Trump’s economic “plan”

So far the Trump administration has launched two countervailing economic thrusts:

income taxes.   

Starting in 2018, the corporate tax rate was reduced from a highest-in-the-world 35% to a more nearly average 21%.  The idea was to remove the incentive for highly taxed US-based multinationals, like pharmaceutical firms, to shift their businesses elsewhere.  In the same legislation the ultra-wealthy received a very large reduction in their income taxes, as well as retention of the carried interest provision, a tax dodge by which private equity managers convert ordinary income into less highly taxed capital gains (this despite Mr. Trump’s campaign pledge to eliminate carried interest).  Average Americans made out less well, receiving a modest reduction in rates coupled with loss of real estate-related writeoffs that skewed the benefits away from heavily Democratic states like California and New York.

Washington made little, if any, attempt to end special interest tax breaks to offset the lower corporate rates.  The result in 2018 was a yoy increase in individual income tax collection of about $50 billion, more than offset by a drop in corporate tax payments of about $90 billion.  Given the strong economy in 2018, the IRS would likely have taken in $150 – $175 billion more under the old rules than it did under the new.

What I find most surprising about the income tax legislation is that the large deficit-increasing fiscal stimulus it provides came at a time when none was needed–after almost a decade of continuous GDP growth in the US and the economy at very close to full employment.

the tariff wars.

Right after his inauguration, Mr. Trump pulled the US out of the Trans-Pacific Partnership, a trade group aiming to, among other things, fight China’s theft of intellectual property.  However, exiting the TPP for a go-it-alone approach hurt US farmers, since it also meant higher (and escalating each year) tariffs on US agricultural exports to TPP members, notably Japan.

Next, Trump presented the tortured argument that: (1) that there could be no national security if the economy were not growing,  (2) that, therefore, the presence of foreign competition to US firms in the domestic marketplace threatens national security,  (3) that Congress has given the president power to act unilaterally to counter threats to national security, so (4) Trump had the authority to unilaterally impose tariffs on imports.  So he did, in escalating tranches.

No mention of the fact that tariffs slow GDP growth, so under the first axiom of Trump logic are themselves a threat to national security.

Not a peep from Congress, either.

Recently, Mr. Trump has announced that he also has Congressional authority, based on a 1977 law authorizing sanctions against Iran, to order all US-based entities to cease doing business with China.

Results so far:

–the predictable slowdown in economic growth in the US

–retaliatory tariffs that have slowed growth further

–higher prices to consumers that have for all but the ultra-wealthy eaten up the extra income brought by the new tax law

–a sharp drop in spending on new capital projects in the US by both foreign and domestic firms

–tremendous pressure by Trump on the Federal Reserve (in a most un-Republican fashion (yes, I know Nixon did the same thing, but still…)) to “debase” the dollar.

Why?

A falling currency can temporarily give the appearance of faster growth.  But it can also do serious, and permanent, damage to a country by reducing national wealth (Japan is a good example).  Its only “virtue” as a policy measure is that it’s hard to trace cause and effect–politicians can deny they are mortgaging the country’s heritage to cover up earlier mistakes, even though that’s what they’re doing.

–an apparent shift in the goal of US trade negotiators away from structural reform in China to resuming purchases of US soybeans

my take

–if there had been a plan to Trump’s actions, tariffs would have come first, the tax break later.  The fact that the reverse happened argues there is no master strategy.  Again no surprise, given Trump’s history–which people like us can see most clearly in his foray into Atlantic City gaming.

–what a mess!

A better way to combat China?    The orthodox strategies are to strengthen the education system, increase scientific research spending and court foreign researchers to come to the US.  Unfortunately, neither major domestic political party has much interest in education–Democrats refuse to fix broken schools in large urban areas and Republicans as a party are now against scientific inquiry.  The white racism of the current Washington power structure narrows the attraction of the US in the eyes of many skilled foreigners.   The ever-present, ever-shifting tariff threat–seemingly arbitrary levies on imported raw materials and possible retaliatory duties on exported final products–means it’s very risky to locate plant and equipment in the US.

For what it’s worth, I think that were the political situation in the US different there would be substantial Brexit-motivated relocation of multinationals from London to the east coast.

investment implications

To my mind, all this implies having a focus on software companies, on low-multiple consumer firms that focus on domestic consumers with average or below-average incomes, and on companies whose main business is in Asia.  Multinational manufacturers of physical things for whom the US and China are major markets are probably the least good place to be.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

fr

$30 billion in new tariffs–implications

Yesterday Mr. Trump announced by tweet that he intends to impose a 10% duty, effective next month, on all US imports from China that are not yet under tariff.  That’s about $300 billion worth, which would produce an extra $30 billion in tax revenue for the government, were imports to continue at the pre-tariff rates.

What’s different about the current move is that tariffs will be predominantly on final goods, that is, stuff that’s completely made and ready for sale, things like like toys and everyday clothing.  For the first time, tariffs won’t be disguised.  Up until now, they’ve been mostly on raw materials or parts, where the connection between the tax and price increases of the final product is obscured–the political fallout therefore milder.   The new round will be more visible.

 

Standard microeconomics will apply:

–the cost of the new tax will be borne in part by US companies and in part by consumers, depending on how much market power each has

–over some period of time, companies and consumers will both look for lower-price substitutes for items being taxed.  Firms will, say, offer lower quality merchandise at the current price point; consumers will either buy fewer items or shift to cheaper merchandise

 

The new tariff amounts to a subtraction of about $250 from family discretionary income, meaning income after taxes and all necessities are taken care of.  That’s not a big number.  As with the other Trump tariffs, however, average Americans will be disproportionately hurt.  The bottom 20% by income have less than nothing after necessities now, so they will be the worst off.  Residents of the poorest states–eight of the bottom ten voted for Trump–as well.  So too anyone on a fixed income.

 

Netting out the positive effect of the 2017 income tax cut, the only winners are the top 1%, traditional Republican voters.  Other Trump supporters appear to be the biggest losers, although far they don’t appear to have connected the dots.  Nor does anyone in Congress seem to be questioning the administration rationale that national security does not require better infrastructure and education but does demand more expensive t-shirts and toys.

 

The stock market selloff underway today doesn’t seem to me to be warranted by the new tariff.  And it’s not exactly news that Washington is dysfunctional:  we’re led by a man who thinks our independence was won by controlling the airports; the leading opposition candidate somehow mistakenly thought his businessman/repairman/car salesman father was a laborer in the Pennsylvania coal mines.  So the most likely explanation is that in August human traders/portfolio managers head for the beaches, leaving newspaper-reading robots in control of Wall Street.

If that’s correct, the thing to do is to look for stocks to buy where the selloff appears crazy, getting the money from clunkers, which typically hold up in times like this or from winners whose size has gotten too big.

 

 

 

 

 

 

 

 

 

 

Macroeconomics for Professionals

Starting-out note:  there’s an investment idea in here eventually.

I’ve been going through Macroeconomics for Professionals:  a Guide for Analysts and Those Who Need to Understand Them, written by two IMF professionals, with the intention of giving it, or something like it, to one of my children who’s getting more interested in stock market investing.  I’m not finished with the book, but so far, so good.

counter-cyclical government policy

The initial chapter of MfP is about counter-cyclical government policy, a topic I think is especially important right now.

Picture an upward sloping sine curve.  That’s a stylized version of the pattern of economic advance and contraction that market economies experience.  Left to their own devices, the size of economic booms and subsequent depressions tend to be very large.  The Great Depression of the 1930s that followed the Roaring Twenties–featuring a 25% drop in output in the US and a decade of unemployment that ranged between 14%-25%–is the prime example of this.  National governments around the world made that situation worse with tariff wars and attempts to weaken their currencies to gain a trade advantage.  A chief goal of post-WWII economics has been to avoid a recurrence of this tragedy.

The general idea is counter-cyclical government policy, meaning to slow economic growth when a country is expanding at a rate higher than its long-term potential (about 2% in the US) and to stimulate growth when expansion falls below potential.

 

applying theory in today’s Washington

Entering the ninth year of economic expansion–and with the economy already growing at potential–Washington, which had provided no fiscal stimulus in 2009 when it was desperately needed, decided to give the economy a boost with a large tax cut. Although pitched as a reform, with lower rates offset by the elimination of special interest tax breaks, none of the latter happened.  Then, just a few days ago, Washington gave the economy another fiscal boost.  Mr. Trump, channeling his inner Herbert Hoover, is also pressing for further interest rate cuts to achieve a trade advantage through a weakened dollar.

This is scary stuff for any American.  The country faced a similar situation during the Nixon administration, which exerted pressure on the Fed to keep rates too low during the early 1970s.  Serious economic problems that this brought on didn’t emerge until several years later, when they were compounded by the second oil shock in 1978 (that was my first year in the stock market; I was a fledgling oil analyst).

why??

Why, then, is Mr. Trump trying to juice the US economy when he should really be trying to wean it off the drug of ultra-low rates?

I think it’s safe to assume that he doesn’t understand the implications of what he’s doing (the thing Americans of all stripes recognize, and like the least, about Mr. Trump, a brilliant marketer, is how little he actually knows).   If so, I can think of two reasons:

–as with many presidents a generation ago, he may see ultra-loose money as helping his reelection bid, and/or

–the “easy to win” trade wars may be hurting the US economy much more deeply than he expected and he sees no way to reverse course.

If I had to guess, I suspect the latter is the case and that the former is an added bonus.  I think the main counter argument, i.e., that this is all about the 2020 election, is that the administration seems to be systematically eliminating any parties/agencies that want to investigate Russian interference in domestic politics.

Either would imply that software-based multinational tech companies that have led the stock market for a long time will continue to be Wall Street winners–and that the weakness they are currently experiencing is mostly an adjustment of the valuation gap (which has become too large) between them and the rest of the market.

In any event, interest rate-sensitives and fixed income are the main areas to avoid.  If the impact of tariffs is an important motivating factor, then domestic businesses that cater to families with average or below-average incomes will likely be hurt the worst.

 

 

 

 

the Huawei questions

Huawei is a Chinese telecom company.  It makes niftier smartphones than Apple and has 5G technology that’s better than anything US companies can offer.  The company is certainly a competitive threat to US cellphone makers, as well as to manufacturers of telephone equipment worldwide.

The question that arises with a firm like Huawei, also the perennial question raised about dominant US tech companies since WWII, is the degree to which Huawei will act in the national interest of China.  That is, can/will Beijing eavesdrop on conversations or collect/alter data being carried on Huawei networks–maybe even stop them operating, if Beijing so chooses.

The Trump response to Huawei’s technological edge has been two-fold:  to blacklist Huawei, and to aid its US rival, Qualcomm.

Two questions:

1.is this the proper response?   …or is it like Mr. Trump’s invoking national security to price better-performing Asian and European cars to unaffordable levels, forcing citizens to buy US automobiles that three-quarters of the population now shun?

I’m guessing the former.

 

2. does Mr. Trump have a strategy?   Has he thought out the consequences of what he’s doing?

Here my guess is no.  Otherwise, he would have been promoting science education and welcoming skilled foreign scientists, rather than compelling tech firms to relocate their tech hubs to Canada and elsewhere.

(An aside, sort of:  I was recently listening to a podcast which dealt with Mr. Trump’s weak record in real estate by saying that he was rich before he started in the family business and he remained rich after negotiating treacherous waters during the 1980s.  Really?

My read of the president’s career:  he ended (prior to licensing his name and performing in a reality show) with about as much money in real terms as he started with.  So in that highly technical sense what the podcast said is right.  Over the same period, however, a run-of-the-mill real estate developer made, adjusting for risk, four times what Trump did.  A really competent real estate person might have made 10x.  In achieving his result, Mr. Trump was also aided by the public listing, debt refinancing and subsequent bankruptcy declaration of his Atlantic City casinos.  Although Mr. Trump prevailed in the litigation that ensued, as a professional investor I find this an eyebrow-raising episode.

Mr. Trump was “successful” in running a business in the sense that he went fishing during a time when tons of fish were jumping into the boat and he came back with the boat.  Nothing in it …though he was in the area where the most fish were to be had   …and he was soaking wet in a way that suggested he fell out at some point.

I’m also extrapolating from that.)

investment implications?

Throughout my investing career, politics has never made much of a difference.  In fact, to my mind professional investors who based their decisions on reading Washington’s runes simply revealed the poverty of their thought.  I think now is different.  Mr. Trump has exposed the surprising weakness of Congress.  The reality of China as a rival superpower to the US has been made clear.

Unfortunately, Mr. Trump is executing an early twentieth-century strategy to solve a twenty-first century dilemma.  Arguably, but not necessarily, this is a drama where the US is playing the role of post-WWI Britain and China is the 1920s US.  We all know how that worked out. By simultaneously discouraging innovation at home and forcing China to up the pace of its own tech progress, I think the administration is auditioning for the UK part, and thereby potentially doing significant long-term harm to the economy.  Ironically, those hurt most badly will likely be Mr. Trump’s most rabid supporters.  Withdrawal from the Trans Pacific Partnership, for example, is already putting US farms at a disadvantage vs. Australian, Canadian and New Zealand rivals.

What to do?

I’m taking a two-pronged strategy in the US.  I’m looking for companies with worldwide reach and innovative products.  For domestically-oriented companies, I’m taking an approach that might be called, for lack of a better term, “value with a catalyst” (regular readers will likely know that I don’t believe traditional value works any more in the US).  This term usually means a value stock where a turnaround has progressed far enough that the path for the firm to return to health can be identified.  E.g., the stock is trading at 20% of book value in an environment where healthy firms are trading at book.  Only “deep” value investors might be interested.  Then the company recruits a CEO who’s a turnaround expert and the stock begins to trade at 30% of book–this is value with a catalyst.  I’m not so interested in book, though.  I’m looking at price/cash flow.

I’m also looking harder in the Pacific Basin.  I’m even thinking about the EU, although that’s an area where market participants have a thorough value orientation and where lots of local market lore is needed to be successful.  So I find it a bit scary–better said, the rewards not worth the effort.