NWM Financial Advisor Mark Therriault and NWM CIO Rob Edel examine current events and trends that may impact investors and assess the effectiveness of several wealth management strategies.
3. Our Speakers
Rob Edel
Chief Investment Officer
Mark Therriault
Chairman & CEO
Mark Therriault
Financial Advisor
4. Who We Are
Founded in 1994
$4.8 billion in AUM
Vancouver, Toronto, Kelowna, Richmond
5. Budgeting
Cash Flow and
Compensation
Estate And
Succession
Planning Legal
Coordination And
Document Retention
Coordination of
Tax Planning
Philanthropic
Giving And
Management
Asset Allocation
And Investment
Management
Insurance
Placement And
Management
Coordination
&
Management
Our Focus: Total Integration of Financial & Wealth
Management Strategies
13. 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
14. 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
15. 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
16. 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
18. 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.
20. 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
21. 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
22. 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
23. The Daily Shot – Aug 24, 2016
The 1%
Top
2-5%
Top 1%
Treatment Options
Dr. Trump or Mr. Burns – Trade
24. $347 Billion
$69 Billion
$65 Billion
$63 Billion
• U.S. Trade Deficit ~ $500 billion
• Not just Tariffs - VAT
• U.S. Exporter pay VAT
• Foreign Exporters get a VAT Credit
Treatment Options
Dr. Trump or Mr. Burns – Trade
Oxford University
• Nearly 50% of U.S. Jobs will be automated in 20 years
McKinsey &Co.
• 45% of today’s activities can be automated
• But less then 5% can be full automated
Deloitte
• Automation could lift global productivity 0.8% - 1.4%/yr over
next 50 years
25. Pew Research - 2020-2040
• Working population +0.3%
• 500,000 less +0.1%
• 1,000,000 less -0.1%
Treatment Options
Dr. Trump or Mr. Burns – Immigration
Pew Research
• 8 million undocumented workers
• 5% of civilian workforce
• 92% between 18-64 years old
• 70% in Agriculture and Construction
26. Treatment Options
Make the Economy Great Again - Education
Math
U.S. #38 of 71
Canada #9 of 71
Reading
U.S. #39 of 71
Canada #3 of 71
Science
U.S. #24 of 71
Canada #7 of 71
WSJ – Dec 8, 2016
President’s Council of Advisors on Science and Technology U.S. will need ~1 million more STEM professionals
over next decade than will currently produce. Need to increase STEM degrees by 34%.
28. The 2016 Long-Term Budget Outlook
Treatment Options
Make the Economy Great Again – Entitlement Spending
29. WSJ – Aug 21, 2016
Low/Negative Interest Rates
• Lowers consumer confidence – communicate fear
• Hurts savers
• Increases wealth gap – low rates helps financial assets
Treatment Options
Make the Economy Great Again – Monetary Policy
Monetary Policy
• Need to normalize interest rates
• If only U.S. then US$ will increase
Trade
• Need to balance trade flows
• China, but also Germany
33. Treatment Options
Make the Economy Great Again – Monetary Policy
http://www.canadianbusiness.com/economy/canadas-50-most-important-economic-
charts-for-2016/
34. Treatment Options
Make the Economy Great Again – Monetary Policy
http://www.canadianbusiness.com/economy/canadas-50-most-important-economic-
charts-for-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
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
41. 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
48. 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%
49. 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
50. • Prices were down 35%
• Yields were up more than 50%
• Taxes on income 20% less than interest (equal to bonds
paying 8%)
• Good chance of capital recovery over five years
What Happened ?
51. A Tale of Two Shares
7.9% after fees
5.3% before fees
Purchases at depressed
prices
35% recovery
53. • 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
54. Many Happy Returns?
Can a 4% real rate of return be achieved without
significant increase in risk?
56. 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 and 2nd quartile over ten years
57. 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 weighted
60. 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
creates results better than
buy/hold
61. CAN CI Bal Inc (PSG) 100/100 (PS1) Trimark Glbl Balanced Cl Srs P USD IG/GWL Balanced GIF 75/100 A
TD Advantage Balanced Portfolio-ABMO Asset Allocation - ARBC Bal Fund Series A
Source:GlobeInvestorGoldApr4,2016
Beyond Stocks and Bonds
62. Beyond the 60/40 Approach
Canadian Equities
Foreign Equities
Bonds
Foreign Bonds
High Yield Bonds
First Mortgages
Second Mortgages
Real Estate
Private Equity
Preferred Shares
Alternative Strategies
NWM
66. Hard Asset Real Estate
SPIRE RE LP (2005) SPIRE US LP (2010) SPIRE VA LP (2014)
$2 billion gross assets ($1 billion client equity)
67. Private Equity vs. Public Equity
Northleaf: “Private equity should
continue to provide investors with a
premium of 3% to 5% relative to
public markets over the long term”
Issues with Private Equity
• Large minimum investment
• No liquidity for 7 to 10 years
• Capital calls and return of capital
• Concentration risk
72. 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.
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.