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.
Implications
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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