Aren't you sick and tired of the spin and half-truths that corrupt the debate about the U.S. economy, taxes, spending, and the budget deficit? Do you feel that you can't believe anything that any politician or their hacks in the media say because ideological spin makes it impossible to engage in truthful, honest debate? What we need are pragmatic, centrist adults to govern our economy.
Here's the lowdown based on sound economics and facts, not politics:
1. Federal budget deficits are ok during a recession, even preferable. Economies are cyclical, because they are based on human behavior and therefore subject to greed, fear, short-sightedness, and all the foibles of humans. Maintaining federal spending while private spending and tax revenues are in decline is ok, as long as it is off-set by a corresponding surplus.
2. The problem with the federal budget deficit really comes during growth periods, not recessions, because politician do not raise tax rates during the booms and therefore run a surplus. The one exception to this rule was during the late 1990's, when tax rates were maintained or raised slightly during a period of strong economic growth. Guess what, we ran a federal budget surplus for the first time since the early 1960's! I remember people opining about what would happen to the world economy without U.S. Treasury Bonds as an investment option. Yea right!
3. There are structural issues, namely (in the order of importance) Medicare and Social Security that go beyond the cyclicality of the U.S. economy and it's influence on budget deficits. Look at what happened to companies such as GM and Chrysler, as well as governments such as Greece, and many others that don't manage their long-term commitments prudently. Structural deficits must be addressed politically, preferably by a bi-partisan commission with teeth.
An additional area that is ripe for reigning in the budget deficit is plugging the thousands of loopholes in the tax code (such as the mortgage interest deduction, which also contributed to the housing bubble, and should be known as the Bank-Handout law).
4. I propose that we establish a realistic baseline for U.S. long-term economic growth, say 2-2.5%. This would be done by economists, not politicians. If economic growth exceeds the baseline, individual income taxes and individual capital gains taxes would rise on a graded scale. The more we exceed the baseline, the higher the tax rates go (up to a maximum). If economic growth is sub-par and below the baseline, then individual income taxes and individual capital gains tax rates automatically decline.
I purposely excluded dividend taxes from this scenario because earnings are already taxed at the corporate level before they are paid out to shareholders. I also excluded corporate tax from the equation because corporate long-term planning (e.g. hiring) tends to be more sensitive to tax rates.
These proposals would make the Federal Reserve Board's job much easier because the Fed's main policy tool of raising interest rates during "excessive" growth and lowering rates during recessions would be naturally complemented by individual income tax rates. Additionally, these tax rates would naturally fight asset bubbles such as the technology stock boom and the housing boom because if people have to pay higher capital gains taxes, they may think twice about buying into a "mania." These proposals provide a natural brake on speculative activity, put our economy on a sound, long-term growth trajectory, and are fair to all our citizens.
One last thing that has to be debunked, namely this idea that lowering tax rates raises revenue for the U.S. Treasury via increased economic activity. What nonsense! There is no economic evidence for this assertion, but I hear it all the time, mainly from ideologically-oriented talking heads. To take this argument to it's natural conclusion, why not just decrease tax rates to zero, the ultimate stimulus. How much money would flow into the Treasury. Exactly ZERO!
Monday, July 26, 2010
Monday, February 1, 2010
2010 Global Financial Market Prediction
I. US Markets
US stock markets in 2010 will be hostage to three forces: inflation, Federal Reserve policy, and the economy. The economy is almost guaranteed to be weak, which means unemployment will remain high (>9 %). In spite of rampant money supply growth around the world, the weak US economy will keep inflation in check this year. That means the main driver will be the Fed. The Fed has acknowledged that it is preparing to remove some of the exceptional quantitative monetary easing of the past 1.5 years. This will create a choppy stock and bond market, but it appears that this will happen gradually and with plenty of warning so as not to upset markets too much. Hence the economy’s fragile recovery should remain intact. This should lead to high single-digit returns in the US stock market in 2010. One exciting secular investment area for the next few years is in the area of water resources. Fresh, clean water will only grow in importance and scarcity over the next decade and beyond as the world population increases, and rivers, lakes, rainfall, aquifers, etc. become depleted or polluted.
Corporate earnings will continue to grow slowly in a weak economy in 2010, although they will have favorable comparisons to last year’s weak numbers. The stock markets snapback from last year’s panic lows is now over. Further gains in 2010 will be predicated on accommodative Fed policy that renders safe alternative investments such as money market funds, CD’s, and treasury bonds unattractive. Bankruptcies are still growing in the corporate sector, but the junk bond market discounted a depression in 2008, and it turned out to be “only” a Great Recession. This “upgrade” accounted for sterling junk bond returns in 2009, but will not be repeated. One can expect to collect the coupon from junk bonds in 2010 (~9% depending on the credit risk) at best, with minimal appreciation. Treasury bond investments are only be for the most risk-averse in 2010. The monster rally in Treasuries in 2008 and early 2009 was a pure flight-to-quality, and has left yields at historically low levels (3.6% for a ten years).
Economic growth will be inhibited by weakness in real estate markets, including both commercial and residential. Foreclosures in both markets are still growing. Residential foreclosures have migrated from sub-prime where they started to prime markets. Residential markets are closer to healing because the market crashed remarkably quickly in 2008. Commercial real estate markets are experiencing a slow-motion meltdown, mainly due to the nature of long-term leases and the reluctance of banks to take big write-downs. It is a bit early to invest in commercial real-estate, but the time may be getting close to start picking through some of the carnage. Publicly-traded REIT’s actually are faring pretty well, all things considered, because they were restricted by securities laws from over-leveraging like some of the private companies. Therefore this year may be a good time to begin accumulating commercial real-estate investments on weakness.
The world economic pie will continue to grow over the long-term, but it will be driven mainly by emerging markets and the desire of 4 billion poor people to achieve a higher standard of living for themselves and their children. The US’s percentage of the world economy will continue to shrink in the long-term as will all developed markets. This is an unstoppable secular trend and the US will adapt one way or the other. It is very important to understand that the US economy can still grow over the long-term at 2.0 %, but the relative size of the US economy compared to the rest of the world will shrink as the world economic pie gets bigger at rate significantly faster than 2.0%. Education will be a critical element for the US to ameliorate the effects of declining economic might, as well as sound economic management. The excessive borrowing of the past decade was a symptom of US citizens, corporations, governments, etc. desperately trying to maintain past standards of living and economic power. The two huge bubbles that we witnessed over the past decade in technology stocks and real-estate markets is another symptom of the same over-reaching to maintain dwindling economic power. One way or another the US will adapt to these secular trends and cede relative economic power to China, India, Brazil, and the many, many new economies with very high growth potential. This adjustment will include more competitive wages and technologies, more savings, and probably less dependence on the consumer to drive the economy. The US consumer accounted for around 70% in recent years, which is unsustainable. If the US doesn’t adapt quickly enough, world markets will impose discipline on the US through currency depreciation and the pain of market dislocation like we witnessed in 2008-09. Of course these secular trends do not bode particularly well for US stock markets over the next decade. Valuations are still not particularly cheap even after the meltdown in 2008-09. Over the next decade we can therefore expect single digit returns on average from US stocks.
II. Foreign Markets
Expect slow economic growth in developed markets of Japan and Europe over the next few years as these economies heal from the shock of financial meltdown in 2008-09. Japan’s declining population, persistent deflation, and huge budget deficit make Japan an unlikely place to make money in 2010. Europe is not a cohesive market, but a fragmented collection of individual markets. Countries such and Germany and France have manageable budget deficits, while Greece, Ireland, Spain, and Portugal have huge government debt problems. The UK is much like the US in terms of its banking problems as well as excessive government budget deficits. Since developed international markets represent approximately 45% of world stock market capitalization, portfolios should be exposed to these markets, but at a lower percentage.
Canada and Australia are similar in that they are both largely natural resource economies, with relatively sound banking systems. These countries have some of the best economic prospects amongst developed countries in 2010. Of course markets have already discounted these positive outlooks. However, these countries should be over-weighted relative to other developed markets in 2010.
Emerging markets are where the economic growth will be in 2010. China and India are projected to grow at around 9%, while Brazil, Indonesia, and Malaysia are projected to grow at around 5%. Eastern Europe is an interesting place because long-term prospects are good based on their proximity to the huge Eurozone, but excessive borrowing couple with last year falling currencies really put the clamps on near-term prospects. Russia falls into this same camp, with the additional plus of abundant natural resources, and the additional minus of excessive state control in the economy. One exciting area for investment in 2010 and beyond is in “frontier” markets, or markets a tier below “emerging,” since some of the emerging markets such as Brazil, China, South Korea, Taiwan, Hong Kong, and Singapore are becoming pretty large and well established. Frontier markets with high growth prospects include Vietnam, Thailand, some Middle-Eastern, South American, and African countries, as well as some of the better-managed Eastern European countries. Of course these countries carry high risk as well as the potential for high returns, and must therefore be managed appropriately.
III. Commodities
The world population is over 4.5 billion and growing. The vast majority of these people are poor, and have not had the opportunities that we take for granted in America. The introduction of capitalism and consumer economies to huge swaths of these folks will continue to fuel demand for natural resources for many years to come. Therefore commodities will continue to see increased demand in 2010 and beyond. This increased demand will not result in a boom period this year because of sub-par world economic growth, but will entail a gradual increase. Of course demand is only one side of the pricing mechanism. As long as producers can increase supply at a comparable rate, then prices will remain flat or even drop. A good example of this is illustrated by the natural gas market. Natural gas is positioned to be the energy source of the future. It is relatively clean-burning, especially compared to coal. Recent drilling advances in horizontal fracturing technologies have resulted in increased supplies for natural gas and much lower prices over the past year in spite of the rosy long-term outlook. This provides an attractive long-term investment thesis because of the environmental and energy advantages of natural gas. The price ratio of oil/natural gas is at an all-time high which should favor increased usage of natural gas relative to other energy sources over the next decade. Natural gas prices should stabilize or increase slightly in 2010, and continue to head higher in future years.
Gold and gold mining stocks had a stellar 2009, and have come under some pressure of late. This is a good buying opportunity due to three reasons: people are distrustful of financial assets due to the many excesses of the past few years, excessive money supply growth world-wide may lead to inflation if and when economic growth gets back on track, and commodities in general are likely to be in demand for the next decade.
IV. Currencies
What a wild ride for currencies in 2008 and 2009! The dollar was viewed as a safe-haven and therefore soared higher against practically all currencies during the panic of late 2008 and early 2009, then reversed and went into a huge slide as world markets stabilized during the last three quarters of 2009. In early 2010 the dollar is rising slowly once again and appears to be stabilizing at an equilibrium level. This pattern basically reflects similar patterns followed by most markets throughout the world followed over the past two years. Risk-based assets such as stocks, corporate bonds, real estate, sovereign debt and currencies from small or economically-weak countries cratered, while safe US treasury securities and the US dollar soared in a panic-driven flight-to-quality. All this in spite of the fact that the epicenter of the global financial meltdown was right here in the US! Now markets are reaching an equilibrium where future movements will be driven by fundamentals.
Currency movements are driven primarily by perceived economic management, relative interest rates, and balance of trade. The dollar should appreciate against the euro, the pound, and the yen in 2010. The Eurozone is such a fractured place economically with relatively well-managed economies like France and Germany commingled with basket cases like Greece, Spain, Portugal, and Ireland. The European Union cannot discipline wayward members easily, which puts the European Central Bank in a very precarious position. Britain has many of the same problems as the US, but the financial sector there accounts for a bigger portion of Britain’s GDP than in the US. And Japan has the biggest debt-to-GDP ratio of any developed country, a new left-leaning government, stagnant population growth, and a historical propensity to solve their economic problems with currency depreciation. The Canadian and Australian dollars were quite strong versus the US currency in 2009. They should hold onto those gains and possibly appreciate some more due to their well-managed banking systems, relatively low debt, and natural resource economies.
US stock markets in 2010 will be hostage to three forces: inflation, Federal Reserve policy, and the economy. The economy is almost guaranteed to be weak, which means unemployment will remain high (>9 %). In spite of rampant money supply growth around the world, the weak US economy will keep inflation in check this year. That means the main driver will be the Fed. The Fed has acknowledged that it is preparing to remove some of the exceptional quantitative monetary easing of the past 1.5 years. This will create a choppy stock and bond market, but it appears that this will happen gradually and with plenty of warning so as not to upset markets too much. Hence the economy’s fragile recovery should remain intact. This should lead to high single-digit returns in the US stock market in 2010. One exciting secular investment area for the next few years is in the area of water resources. Fresh, clean water will only grow in importance and scarcity over the next decade and beyond as the world population increases, and rivers, lakes, rainfall, aquifers, etc. become depleted or polluted.
Corporate earnings will continue to grow slowly in a weak economy in 2010, although they will have favorable comparisons to last year’s weak numbers. The stock markets snapback from last year’s panic lows is now over. Further gains in 2010 will be predicated on accommodative Fed policy that renders safe alternative investments such as money market funds, CD’s, and treasury bonds unattractive. Bankruptcies are still growing in the corporate sector, but the junk bond market discounted a depression in 2008, and it turned out to be “only” a Great Recession. This “upgrade” accounted for sterling junk bond returns in 2009, but will not be repeated. One can expect to collect the coupon from junk bonds in 2010 (~9% depending on the credit risk) at best, with minimal appreciation. Treasury bond investments are only be for the most risk-averse in 2010. The monster rally in Treasuries in 2008 and early 2009 was a pure flight-to-quality, and has left yields at historically low levels (3.6% for a ten years).
Economic growth will be inhibited by weakness in real estate markets, including both commercial and residential. Foreclosures in both markets are still growing. Residential foreclosures have migrated from sub-prime where they started to prime markets. Residential markets are closer to healing because the market crashed remarkably quickly in 2008. Commercial real estate markets are experiencing a slow-motion meltdown, mainly due to the nature of long-term leases and the reluctance of banks to take big write-downs. It is a bit early to invest in commercial real-estate, but the time may be getting close to start picking through some of the carnage. Publicly-traded REIT’s actually are faring pretty well, all things considered, because they were restricted by securities laws from over-leveraging like some of the private companies. Therefore this year may be a good time to begin accumulating commercial real-estate investments on weakness.
The world economic pie will continue to grow over the long-term, but it will be driven mainly by emerging markets and the desire of 4 billion poor people to achieve a higher standard of living for themselves and their children. The US’s percentage of the world economy will continue to shrink in the long-term as will all developed markets. This is an unstoppable secular trend and the US will adapt one way or the other. It is very important to understand that the US economy can still grow over the long-term at 2.0 %, but the relative size of the US economy compared to the rest of the world will shrink as the world economic pie gets bigger at rate significantly faster than 2.0%. Education will be a critical element for the US to ameliorate the effects of declining economic might, as well as sound economic management. The excessive borrowing of the past decade was a symptom of US citizens, corporations, governments, etc. desperately trying to maintain past standards of living and economic power. The two huge bubbles that we witnessed over the past decade in technology stocks and real-estate markets is another symptom of the same over-reaching to maintain dwindling economic power. One way or another the US will adapt to these secular trends and cede relative economic power to China, India, Brazil, and the many, many new economies with very high growth potential. This adjustment will include more competitive wages and technologies, more savings, and probably less dependence on the consumer to drive the economy. The US consumer accounted for around 70% in recent years, which is unsustainable. If the US doesn’t adapt quickly enough, world markets will impose discipline on the US through currency depreciation and the pain of market dislocation like we witnessed in 2008-09. Of course these secular trends do not bode particularly well for US stock markets over the next decade. Valuations are still not particularly cheap even after the meltdown in 2008-09. Over the next decade we can therefore expect single digit returns on average from US stocks.
II. Foreign Markets
Expect slow economic growth in developed markets of Japan and Europe over the next few years as these economies heal from the shock of financial meltdown in 2008-09. Japan’s declining population, persistent deflation, and huge budget deficit make Japan an unlikely place to make money in 2010. Europe is not a cohesive market, but a fragmented collection of individual markets. Countries such and Germany and France have manageable budget deficits, while Greece, Ireland, Spain, and Portugal have huge government debt problems. The UK is much like the US in terms of its banking problems as well as excessive government budget deficits. Since developed international markets represent approximately 45% of world stock market capitalization, portfolios should be exposed to these markets, but at a lower percentage.
Canada and Australia are similar in that they are both largely natural resource economies, with relatively sound banking systems. These countries have some of the best economic prospects amongst developed countries in 2010. Of course markets have already discounted these positive outlooks. However, these countries should be over-weighted relative to other developed markets in 2010.
Emerging markets are where the economic growth will be in 2010. China and India are projected to grow at around 9%, while Brazil, Indonesia, and Malaysia are projected to grow at around 5%. Eastern Europe is an interesting place because long-term prospects are good based on their proximity to the huge Eurozone, but excessive borrowing couple with last year falling currencies really put the clamps on near-term prospects. Russia falls into this same camp, with the additional plus of abundant natural resources, and the additional minus of excessive state control in the economy. One exciting area for investment in 2010 and beyond is in “frontier” markets, or markets a tier below “emerging,” since some of the emerging markets such as Brazil, China, South Korea, Taiwan, Hong Kong, and Singapore are becoming pretty large and well established. Frontier markets with high growth prospects include Vietnam, Thailand, some Middle-Eastern, South American, and African countries, as well as some of the better-managed Eastern European countries. Of course these countries carry high risk as well as the potential for high returns, and must therefore be managed appropriately.
III. Commodities
The world population is over 4.5 billion and growing. The vast majority of these people are poor, and have not had the opportunities that we take for granted in America. The introduction of capitalism and consumer economies to huge swaths of these folks will continue to fuel demand for natural resources for many years to come. Therefore commodities will continue to see increased demand in 2010 and beyond. This increased demand will not result in a boom period this year because of sub-par world economic growth, but will entail a gradual increase. Of course demand is only one side of the pricing mechanism. As long as producers can increase supply at a comparable rate, then prices will remain flat or even drop. A good example of this is illustrated by the natural gas market. Natural gas is positioned to be the energy source of the future. It is relatively clean-burning, especially compared to coal. Recent drilling advances in horizontal fracturing technologies have resulted in increased supplies for natural gas and much lower prices over the past year in spite of the rosy long-term outlook. This provides an attractive long-term investment thesis because of the environmental and energy advantages of natural gas. The price ratio of oil/natural gas is at an all-time high which should favor increased usage of natural gas relative to other energy sources over the next decade. Natural gas prices should stabilize or increase slightly in 2010, and continue to head higher in future years.
Gold and gold mining stocks had a stellar 2009, and have come under some pressure of late. This is a good buying opportunity due to three reasons: people are distrustful of financial assets due to the many excesses of the past few years, excessive money supply growth world-wide may lead to inflation if and when economic growth gets back on track, and commodities in general are likely to be in demand for the next decade.
IV. Currencies
What a wild ride for currencies in 2008 and 2009! The dollar was viewed as a safe-haven and therefore soared higher against practically all currencies during the panic of late 2008 and early 2009, then reversed and went into a huge slide as world markets stabilized during the last three quarters of 2009. In early 2010 the dollar is rising slowly once again and appears to be stabilizing at an equilibrium level. This pattern basically reflects similar patterns followed by most markets throughout the world followed over the past two years. Risk-based assets such as stocks, corporate bonds, real estate, sovereign debt and currencies from small or economically-weak countries cratered, while safe US treasury securities and the US dollar soared in a panic-driven flight-to-quality. All this in spite of the fact that the epicenter of the global financial meltdown was right here in the US! Now markets are reaching an equilibrium where future movements will be driven by fundamentals.
Currency movements are driven primarily by perceived economic management, relative interest rates, and balance of trade. The dollar should appreciate against the euro, the pound, and the yen in 2010. The Eurozone is such a fractured place economically with relatively well-managed economies like France and Germany commingled with basket cases like Greece, Spain, Portugal, and Ireland. The European Union cannot discipline wayward members easily, which puts the European Central Bank in a very precarious position. Britain has many of the same problems as the US, but the financial sector there accounts for a bigger portion of Britain’s GDP than in the US. And Japan has the biggest debt-to-GDP ratio of any developed country, a new left-leaning government, stagnant population growth, and a historical propensity to solve their economic problems with currency depreciation. The Canadian and Australian dollars were quite strong versus the US currency in 2009. They should hold onto those gains and possibly appreciate some more due to their well-managed banking systems, relatively low debt, and natural resource economies.
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