-Generational Wealth Transfer, I hope to explore many of the aspects of successful wealth transfer, and respond to your questions and comments. My goal is to assist in the optimum multi-generational wealth transfer.
_________________________________________________
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com
Monday, January 2, 2012
Lessons from 2011 for Earning in 2012
The year 2011 was not a good year for many stock markets, investors and advisors, (I count myself among them). However, there are useful lessons to be learned for 2012 and beyond. One rationalization is that we did not pay sufficient attention to “the Risk on/Risk off” dance. These rapid fire flip-flops were focused almost exclusively on macro factors. Macro factors included the overall levels of interest rates and currencies plus political changes. As these changes occurred or were rumored, the markets moved violently. The rapid fire changes were triggered by syllogisms. If you don’t remember your plane geometry, a syllogism is a form of reasoning with two propositions leading to a conclusion, e.g., “If factor ‘A’ is true and factor ‘B’ is true, there is only one possible conclusion.” A contemporary example might be that (a) the US is in a political deadlock, (b) a major credit rating agency lowers the US credit rating, therefore (c) the US dollar, Treasuries, and its stock market will decline. (Those of us trained as analysts of individual securities require a large number of factors to make a decision. We rarely feel absolute certainty about our conclusions, as all the facts never line up on one side.) The “Risk on/Risk off” switches created the volatility that so unnerved individual investors in 2011.
Incomplete/misleading headlines
If one totally believed the flash news, one could complete the syllogism and react quickly. Unfortunately, all too often the headlines do not include enough information to properly evaluate the news. The following are three examples of news articles premised with too-shallow thinking:
The Trend is Your Friend, Go with the Flow, and 1987
In the ever-present attempt to simplify investment assertions, the two expressions “The Trend is Your Friend” and “Go with the Flow” get great market currency in a “Risk on/Risk off” market. There is a lot of evidence that these attitudes can work well for traders who can and do reverse their opinions rapidly during the trading day. Now that we know that the S&P500 for all of 2011 produced a zero return on a price basis, and the Dow Jones Industrial Average on the same basis gained about 5% , we can determine how many of these hyperactive traders actually added value to their accounts. In some respect the year 2011 is similar to the flat performance earned in 1987. Both were the third year of a US presidential cycle and both had significant foreign inputs, but with a difference. In 2011, fears of European problems held the US market in check but did not prevent many companies from producing solid earnings. In 1987, the US domestic economy had growing problems, but in this case was bailed out by its growing exports. While finishing flat, both years had sharp market breaks as well as recoveries. One can take the point of view that 1987 was the required preparatory period that would usher in the market boom of the 1990s. With the current market finishing over thirteen years of no forward movement in the averages, we are ready for a longer term explosive upside that we can explain at the current time.
My bottom line
While we need to examine macro factors closely, we also must keep focus on the micro factors and be in a position to benefit early from the next rise.
My best wishes
My wish to all the members of this blog community is that 2012 brings a happy, healthy, and prosperous year; and that we are able to increase the level of our personal and professional communications.
-----------------------------------------------------------------
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com
Incomplete/misleading headlines
If one totally believed the flash news, one could complete the syllogism and react quickly. Unfortunately, all too often the headlines do not include enough information to properly evaluate the news. The following are three examples of news articles premised with too-shallow thinking:
- “A World with Too Much Debt,” * based on data from the Organization for Economic Co-operation and Development (OECD), examines unfunded liabilities and official government debt as a % of GDP. The US ranks sixth, with a figure of 620% (98% of official debt + 522% of unfunded liabilities). This is pretty scary when Spain, Italy, and Ireland have lower numbers, indicating that the US is in deep trouble, enough to hit the “Risk on” button. That is, unless you look at the details, as micro analysts do. First the unfunded liabilities are the difference between the projected cost of continuing current government programs and net expected tax revenues. Note that the figures do not take into consideration any dedicated assets to these programs. Second and much more importantly, is that liabilities are shown without any calculation as to a nation’s assets, even if it were just the government’s assets. One of the reasons for this mismatch is that the US government does not publish a balance sheet, even an unaudited one. (As regular readers of this blog have learned, I believe our credit rating should be lowered to the mid-investment grade level, not because we don’t have the assets/earnings power to pay off our debts. The downgrade is warranted due to the political unwillingness to materially reduce the US deficit production.) Bottom line, in my opinion: the US debt picture is unhealthy, but does not have to be fatal. Thus, I would delay hitting the “risk on” button.
*This chart was brought to my attention by John Maudlin of Millennium Wave Advisors - “There is significant evidence that the economic growth in China is slowing.” The expressed fear is that to head off a slowdown in China, wages will rise. As we buy so much from China, we will be introducing additional inflation into the US that will hit the Wal-Mart shoppers hard. There are three reasons that this is interesting but not significant. First, a substantial portion of Wal-Mart sales are grocery items, of which very few are imported from China. Second, my guess is that the actual dollar value of imports is approximately matched by the combination of transportation costs, including fuel, and Wal-Mart operating costs. (This company along with a number of other US companies has been very good at finding ways to reduce costs while preserving quality.) Third, we have already seen some production has shifted out of China to lower cost sites, including back to the US, due to increased automation. An important part of the fear of a slowdown in China is that they will no longer buy US dollars and debt, and will begin to be sellers that will lower the world value of the dollar and drive US interest rates higher. One should remember that the largest single owner of US Treasury debt is the US government. In various trust funds, the US government holds about 40% of US debt. Also, the combination of Japan and the UK actually own more of the US debt than the Chinese. Perhaps most importantly, one needs to understand that the Chinese government is not trying to do us a favor by owning our debt, they are solving their own problem. Chinese producers sell their goods all over the world, often being paid in US dollars. To keep the local currency stable and reduce the impact of imported inflation, the Chinese government requires all those that internally hold dollars to turn them into the Chinese banking system in exchange for local currency. With the dollars so corralled, they buy US Government paper. As the trade surplus with the US grew over time, the Chinese became involuntary holders of our paper and very much interested in preserving its purchasing power.
Like most investors and analysts I do not know what is likely to happen to the Chinese economy in the near or far term. I hope to learn more from a trip to Hong Kong, Singapore, and Shanghai beginning the last week of this new month. I would appreciate your suggestions as to investment people I should meet. - “The November decline of Exchange Traded Funds’ Net Issuance”
Some market pundits have raised an alarm about the decline in the net issuance of Exchange Traded Funds (ETFs). In November, the net dollar issuance was only $5 billion, down from $20 billion in October and $99 billion year-to-date. For some, this was another reason to go for the “Risk on” button. Net issuance is the difference between purchases and redemptions. If one disaggregates the data, the biggest decline comes from a drop of $23 billion in issuance of index ETFs. I do not know with certainty the cause of this decline, however I suspect that various hedge funds and others have regular “short book” purchases, less index funds, to offset some of their short positions. My guess is that once we see the 2011 data from the Investment Company Institute, the December numbers will go back to their former trends.
The Trend is Your Friend, Go with the Flow, and 1987
In the ever-present attempt to simplify investment assertions, the two expressions “The Trend is Your Friend” and “Go with the Flow” get great market currency in a “Risk on/Risk off” market. There is a lot of evidence that these attitudes can work well for traders who can and do reverse their opinions rapidly during the trading day. Now that we know that the S&P500 for all of 2011 produced a zero return on a price basis, and the Dow Jones Industrial Average on the same basis gained about 5% , we can determine how many of these hyperactive traders actually added value to their accounts. In some respect the year 2011 is similar to the flat performance earned in 1987. Both were the third year of a US presidential cycle and both had significant foreign inputs, but with a difference. In 2011, fears of European problems held the US market in check but did not prevent many companies from producing solid earnings. In 1987, the US domestic economy had growing problems, but in this case was bailed out by its growing exports. While finishing flat, both years had sharp market breaks as well as recoveries. One can take the point of view that 1987 was the required preparatory period that would usher in the market boom of the 1990s. With the current market finishing over thirteen years of no forward movement in the averages, we are ready for a longer term explosive upside that we can explain at the current time.
My bottom line
While we need to examine macro factors closely, we also must keep focus on the micro factors and be in a position to benefit early from the next rise.
My best wishes
My wish to all the members of this blog community is that 2012 brings a happy, healthy, and prosperous year; and that we are able to increase the level of our personal and professional communications.
-----------------------------------------------------------------
Did you miss Mike Lipper’s Blog last week? Click here to read.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my Blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog.
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com
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