Altus Insight - March, 2014
The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor
Date: March 31, 2014
FR: Forrest Jinks
RE: Ides of March
Not only was Ides of March (March 15th) the day of Julius Caesars famous assassination, on Roman calendars up until the year prior to Caesar’s famous assassination, when Caesar himself introduced a new calendar, the Ides of March was considered the end of the New Year’s celebration, with the New Year beginning on March 1st. New Years, like birthdays, are interesting in that while everything is supposed to be different, in reality little ever is. But sometimes the reverse is true, where it wouldn’t seem that much would change just with the turning of the calendar but it certainly feels like things are different.
As I write this article, there is much that is the same as it was a month ago, and yet, much has changed as well. Further events bring Don Henley’s song “End of the Innocence” comes to mind. This month I will briefly touch on some of what is the same, and in broad strokes consider what has changed, and why those changes might matter.
SAME: Debt, Debt, Debt - The absolute value of the national deficit fell considerably in 2013. While I don’t want to minimize the importance of reducing the deficit (you can’t reduce debt until you reduce deficit), data without perspective is useless. The 2013 deficit is still the 5th largest deficit in the history of the country. Granted, even that can be misleading without some perspective, since the economy is much larger than it was 50 years ago, so let’s look at the deficit another way. According to the Tax Policy Center, 2013 was the highest tax collection year relative to GDP in the history of the country (and 2014 is forecasted to be the highest absolute collections in our history). The issue is that the economy grew at 1.9% in 2013 while the debt, because of the deficit, grew at 4%. This means despite the highest tax collection year ever (relative to GDP) we still are losing ground. Meanwhile, despite historically low borrowing costs the Federal Government had $222 Billion dollars of interest expense last year. Even a 1% rise in realized borrowing costs close to triples the annual interest expense. All this talk of debt and deficit matters because economists from all different economic philosophies and countries around the world have produced studies indicating that once a certain debt level is reached the growth of that country is constrained by the debt load. In short, the reduction in the deficit is fantastic, but hopefully we won’t get so caught up in congratulating ourselves that we fail to realize there is still a lot more work to do.
Same: Washington Doesn’t Understand Business or Taxes - Yes, I realize the header is a huge generalization, but it is still an accurate generalization, which is scary, because Washington passes the laws that affect all of us. Their lack of concern for such laws was obvious a few years ago when a Treasury Secretary was appointed who had not done his taxes in several years. The IRS is a department of the Treasury. Most recently it was Washington showing its ignorance about tax law when several high profile politicians and bureaucrats (and several news outlets) blasted a well known blogger for tweeting that he had just paid his first ACA tax penalty for not having insurance. The justification for the blasting was that the ACA penalty doesn’t start until this year, meaning it wouldn’t have to be paid until 2015. Their error, and where the blogger is correct, is that sole proprietors, general partnerships and corporations all have to pay quarterly tax estimates. Those quarterlies are due April 15th. It is understandable for employees, retirees, and others to not know/understand the tax system, but it is not acceptable for the politicians and administrations who vote and sign taxes into law to not understand. I realize none of this comes as a surprise since the precedence of ignorance of main street business realities was set long ago, but that it is why it is captured in the “Same” section of this article as opposed to otherwise.
Same: Neither do Most Other Governments – “Setting a higher goal for global growth is a good idea to try and build momentum in the world economy,” stated the head of the Bank of Canada at the Group of 20 meetings held in Sydney in late February. He further declared, “What’s emerging is a sense this thing (global economy) isn’t quite ticking over as quickly as we had hoped so I think it is good to develop, nurture a sense of common purpose…”
If only it was that easy, or even possible. While my company may be able to grow by taking business from a competitor, the only way an industry grows beyond the speed of the world GDP is by finding untapped markets, who in turn spend dollars that were previously being spent elsewhere. My company taking business from a competitor or an industry gaining sales at the expense of other industries does not contribute to total growth; it is a trading of dollars. The only way for an economy to grow in aggregate is through a growing population, increased productivity, or an increase in leverage.
Since world governments, especially large ones, aren’t in the business of encouraging their population base to procreate, world economic growth can only come through an increase in productivity or an increase in leverage. Since the largest economies are still going through a major deleveraging to deal with the debt explosion of the 80’s through 2000’s, the only true source of growth available to the world is an increase in productivity. That in turn is based on innovation. The more governments try to get involved in innovation, the less of it actually occurs.
All this leads to the conclusion that statements made like the one above must be for marketing purposes because there is no way the head of a central bank can really think the governments of the world can drive aggregate growth.
New: Real Estate is Local Again - For all of known history up until the 2000’s real estate was considered a local investment. Markets went up and down due to economics of that particular market or region. Real estate was not a monolithic investment vehicle across the country. While there were still some variations in percentages, the 2000’s gave us a national real estate market that went up (and up, and up) and then went down, mostly way down. There are indications that real estate may be returning to its previous stripes. There are parts of the country that have yet to see much in the way of recovery from the crash while other parts of the country have hit new price highs. There are areas that had consistent recovery off the bottom and others that had incredible recoveries but have flattened. Here in California we have markets where properties are selling all cash over asking with multiple offers and only 30 miles away prices have started to drop. Overall February sales in California were down 14% year over year. The Bay Area is still hot but Sacramento has had price declines. In some way it makes investing harder, and can certainly lead to reduced profits (we are experiencing that in Sacramento to a certain degree), but in many ways it is a long term benefit for investors like Altus Equity who are able to take the time and have the network to understand the markets in which we invest. Everybody makes money in an appreciating market. Good investors can make good money in a settling market. Everyone has difficulty in a crashing market. But flat consistent markets offer the least amount of risk because we can most easily forecast future performance.
Moving deeper into 2014 we will be keeping our eye on how interest rates affect the pool of available buyers and on local/regional economic activity.
New: Russia Annexes Crimea - In a vacuum, the return of Crimea to Russian governance would probably have little impact on any of our lives. Some of our investments may be affected, but even then the effect would be relatively minor. But Ukraine doesn’t exist in a vacuum and decisions made in Moscow and then in other capitals around the world could have far reaching affects. The period of relative peace in Europe has been unprecedented. While there are scores of civil wars and some countries talking tough, the entire world has even been relatively peaceful for quite some time. ‘Recency Bias’ is humans believing that because things have been going a certain direction for a while that they will continue to go that direction forever. Risks are then overlooked and/or minimized. This is part of the bubble phenomenon. This is also what was occurring in the early days of the 20th century…the stock market was doing well, international trade and investment rivaled the trading situation of today…what could go wrong? Even the assassination of a duke didn’t seem to hamper the spirits on Wall Street until a few weeks later when the world was at war and the stock exchanges were closed for several weeks to keep hysteria from causing an implosion. More parallels can be drawn to the late 1930’s and early 1940’s when a near dictator (who became an undisputed dictator) started absorbing surrounding countries in the name of protecting the citizens native to his own country, all while weak kneed politicians in surrounding countries justified their inaction and swallowed the lies spewed by one Adolf Hitler. Are the months leading up to WW1 a good example of the road the world is going down? Or is it more like WW2? Or hopefully neither? I really have no idea and obviously hope and pray for peaceful resolution, but the possibilities of history repeating itself certainly makes me examine my own investment assumptions. There is nothing I can do to change the path of these world events, but I do have control over my own actions in anticipation of possible events or in reaction to what does end up occurring.
End of the Innocence: It is better to not have to work – Our country was built on the American Dream where any citizen through gumption and hard work could build a better life for themselves, and with a little bit of luck might be able to become wealthy or change the world. Apparently, that American Dream has been shelved and a new one taken its place. According to statements made recently by Jay Carney, and Nancy Pelosi (among others) the great thing about the Affordable Care Act (ACA) is now people don’t have to worry about their medical so they don’t have to work as much to cover their other costs and can instead spend that extra time pursuing their hobbies and dreams. This is a direct quote from Mr. Carney, “Opportunity created by affordable, quality health insurance allows families in America to make a decision about how they will work, or if they will work.” Of course, there is no mention that the cost of this medical care is being supplemented by people who actually are working. What happened to politicians who instead said, “Ask not what your country can do for you, but what you can do for your country?”
End of the Innocence: Centrally planned economy – The Federal Reserve has two official mandates, keep prices stable (avoid inflation) and maximize employment. Since the Great Recession the Fed has been adding to their “responsibilities” almost at will. The latest attempt to broaden the scope of their power over the economy is a new effort for their mandates to also include the avoidance of asset bubbles. The idea is that their forward guidance on interest rates, and then their ensuing interest rate moves wouldn’t be based solely on avoiding inflation and maximizing employment (which are things that benefit the “every man”) but would also be largely impacted by efforts to try and avoid asset bubbles (a protection of the “rich”). The humor and irony of this is not lost on those who remember the Fed’s previous success in calling bubbles. They have no previous success. All a person has to do it listen to Bernanke speeches from 2007 and 2008 or Greenspan speeches from 2000 and 2001 to realize this in spades. I realize the Fed has a tough job and I don’t want to criticize them for that, but I do have criticism for them in trying to control uncontrollable things. Centrally controlled economies don’t work, especially in societies that even pretend to simultaneously give their citizens freedoms. Are we already forgetting the lessons learned from the USSR and others? Change can be stressful, bubbles can be painful, but it is change that leads to opportunity for those willing and able to adjust.
Altus Equity Group, LP