I wish to bet in favor of an expansion of returns of
investors’ capital, even though this time may be different in that we might be
entering a long-term phase of flat to down stock markets. At market turning
points there is usually not an over-abundance of evidence of a change in
sentiment as to the long-term direction. Thus, to find clues of change I scan all
information that passes through my desk and memory. The following are items
that I think should be weighed and their implications examined.
Intellectual property and
unfunded pension liabilities to be calculated in GDP
In July of this year the US GDP will grow by 3% due to the
inclusion of intellectual property in its calculation, recognizing intellectual
property as a produced asset rather than an expense-only generator. According
to a Financial Times story released
on Sunday, this adjustment will be carried back to the initiation of the calculation
of national accounts at the Bureau of Economic Analysis in 1929. The size of
this addition is roughly equivalent to the size of Belgium’s GDP and the biggest
increase since the 1999 addition of software. This change is in response to the
international accountants recognizing intangible assets such as research and
development expenditures, and royalties on creative works (movies, television shows,
books, music and theater). If these are the results of current spending to
produce long lasting assets, they need to be identified on accounting
statements including the national income accounts that produce our Gross Domestic
Product. At the same time the revision will recognize the unfunded liabilities
of public and corporate pension plans. There are many investment implications
to these changes. The first is that the US economy with its large scale production
of intellectual property will widen the gap from most other countries, which
may play a role in the on-going deficit production and austerity discussions in
the US. Second, intelligent investors have already priced these benefits into
some of their judgments regarding the production of intellectual property in the
biotech sector (including drug companies), as well as others. If recognized this
shift, in addition to published book value, will lower the price/book value
ratios that many so-called value investors favor. Also some states like New
Mexico will get greater recognition for the large amount of R&D conducted there.
Larger in dollar value, but smaller as percentage of total state product, my
home state of New Jersey could also benefit. However the various states as well
as the nation’s GDP numbers will be marked down due to the size of the
underfunding of their pension funds. In most cases knowledgeable investors have
understood these conditions and market prices may already be reflective.
Portfolio liquidity
Many institutional investors have been willing to accept in
the case of their purchase of “lock-ups” through private equity and many hedge
funds that there is a penalty on early redemptions. Recent discussions with
investment committees (who are focused on providing operating funds to their
institutions) have indicated a stronger than normal push to insure the liquidity of their portfolio. They are willing to pay a liquidity premium
beyond the current year’s needs to feel comfortable in meeting the requirements of
their organizations, particularly if business and donor support slows down in
the year ahead. At the moment there is less competition
for long-term investment opportunities which in turn may lead to better entry
prices or terms for lower fees or less onerous exit terms. Thus, now may be a
particularly favorable time to be a long-term investor with cash to spend.
Four letter words
From a young age we have been instructed to avoid the use of
certain four letter words. In this prohibition, we tend to forget two additional
very important words; Love and Like. The world would be a far less attractive
place without these words in practice. But there are two other four letter
words that now need to be understood. The first is “real.” This term is used in
reporting the impact of inflation on income and price performance recognizing that
published nominal rates don’t measure the “real” cost or benefit received from
a number. My problem with the designation of real is that the number for
inflation is increasingly recognized as questionable. There are growing
questions as to the price inputs, methodologies applied and the accuracy of
each procedure. In my talks with various institutional and individual investor
audiences I have yet to find people that perceive the published consumer price
index is representative of their experience. I would suggest that it would be
prudent to use “real” rates of return as estimated and not certain in the
specific situation of the investor or citizen. The second four letter word that
should be handled with care is “copy.” Something that bears no resemblance to
an original will rarely be compared as a copy. The art and the investment worlds
know that a well done copy is not only difficult to spot but also has many
similarities to the original and in some aspects could even be better than the
original. Copying is the sincerest form of flattery it is said. At the right
price a copy could be a useful bargain. In the investment world which follows and
mimics performance leaders, I would not necessarily shy away from good
followers as long as one identifies that they are followers who could produce
better, often more leveraged vehicles, than the original leaders. As long as
one recognizes that those who follow are unlikely to either spot the turning
points when the period of advantage is over or to be an original leader in subsequent
phases. Thus, I would not reject a copy out of hand, but understand as to what
one is dealing with and do so at the right price.
Investor confidence
As mentioned a number of times I follow the weekly
publication of the Barron’s Confidence Indicator of the ratio of yields of
intermediate quality bonds to high grade corporate bonds. When the ratio
declines it is meant to be positive for stocks in the future. Most weeks the
change is below 1% (100 basis points) which I consider a weekly trading
differential. In the past week the decline in the ratio was 1.6% or from 67.9
to 66.3 which is encouraging to those of us that have long positions in stocks.
Markets speak to
non-profits and governmental services
One of the hard realities for many non-profit institutions
that are serving the public through admissions to various locations is that
they are suffering from a falloff in both attendance and donor support. Very
harshly, I am increasingly taking the point of view that if these non-profits
were commercial businesses with the same secular, not cyclical decline in
support, my attitude would be that ‘the market has spoken” and now is the time to
consider basic model changes or closing down. Applying the same thinking to the
deficit production machine being run by most Western governments, I believe
that the situation calls for a significant model change as the public does not
wish to pay in full for all of the omnibus services that it receives. The
current debate is, “do we want European level of services or Asian types of
government spending?” Analytically I reject that simplistic equation. I believe
the tool that is called for is the surgeon’s knife not an axe. I believe that if
the potential audience for a museum or concert or a government service believed
that it wanted the service that was proffered they would show up one way or
another in sufficient quantities to effect a re-pricing of the services. We
should not close support institutions and governments entirely, but just
rescale them to fit today’s demand levels. The investment implication is that
there is a third way out of our box, which is to find the level of demand for
services that people will fund for themselves in monetary or work terms. If we
see more of this new thinking, the future
will be positive for our children and grandchildren.
What
Do You Think?
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