There's battle lines being drawn
Nobody's right if everybody's wrong
The battle lines are being drawn, and the war is being fought on multiple fronts. You may not have realized that we are at war, but we are. I'm not talking about Iraq or Afghanistan, I'm talking about the civil war right here in the United States of America. Part of it is "Class Warfare," part is "Financial Repression," part of it is "Crony Capitalism," and part of it is a growing "Police State." Overall it is a battle for the future of America.
It's funny that most people think that Stephen Stills wrote, "For What It's Worth" in 1966 as an anti war anthem, but the truth is that he wrote it to protest the heavy handed police state that was closing down the night clubs they hung out in on Sunset Strip in LA. It's a song written to open peoples eyes to threats to our freedoms right here in our own back yard. "Stop, children, what's that sound? Everybody look what's going down."
Professionally I often see myself as an "Investment Mercenary," nobody cares what you think, whether you're right or wrong, they just want to know if you made them money. Generally I'm OK with that, I've learned long ago that making money is what I'm paid for, being right is secondary. Personally though I love "Freedom," and "Free Markets". Today I'm going to share a few of my thoughts on the various attacks I see taking place on our freedoms and their investment implications.
Class Warfare - The other nights State of the Union address made it clear to all that President Obama's reelection campaign will be based on pitting one class of Americans against another. Not about uniting, but dividing. In 2008 when then Senator Obama was asked why he would support raising capital gains taxes even though revenues from the tax increased when the rate had fallen in prior years, he replied, "I would look at raising the capital gains tax for the purposes of fairness." Tuesday night President Obama used the word "fair" to describe his goal of wealth redistribution seven times (That's seven shot's for those of you playing along at home). He even had the nerve to put Warren Buffett's poor secretary next to the first lady. As an aside, if Warren's secretary is paying 35% on her AGI then she is making in excess of $200,000, not your typical poor secretary. The Congressional Budget Office notes that the effective income tax rate of the richest 1% is about 29.5% when you include all federal taxes, including distributions of corporate taxes. Many wealthy earn money which they are taxed on, they then invest that money in corporations. Those corporations pay taxes on their earnings before they distribute dividends. Those dividends are then taxed again at the individual rate of 15%. If the income is taxed at the corporate rate of 35% and again at the individual rate for dividends or long-term capital gains at 15%, the combined effective tax rate is 44.75%. The effective tax rate for the bottom 50% of taxpayers is 2.5%.
Investment Implications - If a new super duper alternative minimum tax of 30% is applied to those making over $1,000,000, will their investment habits change? Will they buy fewer municipal bonds if their municipal income is no longer tax free? What interest rates will municipalities have to pay to entice investors? Won't that cause all of our local taxes to increase? Will they take the risk of starting new companies knowing that their returns will be significantly lower? Will wealth be created in the United States at the same rate that it was in prior decades? Will growth slow or accelerate?
Class warfare leads to less risk taking and slower economic growth. As Margaret Thatcher once said, "Socialism works until we run out of other peoples money".
Financial Repression - Wednesday Fed Chairman Bernanke gave his State of the Economy address and made it very clear to all that financial repression will continue. The Fed has been implementing their zero interest rate policy (ZIRP) for years now, and again stated that it will continue to do so till late 2014 at the earliest. When asked during the news conference about the pain he was causing the millions of prudent savers Bernanke said, "I guess the response I would make is that savers in our economy are dependent on a healthy economy in order to get adequate returns. Once low interest rates enable the economy to recover, that in turn will lead ultimately to higher returns across all assets for savers and investors." He could of just said, "The beatings will continue until morale improves." Holding interest rates below inflation to ease debt levels and limiting capital mobility is known as "financial repression", and it can last for years, even decades.
The Fed wants inflation, they want the value of the dollar to fall in order to make our massive debts smaller in real terms. The Fed has 22,000 employees and operates outside the congressional appropriations process. Even the CIA and the Navy Seals don't enjoy the Fed's unlimited spending power. They have the power to manipulate interest rates and manipulate the dollar, in fact they are the worlds biggest currency manipulators.
In the SOTUA President Obama also proposed that he would use tax policy to penalize individuals and corporations who move jobs, assets, or profits offshore.
Investment Implications - After the Fed's pronouncement gold immediately rose above $1,700 an ounce. Yields on Treasury bonds fell (prices rose), and stocks rallied momentarily. Stocks are in a quandary. On the one hand lower yields on bonds make stocks (especially dividend payers) more attractive, but on the other hand the Fed's pronouncement that economic growth will be subpar for years means earnings growth will be subpar too. Capital will always flow to where it is treated best. If the US practices "financial repression" and restricts the flows of capital, will capital flow willingly into the US?
Crony Capitalism - Crony capitalism is the system of politically motivated handouts from the government disguised as bailouts or "investments." Unfortunately the United States is dominated by two parties that are very comfortable implementing their form of crony capitalism. Whether it's the long-running funding of the military industrial machine, the "investment" in clean fuels like ethanol or solar, or the bailouts of banks and auto companies, the United States is a long way from Capitalism. Pure capitalism is when one or more investors provide their own capital to a venture, sometimes risky, sometimes safe. The key is they are investing their money. Spending someone else's money is easy, painless, and risk free...for both the "lender" and the recipient. Washington has become very adept at "investing" OPM, just look at Solara Solar.
Investment Implications - The government has taken an increasingly active role in picking corporate winners or losers, whether its alternative energy versus fossil fuels, or companies that source their labor exclusively in the US versus those that are global. The investment field is uneven, unfair, and manipulated. As Jamie Dimon, CEO of JP Morgan, said today in Davos, "We should describe it as bankruptcy for big dumb companies, including banks, we have to get rid of too big to fail." He went on to say, "What the American public wants to know is that it is not going to cost me money." Unfortunately the American public and investors aren't playing in a capitalistic economy where those that are successful are rewarded and those that fail go out of business. Never before have we witnessed such a massive misallocation of capital. Stocks trade at lower P/E multiples (Price to Earnings) in countries where crony capitalism is rampant.
Police State - This week we saw US Senator Rand Paul, son of Presidential candidate Ron Paul, detained by our crack TSA for his refusal to be groped. We also saw President Obama allude to increased penalties on those companies that operate globally. Fortunately this week also saw the Supreme Court shoot down the demand for the police's use of GPS tracking devices affixed to cars without a warrant. These are just two examples of what has been a marked increase in the power of the government to intrude into the private lives of citizens. Much of this has been done under the guise of anti-terrorism, but it is a very slippery slope that we are traveling down. It has become increasingly easy for the government to detain individuals, freeze, and confiscate their funds.
Investment Implications - Again, capital flows to where it is treated favorably. A government that restricts the flow of funds into and out of its borders, simply because it can, will not attract capital versus a state with open borders. Witness the billions in cash on US corporate balance sheets sitting in overseas banks because of the confiscatory taxes imposed on repatriated funds (Apple alone has $64 billion of it's $98 billion parked overseas). A heavy handed police state restricts growth.
Now I know it may not sound like it, but I'm an optimist. I still believe that we live in the greatest country on earth, but that we need some serious work in order to stay that way. I just finished Steve Jobs biography written by Walter Isaacson, and it was a great read. If it doesn't give you faith in our abilities to alter our future than nothing will. Those who worked with Jobs said he often operated in a "reality distortion field," where he would simply force his own reality to win out. I believe that "we the people" can effect massive change, but first we have to stand up and take notice. Washington has grown very powerful, and they are very good at pitting us against each other, but if we are vigilant and aware we can still prevail. Social media may be the best thing that's ever happened to this republic.
It's time we stop, hey, what's that sound?
Everybody look what's going down.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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