Yes, the title of this week’s Dividend Café is a purposeful play on the big sporting event of this week, something we recognize a lot of you do not care about – and that is the college basketball tournament commonly referred to as March Madness throughout pop culture. You can read our concluding paragraph below to see if I care about it or not, but there is one thing most all of us care about, and that is Market Madness. This week’s Dividend Café will look at the state of the market, where China stands, unemployment, drug prices, interest rates, and more. There may not be any buzzer beaters, but it’s worth reading nonetheless.
The Fed Ahead
As expected, the Fed raised rates a quarter point on Wednesday, bringing the Federal Funds rate to the still brutally low level of 0.75% – 1% (they set the rate as a range like that). The commentary I will offer on the rest of the year is this: The Fed is somewhat handcuffed by the low rates of Europe and Japan, the Fed is very much handcuffed by the governmental cost of funding their own debt (see elsewhere in this commentary for more info), and yet the Fed is well aware that they need to stay on a path to normalization to keep the distortions in capital markets that excessively low rates create to a minimum.
A Stimulus by any other name
With all the talk about the ObamaCare repeal bill (first), and then corporate tax reform (second), the subject of repatriation has been somewhat removed from media dialogue. But a major part of President Trump’s policy platform is the intention to allow U.S. companies holding large cash balances offshore bring those moneys back onshore without facing double taxation (there are a number of ways this can be done), A big focus of conversation has been on what strings will be attached to this effort – what will the administration do in the legislation (if anything) to insure that companies invest those moneys into job-creation, capex, new factories, and generally “stimulative” business activities. We have suggested for some time that it would not be necessary (or American) to tell companies what they have to do with the capital – that Washington D.C. is not as effective an allocator of capital as individual companies would be in their own situations anyways – BUT that we could see the President using his twitter and basic Presidential bully pulpit to push companies towards headline-creating businessinvestment. That remains our forecast, but we will echo what we shockingly saw Jamie Dimon, CEO of JP Morgan, say this week: It is a massive fallacy to assume that should companies use the money for stock buybacks and especially dividends, it would not be stimulative. The reality is that corporate cash repatriated back into the U.S. economy and paid out as dividends would be a very low cost way to allow shareholders what to do with the money, it would not distort capital markets (like QE), and it would indeed be put to work across a host of organic and healthy economic uses.
Checking in on China
I dug deep this week into the general state of affairs in China behind a slew of recent data releases from the Chinese government. Demand continues to seem high for industrial production, as producer prices keep growing, commodity prices have stayed high, and Chinese exports are up, not down. New equipment purchases are jumping, indicating ongoing appetite for construction, and a new breath inside their manufacturing sector. The government attempts to prop up housing as a tool to offset a decline in other aspects of construction spending and general investment may be working right now, but certainly do not seem sustainable. China’s central bank has modestly begun tightening monetary policy but credit growth has barely skipped a beat, providing both the good news and the bad news in China. The good news? For the time being, excesses do not appear to be doing damage. The bad news? Excesses are still in need of being purged.
From 25% to 4% Unemployment
President Trump famously complained throughout the previous administration that the “real” unemployment rate was 25% (or so), not 5% (or so) being claimed. Last week, the February jobs report showed a 4.unemployment rate and 235,000 jobs being created in February. The new administration likes this data. Average hourly earnings ticked up as well. The Fed was going to raise rates a quarter point this week regardless, but this jobs report certainly closed the deal.
Lowering Drug Prices the Old Fashioned Way
If, indeed, President Trump is successful in appointing Scott Gottlieb to head the FDA (Food & Drug Administration), we will know at least one of the major ways the new administration plans to lower the price of drugs. Gottlieb has long advocated for price reduction through overhauling the approval process at the FDA. The argument goes, and we are generally very sympathetic to it, that if the process for drug approval is made quicker, easier, less bureaucratic, less lengthy, and more efficient, that alone would lower company costs on the other end dramatically (by lowering hard costs around legal and approval red tape and by starting the profit cycle sooner), thereby leading to a more competitive price capability.
Higher Interest Rates Help Savers, Banks, and Most Everyone BUT …
The short term interest rate in our society cannot and will not go higher unless there is a perception of higher economic growth and adequate business and investment opportunity to push the prevalent rate higher in an upward direction. While everyone from real estate speculators to distressed credit corporations love lower rates, a higher rate reflects a normalized, non-recessionary economy, it creates better income for savers and retirees, and it generally limits distorted behavior in capital markets. So who has the most to lose with higher interest rates? This is one of the most important things I have ever written in Dividend Café: The loser with higher interest rates is the government, which runs deficits in excess of hundreds of billions of dollars per year, and has an accumulated national debt of nearly $20 trillion; higher rates means higher interest expense on this short-term funded debt, and therefore means higher deficits. Forget Trump’s planned tax cuts and infrastructure spending: An increase in rates may push deficits higher before we have even started in fiscal reforms! And yet no one is talking about this …
Private Eyes on Private Equity See Lots of Cash
We don’t use Dividend Café to talk about our approach to alternative investing enough, and within alternative investing we do not talk about private equity enough. Part of the reason is that the asset class is totally unsuitable for so many investors – those who need current income, for example, or those who are troubled by the illiquidity realities of the space. However, that very thing (illiquidity) has historically provided a wonderful return premium to those who can bear it out, and when combined with high quality operators, can be a very opportunistic way to invest. But we would note that private equity firms presently have well over $530 billion of dry powder on hand – cash they have raised and not yet deployed. It begs the question of how solid the opportunity set is when so much cash has been accumulated. On one hand, we commend operators for not doing deals that do not make economic sense (holding dry powder trumps bad purchases), but we do wonder if the message in the dry powder build-up is not industry discipline but rather a diminished opportunity set.
Cutting the Insanity Down
To really feel like capital is reasonably well-allocated around the world, we would rather see no money providing a negative yield to their holders. However, it is noteworthy that the amount in such a space is down by several trillion dollars from the craziness of mid- 2016. Keep in mind, this number is a by-product of central banks purposely running at negative yields, their belief being that they can stimulate activity from it. The side effects are dangerous, and potentially fatal. Our criticism is intensely real, though we are happy to see the number coming down a bit.
To follow up on last week’s anniversary of the bear market bottoms from early March 2009, we thought this chart was utterly fascinating to see the journey it has been!
Strategas Research, March 13, 2017
Quote of the Week
Money has not only the character of money, but it has beyond this a productive character which we commonly call capital.
– St. Bernadine of Siena