Friday, May 8, 2009
Mr. Waddell Goes to Washington
Earlier this week, Stacie and I had a terrific opportunity to travel to Washington for a comprehensive debriefing. Through my membership in the Society of International Business Fellows (sibf.org), we gained access to outstanding individuals who offered us insights and perspectives on the most pressing issues of the day. As the government extends its reach into the private sector, reformatting policies and regulations, politics becomes an active variable that requires more weight in today’s macro-analysis. The first challenge for us as investors is to decode the messages coming out of Washington; the second is to determine the investment risks and opportunities associated with these messages. Not an easy task. While shifts in policy and governance paradigms can affect investment returns at the margin, larger geo-political events can lead to dramatic gains or losses. Therefore, we must be sensitive to the marginal items (i.e. tax policy changes) and also to the major items (record fiscal deficits), and have investment playbooks for each. After a short overview of this week’s market events, I will offer perspectives on our Washington briefing in today’s edition. I hope my perspectives are enlightening at some level, recognizing that my biases will color the message. I try to stay a-political. I am a member of the investor party first and foremost. At a minimum, my report to you will save you the cost of a plane ticket, Washington hotel rates, and hours of sifting through Washington-speak.
Just another 5% week
Markets converted more non-believers this week as economic data globally met with positive spin. As expected, the bank Stress Tests were nothing to stress over. Just to validate, the KBW Bank Index rallied 29% this week. Simply put, none of the 19 banks scrutinized are going to fail, the additional capital necessary to meet the government’s “stress” scenario appears modest and the capital can likely be raised without further government control or shareholder dilution. Additionally, the TARP fund looks adequate and may even be replenished with paybacks from some of the healthier institutions. Good news… this may be one of the final acts in the 2007-2009 credit crunch drama! Assuming the banks can raise the capital required (highly likely), they will have met the solvency criteria of the Treasury, FDIC and investment community. Barring a new collapse in housing, or something of equal magnitude, the banking system has officially recovered going concern status. To confirm this hypothesis, LIBOR spreads (the interest rate banks charge each other over and above Treasury or swap rates) have narrowed to levels not seen since last August. The LIBOR-OIS spread peaked at 3.64% in October of 2008, and stands today at .73%. If the stock markets joined these credit markets in returning to pre-crisis levels, the Dow would rise above 10,000 and the S&P 500 above 1,100. That level discounted recession and earnings headwinds. The decline between S&P 1,100 and 666 discounted the end of the banking sector and capitalism. With capitalism and financial services now preserved, the waterline may naturally rise toward that range. I can make a case for it and judging by the ticker tape, others are making the case as well.
In Washington We Trust
To apply some structure to these comments I will highlight the topic and speaker, and then offer my impressions and strategic implications for investors.
America on the Brink of Financial Crisis: David Walker
As the previous Comptroller General of the United States and the head of the Government Accountability Office, David Walker has the most sobering and accurate view of the US financial condition. In his opinion, we will survive the first sub-prime crisis in housing, but we may not survive the second sub-prime crisis in government. The growth in deficits and national debt are well documented; what remains undocumented is the plan to reduce them. David hopes that a committee will be appointed to draft and deliver a fiscal responsibility plan sometime this summer. The debt course that we are currently on is unsustainable, period. Unless we reform our entitlement spending and restrict our discretionary spending habits, we jeopardize our credit rating. Any tick lower in the US AAA rating would initiate a series of consequences that in cumulative could lead to the undoing of our supremacy, ala Britain in the early 1900’s. Walker was optimistic, however, that the political process could meet this challenge and therefore preserve our status. I agree in theory, but the investment strategy, given the concern surrounding the issue, must be to have geographic and currency diversity in our portfolios.
The Obama Agenda – The Media View: The First Hundred Days
Candy Crowley of CNN fame probably headlined this panel, but John Mecurio of The Hotline and Anne Kornblut from the Washington Post offered insights as well. Truly the takeaway here is that the media have been bewitched by the Obama administration and though they retain mild skepticisms for the appearance of impartiality, they will not be an impediment to the administration on policy initiatives. In the political process, the absence of protest outweighs the presence of support. With large agenda items, this protest-free distribution network provides the White House with a considerable advantage. The implication for investment strategy is that the media support only increases the likelihood of Obama’s ideas becoming America’s policies.
A View From Abroad
Sir Nigel Sheinwald, the British Ambassador to the US, began his discussion with traditional dry English wit. His discussion concluded with the cautions of protectionism. The reversal of free and open trade initiatives would handicap economic growth prospects worldwide. Concern seems to be brewing that the United States may lead the world with a separatist agenda. Coincidentally, as he urged us not to reverse the gains of globalization, the White House issued its plans for taxing US corporate profits earned abroad, claiming that the existing tax system encourages US corporations to ship jobs overseas. Without getting into the particular merits of this argument, this cannot be seen as an olive branch extended to our trading partners. From an investor standpoint, a reduction in trade activity leads to a reduction in overall economic activity, making the hunt for relative growth more meaningful. Emerging economies maturing their consumer base, with low leverage ratios and without large fiscal debt burdens, may sustain above average growth rates. Furthermore, corporate expatriates bring new skills and capabilities to host countries.
Views from Within – White House Briefing
By far, I found this session the most enlightening. Valerie Jarrett, one of Obama’s most trusted advisors, was scheduled to host us. She cancelled at the last minute and arranged to have her chief of staff host us. He also cancelled at the last minute. Oh well, we still had a strong line-up of three staffers. Almost. One had just joined the Commerce Department last week, and another had responsibility for our Russia policy, which clearly hasn’t been edified yet. The most compelling staffer was Bob Kocher, MD, one of the chief architects of the Obama healthcare plan. His knowledge and experience gathered confidence among the group until he revealed how limited his role will truly be, since it is up to Congress to draft the plan. The White House simply drew a broad outline and looks forward to the strategy and plan Congress will construct. Dr. Kocher expressed very little confidence that Congress would return a plan that met his criteria. “So goes the political process”, he said.
This meeting concluded with remarks from Elizabeth Vale, who acts as the White House’s business liaison. She has a terrific business background, and her responsibility is to construct demonstrations of policy. For instance, to elucidate for the press the $8,000 first time homebuyer credit, the liaison might have the President walk a first time homebuyer through the process before the cameras. Noble enough, except that she kept referring to the participants as “real people”, which is what the White House considers those outside. I asked the person sitting next to me if he felt, given the tax revenue represented in the room, that we had been snubbed by the White House. His response was that while we might represent a good deal of tax revenue, we have very few votes. Point well taken.
My takeaway from this session was that the White House knows exactly where they are going and will happily report on their progress, but they will not be asking for directions. The investment implication? Coupling the tenacity of the White House with an accommodating media, change is not only coming, it’s certain. The costs and benefits of these changes remain to be seen, but status quo has few allies in DC. Our portfolio allocation to healthcare stocks is currently half that of the S&P 500.
Representing the left was Howard Dean, former Vermont Governor and Democratic Committee Chairman. Representing the right was Ed Gillespie, former Chairman of the Republican National Committee. This session was terrific. Both of these individuals were outstanding and found plenty of things to disagree about, as you might expect. The one thing they could both agree on is that the Republican Party has been evicted from Washington. Essentially, the pendulum will not swing right unless the Democrats make a highly visible mistake. The Republicans cannot pick up the ball until the Democrats drop it. I did ask them what they thought the strategic implications were of having a majority of Americans not paying income taxes. Dean responded that this was not an issue, since these individuals will be paying payroll taxes, property taxes, etc. In his words, “we’ll get them one way or another.” Gillespie responded that it was a huge issue, but he didn’t seem to have a strategy to reverse it, or monetize it for voter gain. The investment implication? Presently, there is no credible counter agenda to the Democratic agenda. Resisting government initiatives at the moment is a money loser. Getting in front of government initiatives is a moneymaker.
A Challenged World – The Center for Strategic and International Studies View
This panel couldn’t have been more enlightening. Anthony Cordesman described the Middle East as a tinderbox where the front has expanded from Iraq to Afghanistan, Pakistan, and Iran as well. Of the 30 countries in the Middle East, seven pose strategic threats to us at the moment. Even if we rooted out Al-Qaeda and the Taliban, the region would remain hostile toward us. Andy Kutchins described Russia as a nation confused (as always). Their confidence and capabilities rise and fall with the price of oil, making them perpetually unstable. Charles Freeman spoke about China, which has navigated the crisis well, although regrets being pushed to the forefront as a burgeoning superpower, preferring to keep its powers obscured. My sense is that the US lacks a defined China policy, which breeds caution and mistrust between us. Ultimately, we are business partners and should treat each other as co-dependents. Investment takeaway? The Middle East is a mess. Russia is a trade but not an investment. The economic future of the planet is the US-China relationship. We should have a policy for it.
I returned from this trip with deep respect for what the Democratic Party has accomplished. The Republicans dropped the ball, and the Democrats were quick to pick it up, and they are running with it without much opposition. Whether you agree with their ideology or not, they have put the machine in place quickly, and it is operating.
The best of the status quo revisions would be entitlement reforms. David Walker thinks this may be possible with this administration. This would be structural reform, making us more economically viable, and preserving our AAA rating. The worst of the status quo revisions would be an over-reaching government without fiscal sensibilities that crowds out private industry viewed as insensitive to the American “middle” class. This magnified class warfare would weaken us and confuse our country’s founding virtues. The polls demonstrate that American’s have gone to their ideological corners.
Nonetheless, the Obama administration has achieved a 60% approval rating, won over the media, built a filibuster-proof Congress, and you can keep track of it all on Twitter. With an unobstructed pathway to reform, look for the pace of legislation to be relentless until the 2010 elections. America will then have the chance to re-assess.
David S. Waddell
Senior Investment Strategist
David S. Waddell, biography.
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**This blog represents the opinion of W&A and is for informational purposes only. It is not intended to be construed as tax or legal advice by the recipient. Past returns of investment are no guarantee of future results.
***Any data reported in this blog has been compiled from the Wall Street Journal, Morningstar, Investors Business Daily, or various other informational internet sites.