September 2017 Newsletter

Tax Policy, Class Struggle, Politics and Economics


The broad layout of the new Republican tax plan is out. Don’t spend your time drilling down or getting excited about implications for 2017.  John McCain lives.  So too do far healthier Republican senators: Susan Collins, Rand Paul, and Lisa Murkowski.  And no matter your political ilk, don’t bite on the painful logic that these Republicans are blowing the opportunity of a lifetime to pass legislation given the majority they hold in both houses.  In truth, it never existed.  John McCain’s not-so-covert hostility for this President allows pragmatists to recognize that, aside from better offices, a Republican majority for economic progress never existed.  Therefore, we are more likely to get tax disappointment, muted inflation, sustained lower interest rates and a shortened economic cycle over the next three years leading up to a Presidential election year. Reread the last sentence starting with words “shortened economic cycle”, and you have the Democratic party’s dream come true.  Or as Bill Clinton would say, “it’s the economy, stupid”.  So tax reform followed by Republican mid-term giddiness is unlikely.  The public wants it.  The Democrats don’t, unless it’s on their watch.  That’s politics.  I’d give my view 75 percent probability of accuracy, dropping it to 50/50 if the Republicans are willing to a) shelve their interest in doing away with the estate tax, b) pushing the lowest rate top bracket beyond 39% and c) scaling back the negation of state and local tax deductions. The Democrats may also require some future agreement unknown to the electorate that have to do with global warming, further weakening the state of West Virginia, with its coal unemployed population, thereby converting them to Zuckerberg for President converts.  Mark Zuckerberg wants to give everyone in the country a free sustainable income so they can live their lives engaged in creative pursuits, thereby, unleashing the economic engine of America.  This would crush the dwindling middle class.  However, if the disruptive nature of robots, drones and artificial intelligence has already largely swept the middle classes away, this nation can only fund a Zuckerberg socialist state on the backs of the top 5% of earners.  This would drive the top 5% of earners to high paid tax attorneys, bitcoin, and other bizarre crypto currencies, making extraction more difficult.  And since that won’t work, tax legislators would have to change the rules, making you a top 5% earner.  Never say never.  No whining.  “It’s not fair” never works.  So, if you find your grandchildren working for a corporate robot and this robot defines your grandchild’s sustainable income below a much larger sustainable income source, only to recognize that your grandchild has no time to visit or innovate their way into digital retail heaven, you may want to repatriate your extended family to that outside the US secret place you enjoyed visiting.  Or as the line goes from the old movie, War Games, “The only winning move is not to play”, which in a world that sustains a very low worker participation rate is the new normal.

In the meantime, market volatility remains abnormally low.  This low volatility has some fundamental underpinnings.  They are; low GDP growth, low inflation, low default rates, and a low real Federal Funds rate.  Of course, as the Fed Funds rate advances, everyone should expect a moderate increase in market volatility.  However, previous instances of very low volatility have not preceded a significant sell off.  According to Credit Suisse research, there have only been two occasions since 1964 when the S&P500 has not corrected by more than 5% over 14 months, as is now the case.  Six months later the market was up 1.0% and 7.6% respectively.  While this past performance data is no assurance of future volatility trends, Credit Suisse research analysts argue that low volatility is the underlying reason relative risk adjusted returns favor equities and a shift toward more equity participation among investors as rising interest rates cause bonds to decline in value.  The core implications of these research opinions by Credit Suisse are as follows.

  1. Bond yields are too low. Over time, an estimated 12-24 months, rates will advance from current levels, causing bonds to be the worst performing class.
  2. Volatility will pick up; making stock selection and diversification even more important
  3. Stocks today are not a crowded trad relative to the expected overvaluation of equities in the next two years.
  4. Equity valuations presently are justified.
  5. Inflation is not picking up even as the Federal Reserve balance sheet (the Treasuries it holds) has declined. In fact, the Fed’s ownership of the Treasury market has already declined 3 percentage points since 2014, and this was accompanied by a decline in US yields, not a rise!

Therefore, it does not appear that the Federal Reserve’s balance-sheet normalization is disrupting markets. Moreover, given ongoing purchases by the Bank of Japan and the European Central Bank, global central bank balance sheets are unlikely to contract in aggregate until the fourth quarter of 2018. Therefore, financial conditions remain very loose. Global excess liquidity growth is yet to signal a time when the multiples investors pay for equity growth should contract. Therefore, a best of times scenario, as defined by both multiple-expansion and earnings-expansion, remains intact; albeit in the later stage.

Key risks to this fundamental backdrop is 1) if the FOMC changes its emphasis to ignore low inflation and instead focus on elevated asset prices 2) wage rate inflation begins to show up, creating a larger than expected slowdown in corporate profits and 3) a sharp slowdown in Chinese growth.

If you’ve read this far into this newsletter, allow me to again thank you for your continued trust and support. Some of the economic signs and implications from fundamental and technical research systems used to manage your hard-earned savings and investment portfolio have been stated in this letter. Many other elements do not fit within the themes of this discussion. Nevertheless, I hope to introduce additional ideas in time. In the meantime, please feel free to query me by email or phone anytime as I am sure you must come across questions or ideas day to day.

Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal.  Past performance is not a guarantee of future results.  Asset allocation cannot assure a profit nor protect against loss.  Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed.  Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0223