The difficulty lies not so much in developing new ideas as in escaping from old ones.
John Maynard Keynes
Our insights, reflections and musings on the most timely topics relevant to managing your investments.
2018 is off to a fast start. We actually got tax reform to end 2017, and the University of Georgia Bulldogs made it to the National Championship game for college football. Is it any surprise that much of the nation is feeling like hell must have frozen over? Well, Alabama took care of business and […]
Have you seen Disney’s “Prep and Landing” children’s Christmas specials? They are worth the watch. The premise is that Santa is assisted with his Christmas Eve duties by an elite team of elves who prepare each house for the big man’s arrival. Naughty children, however, are visited by another group of elves, the Coal Brigade. […]
This rally just will not end. It has changed character several times, with different segments of the market taking the lead. It has had slight pauses that might signal an oncoming market correction, but through it all this market just keeps climbing. The recent leadership has come from China. Emerging markets have been the best […]
The fact that the market has been positive thus far this week suggests to me what we already know: The computers are in charge of the short-term movement today. Investors have always been characterized as being heartless, but the machines actually are. The machines and the humans who program them are focused on tax reform. Will it get done?
Labor Day weekend is the official end of summer. It might be to the beach or to Disney World or to see Grandma, but we have all piled into the family car and gone down the road on a hot summer day. Thirty minutes into our four- or five-hour drive the kids start asking, “Are we there yet?” That is what investors want to know.
2018 is off to a fast start. We actually got tax reform to end 2017, and the University of Georgia Bulldogs made it to the National Championship game for college football. Is it any surprise that much of the nation is feeling like hell must have frozen over?
Well, Alabama took care of business and the temperatures are moderating once again. After all, we may celebrate new beginnings every January 1, but in reality, it is just another day. Of course one would not know it if she listens to the commercials for “Wealth Managers” or watches CNBC.
Every January we go through this ritual of wrapping up the previous year and then debating what new strategy we need for the upcoming year. But why? First of all, January 1 is not all that different from December 31. Secondly, if a change is needed then it is needed when it is needed, not at some random moment on the calendar.
Imagine what would have happened if Alabama’s coach, Nick Saban, had waited until next football season to change his quarterback and his game plan? UGA would be national champions. If a change is needed then it is needed now; if it is not, well then don’t fix what isn’t broken.
We have been doing this so long at Iron Capital and our clients are so loyal that I sometimes forget to remind folks what it is that makes us different. Wall Street celebrates milestones like the New Year because they are in a transaction business. They want investors to change strategies as often as possible because that means transactions, and transactions mean revenue. At Iron Capital we are in the relationship business and we make more money when your portfolio grows, not by more transactions.
The traditional financial adviser is trained as a salesperson. They spend their days servicing existing clients and prospecting for new ones. They do not spend their days reviewing every investment that their clients own and deciding if they are still appropriate. They look at the client’s portfolio when it is review time, and guess what: a change of some sort will be in order.
Will 2018 be different than 2017? There is no doubt it will; no two years are exactly alike. But, is January all that different from December? Not so much.
So what will 2018 bring in the market? In all likelihood it will be more of the same. The economy is moving ahead strongly, not just here but also globally. The stocks of international companies are still far behind their American counterparts in terms of returns, and that gap will likely continue to close. Small companies who cannot afford expensive lobbyists will likely benefit more from tax reform than large companies who benefited from loopholes. Interest rates should rise as the economy improves, but they remain low. In other words, the world did not chance substantively on January 1, and neither should your portfolio.
Nothing goes up in a straight line and it would not be surprising to see the market experience a mild correction. We would see that as an opportunity, not something to fear. If something changes then so will we, not next season but during this game. That is what makes us who we are.
2017 was a good year for our clients and 2018 is off to a great start. For all of our Alabama friends, Roll Tide, and for the rest of us, well it’s a new year!
~New Year, New Market?
Have you seen Disney’s “Prep and Landing” children’s Christmas specials? They are worth the watch. The premise is that Santa is assisted with his Christmas Eve duties by an elite team of elves who prepare each house for the big man’s arrival. Naughty children, however, are visited by another group of elves, the Coal Brigade. They get coal in the stocking with a note which says, “Try harder next year.”
So what about us? Did we just get coal in our stocking or is that a diamond? Tax reform is finally here and the Republicans have their victory, but what does that mean for us? It means that the vast majority of Americans will pay less in taxes. Beyond that, no one really knows and anyone who says they do is selling something.
I have a Bachelor of Arts degree in Economics from Wake Forest University, and maybe I am just getting more nostalgic as I age, but I miss the days when economics was more of an art and less of a science. Here is what we actually know about taxes and economic activity: We know that when you tax the private sector – individuals and companies – you take money away from the productive force in our economy and give it to the government. Government is necessary, and there are many legitimate roles of government, but government does not create productivity and growth. Government takes what is already there and redistributes it.
I hear the naysayers now, “What do you mean government does not create productivity? They build roads, etc.” This is true; providing a community-wide infrastructure is an important and legitimate role of government. But, government does not create the need for the road. We need roads because we live here and work there. It is our activity that creates the need for infrastructure and since it is a shared need, it is best fulfilled cooperatively through democratic government. It doesn’t have to be that way; as anyone who has ever been stuck in traffic in Atlanta knows, not all city streets are planned. The horses decided where the infamous Peachtree Street would meander, as they traveled the safest route along the ridge. If any visitors to Atlanta doubt Peachtree is actually a ridge I would encourage you to get out of your hotel and take a jog. (While I am on the subject, of course you can drive in the snow in Chicago; Chicago is flat and the streets are in a grid…)
I digress. It is often useful to think of the economy as a pie. One can slice it up many ways, but for our illustration we have just two slices, the private sector and the government. All growth comes from the private sector, so the bigger it is relative to the government, the more economic growth we have. Government is necessary and can only be funded by taxation. The ideal tax system is one with low rates and no loopholes. That is unfortunately politically impossible. This current reform does, however, move us in that direction, and is therefore a good thing on the whole.
I don’t expect Democrats to admit that, because it is a Republican bill. Even though corporate tax reform was on the Obama agenda. This, in theory, is something everyone agrees on, but the Republicans refused to give Obama a “victory” when he was in office, and now the Democrats refuse to go along. It is disappointing, but unfortunately not surprising. This is the state of our politics. Nothing is about policy anymore; it is all about us vs. them. We have unfortunately come to expect that from our politicians.
The sad thing is that we now seem to have this same dynamic within our supposedly non-partisan policy experts. Facts are cherry-picked to fit the pre-determined narrative, and projections that serve that narrative suddenly become fact. Projections are not fact. In fact, the only thing one can be certain of when projecting the future is that the projection will not be accurate. It might come close, but that is the best any fortune-teller can hope.
Will this tax bill add to deficits in the long-term? That depends. This bill will stimulate growth, this is certain; the unknowable question is, how much growth? The naysayers think it will add only a little to the economy and therefore it will be a net loss in tax revenue. The proponents say there will be substantial gains, and therefore the cuts will pay for themselves. The truth? Only time, not politicians or pundits, will tell.
In the meantime, enjoy a little bit more of your money, and have a very Merry Christmas!
Chuck Osborne, CFA
~What’s in Your Stocking?
This rally just will not end. It has changed character several times, with different segments of the market taking the lead. It has had slight pauses that might signal an oncoming market correction, but through it all this market just keeps climbing.
The recent leadership has come from China. Emerging markets have been the best place to be this year and Chinese technology companies have led the way. Can it last?
Yes, it can. Of course, there are never any guarantees in the financial markets and something can always go wrong, but this rally is mostly based on better company results, which means a better economy and ultimately a better consumer. We see it in the economic data and we also see it in real life.
This past Sunday was my son Charlie’s tenth birthday. For his birthday we gave him a trip, wherever he wanted to go – within reason and budget of course. He chose Disney World. Our flight to Orlando was packed; our hotel was completely full. The parks were wall-to-wall people, a large portion of whom were wearing matching t-shirts, and one brave man who won my affection by wearing a shirt which simply stated that no one was ever getting him into a matching t-shirt. Everyone must stand for something.
Perhaps the greatest signal of economic strength was found in the fact that on my son’s birthday some people – not the Osbornes – were willing to wait for 170+ minutes to ride the Seven Dwarfs Mine Train, the newest roller coaster in the Magic Kingdom.
Disney World is an interesting place. Some people absolutely love it and others absolutely hate it, but there is no doubt that it is an American landmark. I got to meet a sailor in our U.S. Navy who took his four kids to the park using tickets given to him through a military charity. It was a treat before he shipped off in a week’s time. I met a family with five sons, all adopted but no less brothers. I won’t lie, my family witnessed some rude behavior some from children but unfortunately much from parents. However, we witnessed a hundred small kindnesses as well. We witnessed the great diversity of our nation and our shared culture.
When one takes it all in he realizes that he has much for which to be thankful. In keeping with our tradition here is my list. This year I am thankful for:
~ A good year in the financial markets.
~ The United States of America, where people from all walks of life can share experiences like Disney World.
~ My children, whose enthusiasm for the small things in life reminds me of what is truly important.
~ My family, immediate and extended.
~ All of my friends.
~ As always, Mama’s pumpkin cheesecake and my loose-fitting pants which make enjoyment of said cheesecake possible.
~ Finally, for you, our clients and friends. Your trust in Iron Capital is our greatest asset and we value it every day of the year.
Chuck Osborne, CFA
It is hard to think of work when tragedy strikes like the one in Las Vegas Sunday evening. Our thoughts and prayers are with all those who have lost loved ones and suffered injuries in this truly senseless act.
Even in tragedy, life goes on and the market keeps on going. The fact that the market has been positive thus far this week suggests to me what we already know: The computers are in charge of the short-term movement today. Investors have always been characterized as being heartless, but the machines actually are.
The machines and the humans who program them are focused on tax reform. Will it get done? It brings to mind the last time tax policy was really under debate. We dedicated an issue of our Quarterly Report newsletter to the subject in 2010, which can be re-read here. Back then we were talking about raising taxes and now the talk is about lowering them, but the principles of tax policy remain the same.
The biggest area of concern for the markets is corporate taxes. The United States has the highest corporate tax rates in the developed world. Our outdated system puts us at a disadvantage for global competition. Of course, politics will be played, but this was an agenda item for the last administration as well. We need to reform our system.
Those against reform will tell you this: While 35 percent is the stated rate in the U.S., what actually gets paid is a more modest 24 percent. That number comes from the Center on Budget and Policy Priorities. The response to this argument should be to simply say, “Exactly.” You see, this is the problem in our system and it is the problem with high tax regimes in general. Politicians love to get on the stump and rant about those evil greedy capitalists. “They are going to pay their share. We’ll have the highest rates in the world.” Then they quietly say, “But we didn’t mean you, Mr. Donor. Your company will be given a loophole.”
It is very popular today to claim that the American system has become rigged, but no one then reflects on how would one actually go about rigging a system? One way would be to make tax rates very high and then give out loopholes to favored taxpayers. This may sound like blasphemy, but we might not need a tax cut right now; we are, however, badly in need of tax reform.
The biggest beneficiaries of real reform would be smaller companies. These are the ones who end up actually paying the higher rates. Of course, because of the high rates and the fact that business income is actually taxed twice if it is paid out to owners, many small businesses have gone to alternative business structures where the business income is “passed through.” This means the owners simply include the business income in their own personal taxes. This works for several types of companies, but the problem for many is that this system provides a disincentive to reinvest in the business.
If a business owner is going to have to include all the business income in his personal taxes, then why would he not at least get the personal enjoyment of that money? To grow one’s business an owner must reinvest in plants, equipment, training of workers, and ultimately more workers. If she has to pay personal income taxes even if she didn’t spend the money on herself, then why would she reinvest? The data over the last decade-plus would indicate that the answer to that question is that she wouldn’t.
Our economy cannot grow if businesses do not grow, and businesses cannot grow without investment. We need a system that encourages investment, and one that does not favor one industry or company over another. Will we get it? Doubtful, but unlike politicians who allow perfection to be the enemy of progress, the market will applaud progress. If we get anything that reasonably could be called reform, it will help the economy and that, in turn, will help your portfolio.
Chuck Osborne, CFA
~A Taxing Debate
Labor Day weekend is the official end of summer. When I was a kid, school had either just started or was about to start this week. Our summers were full of unscheduled, unstructured, and most importantly, unsupervised adventures. Today most kids (at least here in Georgia) have been back in school for a month. Everything they did this summer was scheduled, structured, and most importantly, supervised. The only thing that remains similar is the mandatory summer road trip. It might be to the beach or to Disney World or to see Grandma, but we have all piled into the family car and gone down the road on a hot summer day. Thirty minutes into our four- or five-hour drive the kids start asking, “Are we there yet?”
That is what investors want to know. The long market rally was interrupted by the month of August, which saw the S&P finish basically unchanged while small companies were actually down. The rally had already changed complexion from a broad-based celebration of hope lifting all types of companies to an only-the-strong-can-survive, FANG-driven market. That was a troubling sign. Now we have basically hit pause and many are wondering, are we there yet?
And where is “there,” one might ask? There is where we turn around and head in the other direction. In this case: down. So, are we there yet? Every time my six-year-old daughter asks that question, I tell her that it adds another hour to the trip. While that is not actually true of a car trip (which my daughter knows, and reminds me every time I say it), it can be true of the market.
There is an old saying in our business that markets climb a wall of worry. When people are saying, “It is time for a correction,” that is usually a sign that we, in fact, are not there yet. When they start saying things like, “This time it is different,” that is when it is time to worry. Yes this rally has come a long way, but it has been backed up by strong corporate results and better economic growth -v GDP growth was just revised up to 3 percent for the second quarter. It has also been prolonged because it has changed complexion. Old leaders peter out and new ones have come to the fore.
However, we have come a long way in a short time and it would not be a surprise if we slowed down. Our best guess (others might say forecast, but best guess is more accurate) is that we pause a little longer, then a stimulus comes to push us one way or the other. The most likely thing would be tax reform. If the administration and Congress could actually pull off a package, then the rally is back on. Negative stimuli are always harder to see. (In fact, most of the time no one sees it until after the fact, and then everyone claims that they really did see it. We’ll save that insight for when it happens.)
Let’s hope for the positive. We need it. This past week there was a story in The Wall Street Journal about an economic study which showed that corporate America has gotten more concentrated. There are fewer but larger companies than in the past. As this has happened, marginal profits have spiked to what the researchers say are historical heights. In a free market that would not happen because the extraordinary profits attract competition. They theorized that the cost of technology is a driver in what has led to this situation. Their data shows that this spike to profits started in 2009, which coincides with a trend for fewer start-up companies.
This research is interesting and worth pursuing. However, there seems to be another, perhaps more obvious, source of this problem: high taxes and over-regulation are two of the most effective barriers to entry ever created. The more expensive – and just plain frustrating – it is to build a company, the fewer companies will be built, as we have seen since 2009. Fewer companies means less competition, which means higher profit margins, as we have seen since 2009. Less competition for consumers also means less competition for workers, which means flat wages, as we have seen since 2009.
Tax reform would signal a true change in direction and could be very helpful to more than just the stock market. Fingers crossed they get their act together is Washington and give us something. If not, then it is more of the same and we will have to ask, “Are we there yet?”
Our thoughts and prayers remain with our friends and clients in Houston and the surrounding areas.
Chuck Osborne, CFA
~Are We There Yet?