Month: November 2016

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

NOVEMBER 23, 2016

Contact Richard Power with comments or questions.  IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

This week in IntelDigest, we will review the market reactions to the election surprise, and the short-term prospects for several asset classes. Over the next three weeks, we’ll take a closer look at the theory behind the Trump economic proposals, speculate on the likely economic future for the United States during the next presidential administration, and make some policy proposals which we think the new government should consider.

 
Reaction

To most people, the Trump victory was a surprise and a shock.  As we wrote on the afternoon after Election Day:

“Most foreign markets dropped immediately by 2-4%, and U.S. stock futures fell by up to 4% overnight (when U.S. markets were closed). However, by the time that U.S. markets opened this morning, things were already returning to normal.  It is likely that markets around the world will calm down and return to (relative) normal within a day or two.”
Indeed, the broad markets have rallied in the short-term … and will probably do so into early next year … on the expectation that a Trump presidency will be good for business.  The President-Elect has vowed to lower taxes (especially on corporations), commit Hundreds of Billions of Dollars to infrastructure spending, and reduce government regulation. Investors are encouraged, and have piled into equities since Election Day; some sectors have performed better than others (which we discuss on page two).

 

Corporate tax reform is at the center of the Trump agenda.  For years, U.S. multinational companies have parked significant sums (now amounting to $2.5 Trillion Dollars, by some estimates) in offshore tax havens, in order to avoid U.S. corporate income taxes, which can be as high as 35%.
During the campaign, Trump proposed reducing the tax rate to 10% on cash which companies would repatriate from overseas.  When Trump assumes office, he will be working with a Republican-controlled Congress, and an incoming Senate Minority Leader, Chuck Schumer, who has expressed a desire to get corporate tax reform done.

 

If anything like this proposal becomes law, giant U.S. multinationals will be flush with the repatriated cash, and their shareholders can expect significant increases in dividend payments.

 

A commitment of the U.S. government to massive infrastructure spending … on roads, bridges, ports, airports, et al … would obviously boost corporations in the construction sector, while cutting government regulations is bound to help businesses across the board.

 
Early Winners

Three sectors have enjoyed immediate benefits in the two weeks since the election.  The stocks of Industrials have increased more than 6% in that short time.  Many companies in this sector would benefit directly from infrastructure spending.

 

Shares of Financial Institutions have skyrocketed, having increased by more than 11% over two weeks.  The President-Elect wants to dismantle the Dodd-Frank law, which was enacted in the wake of the 2008 financial crisis and places strict regulations on the banks and other financial companies which were at the center of the crisis.  Reversing that regulation would reduce compliance costs and boost bank earnings.

 

Also reaping the benefits of the election results is the Defense Industry, with shares up by more than 8% since Election Day.  The Trump Administration is intent on increasing military spending at least $500 Billion, and perhaps as much as a Trillion Dollars.

 
Impact on the Bond Market

The yield on the 10-year Treasury bond has jumped 22% since the election.  Trump is expected to pursue an aggressive fiscal policy.  So, investors think that the combination of higher spending and tax cuts could lead to a soaring U.S. deficit, which would push the federal debt even higher in the long term.

 

The yield on the 10-year bond is up to 2.355%, its highest level in 16 months.    This is important because higher yields impact every area of the market.

Utilities, for example, are sensitive to higher interest rates.  Many investors own these stocks specifically for their stable dividends.  When interest rates are high or likely to rise, they lose some of their appeal because investors can get decent income from other assets, such as bonds.

Utilities have lost ground since the election, and will probably lose more over the next couple of months as yields continue to rise.
Higher yields can be expected with Increased infrastructure spending by the new administration.  Trump campaigned heavily on this issue, he has experience with construction, and it will likely be the centerpiece of his domestic policy.

To fund these projects, the government will likely sell more bonds.  A greater supply of Treasury bonds should push prices lower and yields higher.  If Trump pressures the Federal Reserve to raise interest rates … which is likely considering his campaign rhetoric … that’s another point for lower bond prices and higher yields.

 
The Dollar Rules

The jump in Treasury yields has boosted the U.S. Dollar  …  which has moved up against the Euro and other currencies in recent days  …  and knocked down both precious metals and emerging market stocks.  The new administration’s bias toward fiscal expansion is stoking inflation fears, and some investors expect the Federal Reserve to respond by accelerating the pace of interest rate hikes in the new year.

Reuters explained how the spike in Treasury yields affects the emerging markets:

“The most volatile trading on Friday was across emerging markets, as investors bet that Trump’s fiscal policies will be inflationary, push U.S. rates up, and drive investors into dollar-based assets.”

The anticipation of higher interest rates also hurts precious metals in the short-term.  Gold has retreated by almost 8% since the election, in spite of expectations for higher inflation.

 
Short-Term Expectations

So far, the U.S. Dollar and the stock market are the short-term beneficiaries of the surprise election results, while bonds and precious metals have suffered.  These trends should continue into the new year and up to inauguration day.

Where will the trends lead thereafter?  If inflation expectations continue to increase, will investors resume buying gold as an inflation hedge?  If inflation rises faster than the Fed interest rate hikes, will gold overshoot its recent highs?

Precious metals tend to do well in times of uncertainty.  Will Donald Trump be the same wild card as President as he was on the campaign trail?  Will his policies work to rein in the national debt, or make things worse?

We will address these questions over the next few issues.

Happy Thanksgiving to all!!

 

 

 

InnOvation Capital & Management, LLC

 
IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

NOVEMBER 16, 2016

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.

 

 

 

This week in  IntelDigest, we address a major policy issue which had a significant impact on the election of the next President of the United States.  That issue is  Trade Policy, but voters often focus only on certain economic provisions, referred to as  Free Trade.

Arguably, the election turned on this very issue, as formerly “Blue” states in the Rust Belt were won … by narrow margins … by Donald Trump. These states had been solidly-Democratic, but Trump’s argument … that Free Trade had taken away millions of American jobs … resonated with enough voters to turn the tide.

Enmity focused on:  (1) a dated trade agreement, the North American Free Trade Agreement (NAFTA), which was negotiated in 1993;  and (2) a proposed agreement, the Trans Pacific Partnership (TPP), which would go into effect by 2018 if ratified by all the parties.

While job losses over the last twenty years have resulted as much from technology, automation, and productivity gains as from Trade Policy, the detrimental effects of foreign competition have been unmistakable.

 

 
Trade Agreements

Trade Agreements are vital factors in relations among nations.  Although many people see them as strictly economic agreements, the fact is that they form the basis of economic, political, and strategic relationships. Trade Agreements are often primarily diplomatic accords, with economic details secondary.

The central economic feature in such agreements is usually referred to as Free Trade, meaning that goods and services may be sold between countries without any sort of tariffs, quotas, or other prohibitions. However, these agreements can cover a wide variety of issues, including labor and workers’ rights, currency manipulation, regulatory compatibility, movement of capital, data transfer, protection of intellectual property, bribery and corruption, environmental concerns, et al.

 

The importance of such agreements is greater than ever before, because … whether we like it or not … the world has been growing increasingly interdependent.  We are living in the age of Globalization, where advances in communications and transportation have facilitated the world-wide exchange of products, ideas, capital, and cultures.

 

 
Development of Free Trade

Protectionism had been the way of the world, from the Industrial Revolution and throughout the 19th Century and into the 20th.  In the U.S., tariffs were regularly imposed in order to protect this industry or that from foreign competition, and to help their proponents win re-election.  However, the theory of  Free Trade took hold in the 20th Century, especially after World War II.

Open markets between countries would give people wider access to goods at lower prices, and spur economic growth.  In the second half of the 20th Century, hundreds of bilateral and multilateral trade deals were negotiated and ratified, affecting every country on the planet.

However, there are practical difficulties which can offset the theoretical advantages of  Free Trade in many economies.  In order to trade, a country must make products which others need.  If its markets are not protected, more advanced countries will offer products at lower prices and better quality.  As a result, the country will be unable to fully develop its industry, and will be unable to purchase even low-cost goods, thus perpetuating underdevelopment and poverty.

The theory of  Free Trade has been attacked from both ends of the political spectrum.  One argument, from the Left, is that protectionist measures early in the industrial development of a country are necessary to allow that country to enter into competition with other nations.  Free Trade agreements can lock out economies struggling to develop, and lock in advantages to established economies.

The argument from the Right is that Free Trade doesn’t work when successful emerging economies, such as China, take advantage of temporary low wages and their own formal or informal protectionism. Lower wages in the emerging economy can devastate important sectors of a competing advanced economy, while keeping out exports that could compete in other sectors of the emerging economy.  In other words, developing countries can use Free Trade to destroy some sectors of economies in advanced countries.

The argument FOR Free Trade is that, over time, the dislocations caused by open markets will lead to tremendous benefits that will be equitably distributed among all parties.  But, the issue is:  how much time?  For devastated industries and displaced former employees in a particular country, it may take a generation for the benefits of increased national wealth to create new industries based on new inventions.  While that is not a long time for a country, it is a very long time for an individual.

A middle-aged worker who loses his job to foreign competition may find that learning the skills needed for a new industry is impossibly expensive and takes too long.  That worker may never be employed in a job that supports him as he had lived before.  This creates a personal disaster that could affect large numbers of people.

In the short term,  Free Trade can devastate a particular economic segment.  This may balance out, in the long run, but time and the unequal distribution of benefits pose a political problem.

 

 
Globalization and Its Consequences

Dani Rodrik, a professor of economics at the John F. Kennedy School of Government at Harvard University, has argued that “unmanaged globalization” is undermining democracy.

“The promise of free trade is undeniable:  Everybody likes those everyday low prices.  But the consequences of the differential distribution of the benefits of globalization are becoming disturbingly clear:  For the upper classes, the world is their oyster.  For the lower classes, the world is their competitor.”

Those who can take advantage of the global economy can benefit from Globalization, while those who don’t have the resources and skills are left behind.

Because of the uneven distribution of the “fruits” of Globalization, wedges are driven between upper and lower classes in the developed economies. As a result, there is a disconnect between the lower classes in developed economies and the citizens of other nations, who are painted as enemies by populist demagogues.

The fundamental problem is that economic globalization is having a distorting effect on politics all over the world.  In the U.S., resentment over the ill effects of trade has been manifest for almost 15 years.  In areas hard hit by job losses caused by trade with China, voters have been electing more extreme legislators, exacerbating the polarization that has made Congress so dysfunctional.

By its uneven distribution of gains, economic globalization is fostering undemocratic tendencies.  This has been illustrated in the Brexit vote and the results of the U.S. election, and will most likely manifest itself in voting in Italy and other European countries in the coming months.

 

 
Possible Solutions

It is incumbent on economies around the world, including here in the U.S., to pay greater attention to education, re-training, and “trade adjustment assistance” for workers who are displaced when industries are disrupted by  Free Trade.

This is not a new idea;  in fact, it has been a component in the party platforms of both the Democrats and Republicans for years.  But, it has never been addressed seriously;  rather, it has been reduced to a platitude.  Now, it is a moral imperative.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

NOVEMBER 9, 2016

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.

 

 

The long presidential election campaign is finally over, and world markets began roiling last night by midnight.  As expected, the elevation of Donald Trump to President-Elect reverberates both domestically and internationally.

Most foreign markets dropped immediately by 2-4%, and U.S. stock futures fell by up to 4% overnight (when U.S. markets were closed). However, by the time that U.S. markets opened this morning, things were already returning to normal.  It is likely that markets around the world will calm down and return to (relative) normal within a day or two.

That includes the Gold market, which is up roughly 5% as a reaction to Mr. Trump’s election, but will likely pull back this week.

At  IntelDigest, we try to have a long view, so we go forward with our discussion of the Gold market in the coming year, as we promised in our last issue.  There are very important developments coming in the Gold market, which convinces us to continue accumulation of Gold and Gold-related investments going forward.

 
Fundamentals

We have previously discussed the “fundamental forces” which drive the Gold markets;  you can review the archive copy of the July 26 issue of IntelDigest for a detailed discussion of the issues.  Weak economic fundamentals in many countries around the world, ultra-low … even negative … interest rates, and enormous amounts of public and private Debt, all propel investments in Gold.

As we stated in that issue:

“Gold is a traditional safe haven in times of insecurity;  it can provide insurance against cyber and political risks.  And, there are good, old-fashioned fundamentals at work …. demand for gold is growing in the marketplace, from Russia and China to western markets, while supply has been dormant because new mining projects were delayed or closed down over the last few years, when the gold price was receding from its 2011 highs.

All of these factors argue in favor of much higher gold prices.”

 
Looking To The New Year

Now, we look at three important international developments in the Gold market, which argue in favor of increasing investments in Gold by the end of this year.

 

The first is the Shanghai Gold Exchange.

China is the top consumer, importer, and producer of Gold in the world. China probably has the largest Gold reserves of any country, as it has acquired massive amounts of Gold in the last decade, much of it secretly. But, government actions are opaque, so outsiders can only make estimates of the reserves.

Existing Gold markets are centered in the London exchange, and Gold prices are controlled by participating banks … mostly Western banks, but also including the Bank of China.  Many believe that these banks manipulate the price of Gold at the behest of their (Western) governments and for their own purposes.

We won’t get into the full conspiracy theory re: Gold pricing (perhaps in a later issue).  But, remember this significant fact:  the LIBOR and COMEX exchanges price Gold based on futures contracts, and there are currently 252 ounces of Gold claims FOR EVERY OUNCE OF DELIVERABLE GOLD!

China is set on dominating the Gold market.  It established the Shanghai Gold Exchange in 2002, and would now like to make it the center of Gold trading and pricing for the world.  China has proposed that the Shanghai market would set the price on the basis of ACTUAL PHYSICAL GOLD, not on paper futures contracts.

Increased activity in the Shanghai Gold Exchange would be a significant factor in propelling growth in the Gold market.

 
The second development is a change in Islamic law which would allow massive investments in Gold by Muslims around the world, who number 1.6 Billion.

Some interpretations of Islamic law prevent Muslims from investing in trades considered “immoral,” such as alcohol and tobacco;  this ban has included investment in Gold bullion as a tradeable commodity for the last few decades.
As a result, approximately 23% of the population of the world has stayed out of the Gold market.  Now, however, the Accounting and Auditing Organization for Islamic Financial Institutions is working with the World Gold Council to set a standard allowing Gold trading by Muslims.

If the pent-up demand by this group of investors is unleashed, Trillions of Dollars could soon pile into the Gold market!

 
Finally, the last important development in the Gold market is Peak Gold, the theory that the production of new Gold is shrinking around the world. Declines in new Gold discoveries have coincided with a surge in the costs of mining exploration.  This has resulted in a reduction in mining operations and a steady decrease in Gold production.

Goldman Sachs has warned that there are “only 20 years of known mineable gold reserves.”  Blackrock, the largest asset manager in the world, has also warned about “Peak Gold,” and asserts that Gold production is likely to decline by 20% per year for the foreseeable future.

There is no way to predict if Peak Gold is a concept which will last for years, or if new technologies or discoveries will change the dynamic.  But, for now, the production of Gold is decreasing at the same time that Gold demand is about to soar!

 
A New Bull Market

Based on these three pivotal factors, a new, strong bull market in Gold is likely in the New Year.  We see the opportunities in Gold as yielding high Returns on Investment going forward, so we are applying our research efforts to finding the best prospects in this sector.

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

NOVEMBER 2, 2016

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.

 

 

This week in  IntelDigest, we will discuss the financial markets … looking at expectations for the near term, as well as prospects for 2017.

In coming weeks, we will go into detail on the highlights of this discussion … examining the causes of an expected Bond Market downturn, and specific reasons for the expected surge in the Gold Market.  We will also dive into discussions of Free Trade, and Technological Development, as well as outline Medicare regulations and requirements for those of our clients approaching retirement age.

Let’s start with The Election … we do not discuss politics in  IntelDigest, but the results of an election have a major impact on the markets … at least in the near term … so we will discuss the impact of the November 8 results.

 
Election of a New President

It is generally expected that the election of Hillary Clinton has been assumed by market participants, and would result in a temporary lift in stocks.  However, the FBI Director’s letter to Congress has roiled the markets over the last few days, causing uncertainty among investors.  As we have stated several times in past issues, investors and companies HATE uncertainty, so stocks are in a defensive posture until the vote has been completed.

On the other hand, a win by Donald Trump will most likely cause an immediate downturn, perhaps as much as 10% in U.S. markets within a day or two.  If foreign markets follow this downward path, the aftermath of a Trump election could reverberate around the globe and turn a 10% slide into a 15-20% global decline.

If that happens, The Federal Reserve would probably cancel the small interest rate increase which it has targeted for December.

 

 

Looking Forward to a New Year

After the dust settles and we move into 2017, certain economic themes are expected to play out, no matter who is elected President.  One example is Gold.  James Steel, chief precious metals analyst at HSBC Bank, believes that Gold is the only sure winner in the election.  The spot price of Gold today is $1,307;  Mr. Steel expects the price to end the year over $1,400 if Clinton is elected, and over $1,500 if Trump is President-Elect.

As reported in BloombergMarkets, “… both candidates have espoused trade policies that could stimulate demand, with gold offering a potential “protection against protectionism …”  Both candidates are also on record as supporting significant stimulus programs.  A Democratic sweep would almost certainly result in a large increase in federal spending.  An increase in the federal deficit would underline a surge in the value of Gold.

Another 2017 theme is the danger in the Bond Market.  There has been incredible movement into bond funds and ETFs (exchange-traded funds) this year.  Inflows into Bond Funds/ETFs through the first nine months of 2016 have totaled $123 Billion … 4X the previous year … and much of that investment came out of Equity Funds and Money Market Funds.

The risk in Bond Funds … particularly the possibility of default … will be higher in the coming years than it has been in decades.  Liquidity is a major issue for companies who have taken on vast amounts of Debt in the low-interest environment of the last seven years.  Profits are decreasing across the board.

Bonds have sold off recently as interest rates rose, and many investors began dumping bond funds.  The Wall Street Journal reported this week that investors pulled $2.2 billion from all junk bond ETFs last week.  Nearly half of that sum came from just one ETF on a single day:  $998 million flowed out of the iShares iBoxx High Yield Corporate Bond ETF (HYG).  High-grade bonds were also affected;  $1.7 billion was pulled from the iShares iBoxx Investment Grade Corporate Bond ETF (LQD), the biggest weekly outflow since inception.

A serious bond-market decline is expected in the coming year, and these recent outflows could be the first sign of much bigger problems to come.

You should be especially wary of junk bonds, or funds containing such bonds.  The danger is that some combination of rising defaults and higher interest rates will trigger a bond-market panic.  The risk of default is just too great!

 
Return of Inflation

Inflation is making a comeback, and that has a deleterious effect on Bonds.  According to The Wall Street Journal, “… data released on Friday showed that core inflation, which excludes food and energy, hit a two-year high of 1.7%” last quarter.

Inflation is rising in Europe, and soaring in the U.K.  The National Institute of Economic and Social Research (NIESR), a British think tank, warned that inflation could quadruple in the second half of next year.

As we know, higher prices are not good for the average person;  for the Bond investor, inflation is disastrous!  The typical Bond pays a fixed annual interest rate;  as inflation goes higher, it eats into the “real” return on investment.  If inflation leads to higher interest rates, then the market value of the Bond decreases.

Investors in long-term bonds are most at risk;  the future payments of long-term bonds are more vulnerable to rising inflation and interest rates than bonds with shorter durations.  Because they are riskier, long-term bonds pay higher yields.   For example, the 30-year U.S. Treasury has yielded almost twice as much as the five-year U.S. Treasury over the last 10 years.

Investors have loaded up on long-term bonds in recent years because short-term bonds have paid next to nothing.  As Bloomberg has reported, “… Investors seeking relief from central banks’ zero-interest-rate policies have poured into government debt due in a decade or more, swelling the amount worldwide by a record $733 billion this year.  It’s more than doubled since 2009 to about $6 trillion, data compiled by Bloomberg and Bank of America Corp. show.”

Now, with inflation rising, many investors are fleeing from long-term bonds.   As an example, the iShares 20+ Year Treasury Bond ETF (TLT), which tracks the performance of long-term U.S. Treasuries, is down 9% since July.

 
Things To Do Now

It’s time to sell (or stay away from) long-term bonds.  If inflation keeps climbing, investors will sell more bonds, pushing yields higher, which could trigger even more selling.  The global bond market is a $100 trillion market;  these early signs of trouble have already spread to the stock market.

As the Wall Street Journal reported on Monday, “… the Dow Jones Industrial Average fell for a third consecutive month, its longest stretch of declines since 2011.  The S&P 500 recorded its worst month since January, and the Nasdaq Composite snapped a three-month winning streak.”

It is also time to go to Cash;  portfolio managers at several large institutions are recommending Cash right now, including Mohamed El-Erian of Allianz, one of the world’s biggest insurance companies.  Among the reasons to cultivate Cash now:  uncertainty about the election, overvaluation of equities, and falling bond prices as interest rates rise around the world.

Cash also allows you to avoid losses on positions which have declined, reduces the volatility of a portfolio, and maximizes “optionality” (choices) to enter and exit positions, and search for bargains, without having to worry about price.

Having more Cash than other investors allows you to shop for bargains when others are desperate to sell.