Sunday, December 9, 2012

The Shapes and Shadows of Things to Come

As I have stated numerous times in these posts, it is the job of a good analyst to explore impossible thoughts. Too much of the focus of the media and the politicians is on the immediate future. Good analysts, particularly those like me who try to divine future secular trends, need to look to the furthest time horizons that are visible and to understand what might be beyond the horizon. With these thoughts in mind, the following topics are presenting themselves for recognition, interpretation, and investment implications:
1.     The Bernanke-labeled “fiscal cliff” is an income statement problem not a balance sheet problem. We must all recognize that this is a multigenerational challenge.
2.     There is no consumer strike, just a lot of caution.
3.     Multinationals think globally as to where to store up cash and borrow money.
4.     Problem solving by attempts to change the laws and not behaviors is illogical.
5.     Two illuminating front page articles in the Sunday New York Times next to each other, “Clinton’s Countless Choices Hinge on One: 2016” and “Tax Arithmetic Shows Top Rate Is Just a Starter.”  

Fiscal Cliff:  Income statement vs. balance sheet

All of the current focus in Washington on the “fiscal cliff” is focused on changes to current tax rates vs. ten years of budgeted expenditures. This is governmental math. We have never seen a balance sheet for the federal government and for that matter most governments. The expenditure for payrolls is treated the same as for buildings and equipment that may have some value after the money is spent, as distinct from payroll spending. If the government was a business there would be charges to depreciation and amortization accounts. Further the government does not recognize future liabilities, particularly contingent liabilities; e.g., replacement of existing facilities, impacts of changing health expense inflation, technological obsolescence. To be fair we have not seen even a list, let alone a valuation of governmental buildings, lands, mineral rights, and what intrigues me the most, intellectual property. Because of these assets I am not now worried that the US government will be forced to default on any of its loans. Nevertheless, I believe that its practice of being a slow payer will continue and accelerate. Please bear in mind our possible forerunner in terms of debt repayments, Greece, is having difficulty in selling some of its assets, but at the right price the Greek government will trade. I believe that the US has better quality assets and could raise substantial capital through sale or lease programs. The rating agencies have threatened another round of credit rating chops if there is not a discernible political willingness to address the spread between US revenues and expenditures.  I am guessing that the global bond market has already discounted on the prospect of another rating cut.

Consumers vs. governments

As regular readers of these posts may remember, my good wife Ruth and I regularly walk and observe in the very glitzy Mall at Short Hills. Today it was raining and parking was directed by security people. By far the biggest line was for pictures to be taken with Santa. Some stores had reasonable crowds, including the Apple store. Others were quite empty. When a clerk at J. Crew was asked about some out of stock merchandise, he volunteered that we should try the website. Internet shopping is filling many FedEx, UPS, and US Postal trucks. These observations suggest to me that consumers are not on strike but are being cautious. Whether they are buying now because they feel that their after-tax income will shrink next year or that prices will rise because of some scarcities, including the need for price relief from higher taxes, I don’t know. We will be watching for trends in early 2013.

Global vs. national

During the week there was news about Emerson Electric borrowing in the US to pay dividends, possibly special dividends, while they had significant cash sitting overseas. The history of Emerson Electric is that it is a prudent Midwestern US company who has a major share of the world market for small motors which drive many machines and equipment. The media commented that this was a strange act to borrow when it had a pile of cash. I believe that the press reaction is also mirrored by this Administration, members of Congress, and the Fed. They all miss the point; that business, consumers, and increasingly investors live in a global world rather than a national location. While I am not privy to the thinking of Emerson Electric, it appears to be rational. The company made money overseas and probably sees opportunities to make more by investing outside of the US. Emerson’s own treasury may feel that the interest deduction is worth more in a high tax state like the US, particularly when they may feel that the Fed has guaranteed inflation so they can repay the debt with less valuable dollars. In setting our economic policies, the leaders of this country should be thinking globally, particularly recognizing the economic problems of other governments and peoples,

“Raise the bridge or lower the water” won’t always work

There is an old saying from Venice, Italy when it was one of the leading city-states of the world, and a leader in financial transactions, that when an overloaded barge could not fit under a bridge they could either raise the bridge or lower the water. Modern governments are attempting to change the rules of commerce to accomplish the same goals of forcing a solution to problems. Many times the solutions are short-term until they come up to a bridge that can not be raised or the water lowered. The only way to move the vessel, or if you will the government, is to off-load some of the burden. While that might help navigate a particular obstacle, it will have no lasting impact without a change in behavior. In order to lower the tonnage that the government is carrying, we must ask the government to carry less and shift some of the perceived necessary burden back on to the people. As with any meaningful behavior modification, it won’t be quick or easy, just look at the attempts to eradicate cigarette smoking; a difficult task, but not an impossible accomplishment to achieve.

Is the front page editor of the New York Times a political prophet?

As mentioned earlier, Sunday’s New York Times had two timely articles next to each other on the front page. The first and somewhat expected article due to the newspaper’s political orientation, explored the possibilities of what will occupy Hilary Clinton’s time  when she steps down from a somewhat impotent position as US Secretary of State. In her next phase she will be able to espouse policies that she has personally developed whatever they happen to be. Even those who have opposed her in the past are very conscious of her own political skills as well as those of her husband.

The Clintons are pragmatists and are good at making political judgments. Whether we will vote for Hillary or not, her attention (or lack of) to the fiscal problems in the run-up to the 2016 is something we should watch.

The second article, somewhat surprising in the New York Times,  deals with the need for substantially more revenue than would be generated by the President’s proposal to tax the wealthy. This is the beginning of an analysis of how difficult it will be to quickly and meaningfully reduce the size of the deficit. In my opinion, our deficit as well as those of many other countries began two or three generations ago. We collectively wanted more from the government than we were willing to pay for in taxes or user fees. My guess is that if it took two or three generations to build these deficits in relatively low interest rate environments, it will take at least as long to eradicate the deficits.


As investors are reading of these shapes and/or shadows, they should recognize that these conditions drive longer-term portfolio choices. At this point while pure US stocks, if there are any, may be cheaper than similar issues overseas, significant global holdings make sense. While European opportunities are enticing trades, selective Asian and Latin American companies are more appealing. Both Mexico and Canada could make sense for some portfolios. In all cases, unless you have specific expertise, I prefer to use funds or management company securities.

Please share your views.  
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