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2017 Strategic Outlook - Vancouver (April 12, 2017)
- 3. Who We Are Founded in 1994 $4.8 billion in AUM Vancouver, Toronto, Kelowna, Richmond
- 5. How can we make entertainment more accessible?
- 6. How can we make transportation more reliable?
- 7. How can we make it easier for customers to get their products?
- 8. How can we diversify beyond stocks and bonds?
- 9. A History of Innovation 2003 2005 2006 2009 2010 2011 2013 2014 Launch of original SPIRE LP Global Equity Real Estate Primary Mortgage Balanced Mortgage Preferred Shares High Yield Bonds SPIRE U.S. Global Bond Tactical High Income Van Edge – Digital Caledonian – Royalty Renewal 2 – Sustainable Private Equity LP Alternative Strategies Precious Metals Bonds NWM Core Portfolio Bonnefield – Farmland U.S. Equity Income 1995- 2003 Individual Real Estate LPs Mortgage Investments + NWM develops Private Giving Foundation First Private Investment Pool (Strategic Income Fund)
- 10. A History of Innovation 2016 20172015 SPIRE Value Add Grosvenor Partnership NWM Farmland LP
- 11. Chief Investment Officer Rob Edel
- 12. Our Agenda 2016 in Review Investment Strategies Dr. Trump Treatment Options Economic Diagnosis Make the Economy Great Again
- 13. 2016 in Review S&P 500 Trump Bump Election UncertaintySearch For Yield Recession Fears Brexit Trump Elected
- 14. 2016 in Review U.S. 10 Year Treasury Bond Yields Trump Bump Election Uncertainty Search For Yield Recession Fears Brexit Trump Elected
- 15. U.S. GDPPurchasing Manager Index 2016 in Review U.S. Economy New Jobs NFIB Small Business Optimism
- 16. WSJ – July 30, 2016 2016 in Review U.S. GDP Symptom: • Why isn’t the economy great? 4.1% 3.8% 2.7% 2.1%
- 17. Economic Diagnosis Why the Economy isn’t “Great”
- 18. Economic Diagnosis Doctor Robert Gordon – Productivity Slowdown WSJ – Aug 10, 2016 Dr. Robert Gordon Productivity Slowdown • Supply-side secular stagnation • Productivity gains from IT over • Norm is lower productivity “We wanted flying cars, but instead we got 140 characters.” - Peter Thiel
- 19. Economic Diagnosis Doctor Larry Summers – Secular Stagnation Dr. Larry Summers Secular Stagnation • Not enough demand • Leads to lower investment • Lack of demand creates lack of supply • Need to borrow more – fiscal stimulus Business Insider – Aug 17, 2106
- 20. Economic Diagnosis Doctor’s Reinhart & Rogoff – De-leveraging Dr. Carmen Reinhart Dr. Kenneth Rogoff Deleveraging • Too much debt • Deleveraging takes 8 years • Recoveries are weaker https://www.newyorkfed.org/microeconomics/hhdc.html Recession • Deleveraging made recession worse • But GDP Growth was slowing well before deleveraging began • Debt increased because GDP slowed WSJ – Oct 6, 2016
- 21. Economic Diagnosis Doctor Mervyn King – Savings Glut Dr. Mervyn King Savings Glut • Unsustainable trade imbalance • Since early 2000’s • US growth - consumption • Asia/Europe growth - Exports • US consumer add debt • China buy US Treasury’s • Lower US interest rates • Lower US inflation WSJ – Nov 16, 2016
- 22. Treatment Options Dr. Trump or Mr. Burns
- 23. POSSIBLE OUTCOMES OF A TRUMP PRESIDENCY AT VARIOUS PLACES ON THE RISK CURVE NUCLEAR WAR BRINGING EMBARASMENT TO AMERICA ON THE WORLD STAGE GOOD DEALS SOME COOL INFRASTRUCTURE STUFF MEXICO PAYING FOR THE WALL Treatment Options Dr. Trump or Mr. Burns Business Insider Probability Return +- TRUMP IMPEACHED DUE TO RUSSIAN COLLUSION TRADE WAR WITH CHINA This presentation is not an endorsement of President Trump or an endorsement of any of President Trump’s policies. NWM has had no contact with any Russian foreign nationals in the past, nor do we intend to in the future. Any statements to the contrary are fake news.
- 24. Treatment Options Dr. Trump or Mr. Burns – Five Pillars TRUMP UNIVERSITY FACULTY OF ECONOMICS
- 25. JP Morgan Eye on the Market – Michael Cembalest Jan 23, 2017 George Mason University • Regulations across 22 industries reduce GDP 0.8%/yr. • Economy would be 25% larger if no regulations since 1980 World Bank - Ease of Doing Business Report • U.S. 51/190 for starting a business • 2012 – 40 days to get a construction permit • 2016 – 81 days 1950 – 5% of workers required a license or certificate 2016 – 30% Treatment Options Dr. Trump or Mr. Burns – Deregulation
- 26. WSJ – Nov 28, 2016 U.S. companies hold $2 trillion offshore Treatment Options Dr. Trump or Mr. Burns – Tax Reform JP Morgan Eye On The Market Michael Cembalest Feb 8, 2017
- 27. Bloomberg – Jan 11, 2017 Average U.S. commuter wastes over 40 hours/yr. waiting in traffic $1 trillion spent over 10 years Moody’s Analytics: Every $1= $1.21 in GDP Treatment Options Dr. Trump or Mr. Burns – Infrastructure Spending WSJ Mar 10, 2017 $1 trillion = +5% to Debt $4.6 trillion = ~ +25% to Debt
- 28. The Daily Shot – Aug 24, 2016 The 1% Top 2-5% Top 1% Treatment Options Dr. Trump or Mr. Burns – Trade
- 29. $347 Billion $69 Billion $65 Billion $63 Billion • U.S. Trade Deficit ~ $500 billion • Not just Tariffs - VAT • U.S. Exporter pay VAT • Foreign Exporters get a VAT Credit Treatment Options Dr. Trump or Mr. Burns – Trade Oxford University • Nearly 50% of U.S. Jobs will be automated in 20 years McKinsey &Co. • 45% of today’s activities can be automated • But less then 5% can be full automated Deloitte • Automation could lift global productivity 0.8% - 1.4%/yr over next 50 years
- 30. Pew Research - 2020-2040 • Working population +0.3% • 500,000 less +0.1% • 1,000,000 less -0.1% Treatment Options Dr. Trump or Mr. Burns – Immigration Pew Research • 8 million undocumented workers • 5% of civilian workforce • 92% between 18-64 years old • 70% in Agriculture and Construction
- 31. Treatment Options Make the Economy Great Again - Education Math U.S. #38 of 71 Canada #9 of 71 Reading U.S. #39 of 71 Canada #3 of 71 Science U.S. #24 of 71 Canada #7 of 71 WSJ – Dec 8, 2016 President’s Council of Advisors on Science and Technology U.S. will need ~1 million more STEM professionals over next decade than will currently produce. Need to increase STEM degrees by 34%.
- 32. Treatment Options Make the Economy Great Again - Healthcare
- 33. The 2016 Long-Term Budget Outlook Treatment Options Make the Economy Great Again – Entitlement Spending
- 34. WSJ – Aug 21, 2016 Low/Negative Interest Rates • Lowers consumer confidence – communicate fear • Hurts savers • Increases wealth gap – low rates helps financial assets Treatment Options Make the Economy Great Again – Monetary Policy Monetary Policy • Need to normalize interest rates • If only U.S. then US$ will increase Trade • Need to balance trade flows • China, but also Germany
- 35. Investment Strategies Equities – Bull Market Strategas – Mar 20, 2017 Second Longest Fourth Highest
- 36. Investment Strategies Equities WSJ - Jan 27, 2017 RBC - Jonathan Golub “In Defense of Trump Rally – Dec 13, 2016
- 37. Investment Strategies Equities – Active Management Bloomberg – Jan 26, 2017 Correlation low % of Managers beating benchmark high ? During QE everything went up. As interest rates normalize, correlations will decrease
- 38. Economy starting to reflate Trump policies could help Risks are too the upside Monetary policy to finally normalize Equities in the short term Active Management Diversification! Summary
- 39. Chairman & CEO John Nicola
- 40. Federal Budget March 22nd Issues and Questions • Size and length of deficits • Response to border taxes • Changes to capital gains tax? • Impact of SBD on incorporated professionals • Restrict who can incorporate • Limit Income splitting • Limit retention of corporate earnings
- 42. Three Themes Demographics Shale Oil U.S. Isolationism
- 45. Trumped?
- 46. Populism
- 47. n 25% swing in 100 years
- 49. By The Numbers 35 years 130% increase
- 50. Demographics It’s windy today. No,iit’s Thursday. So am I, let’s get a beer.
- 51. Senior Moments https://familyinequality.wordpress.com/2013/02/04/is-low-fertility-americas-problem/
- 52. Demographics
- 53. More Saving Less Spending Peak Spending Age 50 Is this deflationary?
- 54. +60% gas production -65% oil imports Will the U.S. need any foreign energy?
- 55. Observations • Demographics matters and in this case the US wins • Shale oil is a game changer • Globalization is under pressure • The US is more independent then perhaps any other single country • Russia is aging and in decline • The Euro shows how hard it is to have a monetary union without a fiscal one
- 56. A Genius Bromance Daniel Kahneman • Introvert • Holocaust Survivor • Psychologist • Taught at UBC • Nobel Prize 2002 in Economics Amos Tversky • Extrovert • Israeli Sabra • Psychologist • Taught at Stanford • Died before Nobel prize
- 57. Loss Avoidance Win 85% Lose 15% Guaranteed Win Majority Guaranteed Loss Win 15%Lose 85%Majority
- 58. Seven Habits of Highly Ineffective Investors
- 59. We’re in the Gifted Program Over-Optimism 80% Think they are in the top 50%
- 60. Gambling with House Money Can we up the minimum bet? Investors increase their aggressiveness when they win first.
- 61. Increase risk when market rises Reduce risk when market drops Gambling with House Money Can we up the minimum bet?
- 62. 4-5% annual loss of return The Impact of Emotion in Investing
- 63. Emotional Investing 5.8% 1.8% Fund Investor Vanguard Value Fund 10-year return (01/2017) Name Fund Investor Vanguard Growth Stock Index 8.1% 5.3% Vanguard Small Cap Value Index 7.5% 4.2% Vanguard Small Cap Growth index 8.1% 7.2% http://www.theglobeandmail.com/globe-investor/investment- ideas/strategy-lab/index-investing/how-factor-based- investors-take-bigger-risks/article34179810/ -2.8% -0.9% -3.2%
- 64. Managing Assets More Efficiently Canadian Equities, 16.7% High Yield Bonds, 7.3% Preferred Shares, 4.5% Alternative Strategies, 15.0% Real Estate, 20.0% Mortgages, 11.0% Bonds, 9.0% Foreign Bonds, 5.4% Cash, 4.0% Foreign Equities, 12.1% 11.4% Re-Balance -7.5% 7.48% Blended 2015
- 65. What Happened ? • Prices were down 35% • Yields were up more than 50% • Rate resets and new bank preferreds were the reason • Taxes on income 20% less than interest (equal to bonds paying 8%) • Good chance of capital recovery over five years
- 66. A Tale of Two Shares 7.9% after fees 5.3% before fees Purchases at depressed prices 35% recovery In one year
- 68. • Good investor behaviour is difficult • 90% of investors do not earn the benchmarks • Volatility can bring on bad behaviour • Diversification is both safe and effective • Picking quality assets takes time and patience Behaviour and Diversification
- 69. Many Happy Returns? Can a 4% real rate of return be achieved without significant increase in risk?
- 70. Above Normal Drivers • Aging populations • Reduced productivity growth • Rising interest rates • Lower profit margins • Higher Taxes
- 71. What Are The Odds? Higher PE = lower future returns http://mebfaber.com/2010/06/09/shiller-pe- ratios-and-10yr-annualized-real-returns/
- 72. Passive vs. Active Investing 146,000 results
- 73. How Do ETFs Compare Over 10 Years? 10% 10% 22% 10% 0% 20% 40% 60% 80% 100% Canadian equities Canadian Bonds S&P 500 MSCI ETF 1st quartile over ten years
- 74. Active vs. Passive Investing What is an Active Manager? • 2007 Yale Study (Updated 2013 FAJ) • Cremers and Petajisto • Focused positions (example Oakmark Select with 20 positions) • Not always within the benchmark • Different trading strategies and not market weightedSource: Goldman Sachs Asset Management
- 75. Passive vs. Active: Another Side Can you find this?
- 76. 6.9%( .54% MER) 11.7%(.53% MER)
- 77. Active vs. Passive Investing 4.03% 6.84% 7.73% Average Return, 5 years ETFs NWM Active Client Returns Dalbar Effect means Average investor lower than this Disciplined rebalancing and asset allocation creates results better than buy/hold
- 78. Summary The Absent Super Power Know Thyself and Behave well Low Cost Active investing Rebalanced
- 79. THANK YOU This presentation contains the current opinions of the presenter and such opinions are subject to change without notice. This material is distributed for informational purposes only and is not intended to provide legal, accounting, tax or specific investment advice. Please speak to your NWM Advisor regarding your unique situation. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. NWM fund returns are quoted net of fund-level expenses. Past performance is not indicative of future results. All investments contain risk and may gain or lose value. NWM is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions.
Editor's Notes
- Agenda: Look at what happen last year In both the markets & the economy Next, we will look at some theories on why the economic recovery has been so slow Before looking at some options for getting growth moving First by President Trump And then a few of our own Finally, we’ll wind up we a couple thoughts on investing over the next year or so
- Equities overall had a pretty good year in 2016, with the S&P + 12% and TSX 21% But it wasn’t straight up , the market moved basically in 4 segments. Early in the year, the S&P 500 was quite week falling 16% by mid February Mainly due to recession fears Next the market recovered, but it was not a broad rally, most higher yielding names The market also dipped after Brexit, which added to the uncertainty The third segment was basically flat as uncertainty over the US election dominated Then finally, Trump was elect. The market initially dipped but then surprisingly rallied strong the rest of the year
- The bond market show the 4 segments even more clearly Yields fell sharply early in the year, but continued to fall until near the middle of the year, hitting absurdly low levels. This is around the same time rates in Europe and Japan were moving solidly into negative territory. Yields recovered somewhat as it became clear negative interest rates were not the answer and perhaps monetary policy had reached it’s limits. The economy was also starting to gain some traction Finally, after Trump was elected, yields briefly dipped in over night trading before rising the next date and next couple of months.
- Looking at the economy It is clear the economy hit a weak spot early in 2016 The ISM Purchasing Manager’s index dipped below 50, indicating the manufacturing industry was contracting, before recovering strongly late in the year New job growth was also weak, especially in January and May, before recovering. In line with weak job growth earlier in the year, wage growth remained very modest, especially given the unemployment rate is below 5% and near full employment levels. Wage growth is important given concerns regarding deflation Again, we have seen more strength in the second half of the year with wage growth finally starting to increase Finally, GDP growth hit a soft spell in Q4 2015 and Q1 2016, coming in under 1%, before starting to recover. While this recovery largely removed concerns the US economy has heading for a recovery, it by all means wasn’t strong, and weak GDP growth has been one of the hallmarks of the recovery from the financial recovery. Not only has this recovery been weak, however, growth has been sub par for a while
- As can been seen in this chart, growth in the 1980’s was over 4%, before slowing to just under 4% in the 1990’s In the last two recoveries, however, there appears to be a significant secular decline in growth, with the recovery in starting in 2001 below averaging 3%, and the latest recovery only averaging just over 2% real GDP growth. In Q4 2016, in fact, GDP growth was under 2% again. This is important because we typically attribute the current slow growth recovery to the fallout from the financial crisis, but really this has been evolving over a much longer time period. The big question is why. There is not point trying to figure out how to make the economy great again if we don’t understand why it has slowed in the first place. And why is not clear cut There is much debate and many different theories. We can see the symptoms, we just don’t know what is causing it. On TV, when there was a medical case that had the doctor’s stumped and lives were at risk, the patient was sent to see Doctor House.
- And I think this is what we need now. We need Dr. House to look at the symptoms and diagnose “How to make the economy great again”. Now on the old TV series, House didn’t work alone, he had a team of doctors that helped him brain storm through various ideas. So tonight, we are going to propose 4 different therories from four different Doctors that Dr. House might want to consider
- Next up is Dr. Robert Gordon, who wrote the book “The Rise and Fall of American Growth Dr. Gordon makes the case that the large productivity gains of the past are behind us. Future gains from technology can’t match those of electricity, motor cars, petro chemicals or indoor plumbing He makes the point that many of the recent technology advances are more geared to entertainment than productivity Gordon doesn’t really offer solution to the problem, but rather makes the case that strong productivity growth experienced in the past has been the exception rather than the rule, and we should lower our expectations. The chart here shows the evidence in Dr. Gordon’s favor as productivity has been slowing and is presently estimated to be only about 0.5%, well below the normal 2-4% range
- Dr Larry Summers is next to give Dr. House his views. Summers, an former Treasury Secretary under the Clinton Administration and current Harvard professor (and president) Agrees with the secular stagnation theory, but rather than a supply issue, he believes demand is the problem Namely American households are not spending enough. This lack of demand or spending has resulted is a pullback in corporate investment and thus the slow demand growth has thus created a slowdown in supply and productivity Summers solution is increased government spending in order to make up the short fall in demand Interest rates are low so it is ok to increase debt even higher And for this reason, interest rates will need to be kept low for the foreseeable future. This is the opposite to what Reinhart and Rogoff believe. Summers is vague when it comes to identifying the cause of the demand shortfall But as can be see in the following chart the preference for saving over spending is clearly evident Income inequality, the erosion of the middle class, uncertainty over job security and retirement saving is likely a major cause
- Well, let’s go to our first Doctor, which is actually a team, Dr. Carmen Reinhart and Ken Rogoff. Apart from being prominent Harvard professors, Reinhart and Rogoff are known for writing the book “It’s different this time” which basically makes the case the financial crisis was caused by US households accumulating too much debt and the slow recovery is a result of the deleveraging cycle, which they estimate has historically taken 8 years. We tend to be sympathetic to the deleveraging theory. Borrowing money to spend to today is basically bringing forward future growth, so it makes sense that it would lead to slower growth in the future if & when it is paid back. As can be seen in this chart showing US household debt building up before the recession, and then declining . The problem is as we showed before, GDP started to slow well before the financial crisis/recession, so the while the deleveraging process has likely contributed to the slow growth recovery, it not the entire answer. It is more likely that slow growth and the resulting slow income growth was the reason US households increased debt as their tried to maintain their standard of living while incomes stagnated. In this way, debt and the subsequent deleveraging was caused by the slow economic growth, not the other way around
- Finally, Dr. Mervyn King weigh in. Dr. King is a former governor of the Bank of England and author of the book, the End of Alchemy In the book. King makes the case that there has been a major imbalance in the world economy brewing since the early 2000’s that is unsustainable The US has run massive trade deficits while Asia (meaning China) and to a lessor degree Europe (meaning Germany) have been running massive surpluses. This chart clearly shows how the U.S. current account deficits are matched by surpluses in China and Europe. King views coincide with Reinhart and Rogoff in pointing to the large amount of debt accumulated by US household’s since 2000 as being part of the problem But then goes the next step and points out that the vast amount of US dollars accumulated by countries like China effectively resulted in a savings glut as they were used to buy US treasury’s As a result, this massive influx of demand for US dollars resulted on In lower interest rates, and lower prices All of this was good for US consumers, but bad for US workers who lost their jobs Kings view makes sense, Before the financial crisis, many felt the US dollar was at risk because of the massive trade deficit and would plummett if China started to sell their vast horde of treasury bonds. As it tunred out, the oppsote has happended
- All four theories likely play a role, but deleveraging in combination with Dr. Kings savings glut appear most instruction to us. But there is one for Doctor to hear from Namely Dr. Trump After all, why did markets rally so strongly after Trump was elected? Markets traded down sharply when it looked like Trump was going to win But rally the next day And then have continued to go up Why the turnaround? Well, using the Doctor analogy, it’s like the story of Dr. Jekyll and Mr. Hyde But in this case, we don’t know who we are going to get: Is it going to be this guy, Dr. Trump – who wants to make America great again and has some ideas on how to do it. Or is it going to be more like this guys, Mr. Burns?
- On November you woke up and saw the headlines in the paper that Donald Trump was going to be the next president of the United State this is like what immediately went through your head: Will Trump Flourish…..or fail? Never has a president so polarized, not only Americans, but the world And it very emotional People are scared We borrowed this idea from Business insider Using a normal distribution curve, we have charted the possible outcomes of a Trump presidency or a risk curve. Outcome or risk, from negative to positive, is horizontal Probability, from low to high, is vertical Moving left to right, or very negative outcome or risk but low probabilitity Is Nuclear War, clearly the worse possible outcome, but hopefully very unlikely An economic crisis due to a default, slightly more likely, but at least not the end of humanity The possibility that Trump is impeached, chances are better That he bring embarasment – well that ship has sailed On the more positive but increasingly unlikely side He could negotiate some good deals And build some cool stuff And maybe even get Mexico to build a wall Who knows. Trump is very unprictable, and it’s hard to predict what will happen But tonight, we are going to stick to the economic benefits, because this is what we believe the market is reacting to. And we think some of his policies have merit. See disclaimer
- There are basically five pillars to Dr. Trump platform Deregualtion Corporate Tax reform Infrastructure spending Trade Immigration The first two he should get down and they are positive for the economy The next two are less clear And the last makes no sense what’s so ever
- Deregulation As you can see in this chart according to surveys, increased regulation is cited as one the number one issues facing small businsess And small businesses create more than 80% of all new jobs According to GM University Regulations reduce GDP by 0.8%/yr And the economy would be 25% larger if no additional regulations since 1980 According to the World Bank The U.S. ranks 51st for ease of starting a business In 2012 it took 40 days to get a construction permit Last year it took 81 days In 1950 – 5% of workers required a license or certificate Last year - 30% require some kind of certification to do their work Trump has already implemented executive order to decrease regulation For every new regulation created, two will have to be eliminated This should increase productivity and growth
- Next pillar is corporate tax reform As you can see in this chart, tax rates around the world have been falling, while the US has been stuck at 35%, one of the highest in the world As a result companies have been leaving the U.S. tax jurisdiction by buying companies outside the U.S. and moving their head office and manufacturing offshore. While the plan hasn’t been finalized, Trump and the Republicans want to lower the Tax rate and level the playing field. They are also to help US companies re-patriate the nearly $2 trillion in cash stuck in foreign subsidies that can’t be brought back to America without incurring the higher US Tax rates. The problem is lowering taxes without generating any offsetting revenue will increase the US budget deficit, as see in the chart on the right. Anything Trump can do to increase corporate profits, through either lower taxes, and/or bring more companies back to the US, is good for growth At the very least, look for some kind of legislation or tax holiday to get $2 trillion back to the US.
- Even at a lower tax rate, bringing this $2 trillion back onshore will create tax revenue And one use for it could be instrastructure spending This one should be easy – during the campaing both parties were promising spending on instrastructure. Not only would this satisfy Larry Summers call for more fiscal spending, but it is badly needed As seen on the chart on the left, U.S. instructure is badly in need of an upgrade, with government assets at their oldest age on record, and private assets at their oldest since 1955 This hurts productivity The average US Commuter wastse over 40 hours a year in traffic As per Larry Summers, it could also give a boost to demand Trump want to spend $1 trillion, which over 10 years could employ 800,000 for 5 years Moody’s estimates the impact on GDP would be even higher The only problem? Again, how to pay for it As seen in the chart on the right, there is an estaimted $4.6 trillion need in order to bring America’s instructure up to finactioning levels Just $1 trillion would add 5% to debt 4.6 trillion would increase debt 25% Fincally respsonible Republicans won’t go for this. He will get some of this, but private funded energy related infrascture is the best bet.
- Trade is more controversial. This chart is basically why Trump won the election, and Hilary lost. It shows globally from 1998 to 2008 which income group experienced the highest increase in income. Who did the best were people in the top 1%, the very rich, and people around the 60th percentile, which on a global perspective was dominated by the Asian middle class, or China. The group that had virtually no income growth was those in around the 80th percentile , which was domininated by the US middle class. In fact McKinsey believes 81% of Americans have had flat or declining income over the past decade. This chart is also referred to as the “Elephant” chart
- Trade is a big reason why income have stagnated in America, and as you can see from this chart, American companies are not competing on a level playing field And it’s not just tariffs. The US is one of the few countries in the worlds that does have a VAT tax. If a US companies exports to Mexico, at 20% VAT is immediately levied When Mexican companies export to the US, however, they are credited back to the 20% VAT under the assumption that a VAT will be applied by the destination country, which in the case of the US, is not. The following chart show the total Average tariff and VAT of countries around the world. The darker the blue, the higher the countries average tariff and VAT. In the case of the US, the colour is very light, with tariffs averaging only 9% China is darker, at 27% Japan is actually quite low, at 12% Germany is 24% Mexico is 23% Trump is right about trade being unfair, he is wrong to blame it on free trade deal, as only Mexico has a trade deal with the US The US has a trade deficit of about half a trillion dollars, $250 million is China US needs to level the playing field and help US wages grow Dr. King would agree.
- Immigration we just flat out don’t get. Economic growth is basically population growth plus productivity growth We have already discussed the challenge for productivity growth, but population growth faces an even bigger hurdle The US population growth has been decelerating and only grew 0.7% in 2016 Pew Research estimates grwoth will decline to 0.3% in 2020-2040 If immigration is reduced by 500,000 +0.1% If immigration reduced by 1,000,000 -0.1% As for undocumented workers Most are 18 – 64 years old – the right demographic 70% work in agriculture or construction
- As can be seen on this chart, the US is falling behind when it comes to education According to the Program for International Student Assessment, or PISA scores in 2015 The US scored 38 out of 71 countries in Math 39 out of 71 in reading And 24 out of 71 in Science It is estimated the US will need 1 million more STEM graduates than it currently produces Need to increase STEM degrees by 34% Manufacturing jobs require more skilled workers 2000 – 53% or workers only had high school 2015 – only 9% had only a high school education
- Overall, most of Trump policies should help long term growth Even if just a few of them get passed, it’s good for growth But we have some that he appears to have forgotten First, healthcare Yes, the Republicans are trying to replace Obamacare, but at best it will be a minor improvement What is striking is how much money the US spends versus outcomes. As seen in this chart, the US spends by far the most of any country on healthcare but has lower life expectancy than most developed nations, and it’s been getting worse. Nothing that has been discussed by Trump or the Republican is going to change this. Healthier workers are more productive workers Obesity, drug abuse, all play a role But if you want to make the economy great again, America needs to get a better return for the money they are spending on healthcare According to Gallup, since 1980, inflation has increased 250%, while healthcare spending has increased 500% Education spending actually increased 900%, which is where we will go next.
- Trump has mentioned no plans to tackle out of control entitlement spending program, and in fact has promised to leave them in tact. Every politician in Washington knows the current program spending is unsustainable As seen in this chart the aging population means Health Care spending and social security spending over the next 30 years in projected to grow such that it would leave very little room for any discretionary spending without incurring greater and greater budget deficit. The US will eventually hit a fiscal wall if this is not addressed.
- Finally, monetary policy needs to be normalized Right now, the over night Fed fund rate is 75 – 100 basis points As this chart shows, during a recession the Fed normally lowers rates by 500 basis points This was one of the reasons the market was anxious earlier in 2016 The economy was softening, but there was really nothing the Fed could do Negative rates in Japan proved detrimental and panicked the market With the economy improving, the Fed needs to start normalizing interest ratres Low rates hurt growth, they make businesses and consumers less confident and cause people to save more and spend less They also increase the wealth gap as it inflates financial assets. If the US is the only country that increases rates, then will cause the US dollar to go up Need a plaza accord type agreement Need to balance trade
- The current bull market has been the second longest and fourth highest since the great depression Part of this is due to Trump and his proposed policies Some of which he might not get passed Even if he gets some passed, however, this is good for markets The economy was starting to reflate even before the election Two additional concerns, however Higher interest rates Higher inflation
- What does this mean for investing? Interest rates are going to go up If Trump is really successful they could go up a meaningful amount This is bad for bonds Equities, however, should benefit from a stronger reflating econony. Two concerns, however: Inflation and higher interest rates have historically been bad for equity valuations We think investors have time on both Higher interest rates hurts valuation, but only when interest rates start to slow economic growth, which historically has been when the 10 year hits 5% We are currently at 2.5% Same with inflation. Historically spikes in inflation have corresponded with declining PE ratios, but historically only when inflation has spiked above 4%. The sweet spot for valuations, is actually when inflation is between 1% to 3%, as was the case in the early 2000’s, and where we are today. There will come a time if the economy continues to strengthen that we become more concerned with inflation and interest rates, but for now, both are actually quite accomodative, leaving valuations to drift higher with a growing economy
- The current environment could also be becoming more attractive to active management. Much has been written about investors flocking to low fee ETF’s that track an index versus active fundemental managers that are unable to beat their benchmarks, but a normalization of monetary policy and higher interest rates, should help active managers relative performance As seen in this chart, active managers tend to out-perform when stocks start to become more uncorrelated. When the cost of capital is close to zero, its harder to differentiate a good company for a bad one. Higher interest rates will begin to separate the good and the bad, which should favor active managers Of course as mentioned before, it also means that the normal business cycle will again become a factor, meaning the economy and stock market will eventually turn lower. The current bull market at over 8 years old is the second longest since 1928 largely for this reason
- In Summary The economy has started to reflate, which is why we saw stocks and yields start to move higher mid way thru last year Leaving his unpredictable character aside, Trumps policies should help growth There is some short term risk the market gets a head of itself and discounts too much and Trump falls short on various programs But with the Republicans controlling congress as well, he should make some progress Because of this, risk for the market is to the upside This also means, however, that monetary policy should start to normalize and inflation could move higher This would normally be bad for stock, but not at these levels We would still favor stocks over bonds We also think active management will have better relative performance, finally And as the business cycle advances, asset class performances will deviate more, and diversification will become even more important.