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Corporate Tax Reform

Feb 10, 2017   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

Markets closed higher this week, sparked by President Trump’s comments that he will make a “phenomenal” tax-related announcement in the coming weeks.  In his acceptance speech, Trump talked about infrastructure and deregulation.  In the weeks since the inauguration, several proposals for deregulation have emerged, but little in the way of things that excite the market.  His return to talking about tax cuts, both corporate and personal, is seen as reigniting the Trump trade and was largely responsible for investor enthusiasm this week.

Whether you like tax cuts or not, they have a way of impacting the economy and by extension the stock market.  The House GOP proposal on corporate taxation is particularly important for the U.S. outlook.  While a bit wonky, the proposal is what’s called a “destination-based cash flow tax” (DBCFT).  A DBCFT taxes output where it is consumed, rather than taxing income where it is reported; and disallows deductibility of interest expense.  This proposal would effectively convert the U.S. from a worldwide income tax jurisdiction to a territorial system, and adopt a type of value-added tax.  The implications would be transformational: imports by U.S. firms would no longer be deductible, export revenues of U.S. firms would no longer be taxed, and foreign income would not be taxed.  What this type of plan hopes to accomplish among other things:

  • Eliminate incentives to locate business operations outside the U.S.
  • Reverse the pattern of tax inversions (when U.S. companies reincorporate overseas for tax purposes)
  • Eliminate incentives for firms to “strip” income out of the U.S. with the use of inter-company debt, transfer prices, and other similar means
  • Increase incentives for capital spending relative to incentives to borrow

For this system to work, the theory suggests the value of the U.S. dollar would have to increase by approximately 25% from current levels.  Needless to say, it is very complicated and while in theory could work, in practice has not been tried.

As for company news, there were quite a few interesting stories.  Airbnb, the marketplace for enabling people to list or rent short-term lodging, has been pretty successful in stealing market share away from traditional hotels.  This week Marriott announced it would soon introduce communal hotel rooms that could hold between six and sixteen guests.  Guest have their bedrooms and bathrooms but will share a kitchen, dining room, and lounge area.  That’s outside the box thinking for an old-school hotel company.  In other news, Kroger announced it is acquiring Murray’s Cheese which is a New York staple.  The company has changed hands several times since its opening in 1940, but under the leadership of Rob Kaufelt, has become an iconic cheese shop.  Kroger hopes to offer a wider variety of cheeses and thinks this is a way to differentiate itself.

For something a little different, I often talk about the future of self-driving cars.  The industry is in its infancy, yet seems almost within reach.  Companies from Nvidia to Tesla and General Motors to NXP Semiconductors are all racing to perfect the hardware and software to make this future possible.  But this week I came across a twist on this story.  Uber is stepping up its efforts to make flying cars a reality.  The company hired a thirty-year NASA veteran and engineer to spearhead its research into airborne vehicles.  Now that seems like a stretch.

Here’s another one for you.  How about a bank branch without employees?  Bank of America has opened three completely automated branches over the past month, where customers can use ATMs and have video conferences with employees at other offices.  BofA is set to open 50 to 60 new branches over the next year.  Perhaps I’m showing my age, but this might be one innovation too far.

For the story of the week, I turn to Harvard.  We all know Ivy League schools have huge endowments.  How those schools invest the money is not often reported, instead, the focus being on the amount of donations.  In 2016 Harvard raised a record $1.2 billion from donations.  What you probably didn’t hear is that the college had $2 billion in investment losses last year.  So much for being the best and brightest.  Now you know.

February 10, 2017

Week Two

Feb 3, 2017   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

This week started off on the wrong foot.  Jitters over what would come next out of the White House has everyone a little unnerved.  However, as the week wore on, we received a good Non-Farm Jobs report which helped investors forget, for a moment, that the uncertainty is thick like a fog.

After a weekend which included a temporary ban on immigrants from seven, predominantly Muslim, countries and the firing of the U.S. Attorney General, investors were decidedly unsure how to proceed.  Fortunately, earnings announcements are in full swing, and both the media and the pundits had something else to grab their attention.

As with every quarter, earnings announcements are a mixed bag of beats and misses.  This quarter is no different with about 70% of those companies reporting beating earnings estimates and only 40% beating revenue estimates.  More importantly, analysts this quarter are more focused than usual on forward guidance, being it is early in the year, and this metric can often foretell what’s in store for the remainder of the year.  Anecdotally, it is hard to tell when a company reports weak guidance whether it genuinely thinks it is going to be a difficult year, or whether management is intentionally setting the bar low.

From what we’ve seen so far, a lot of companies are providing only modest growth assumptions with an average in the low to mid-single-digits.  Currency headwinds are still an issue for those companies that sell a lot overseas, but year-over-year comparisons should be easier as the year progresses.  Stock repurchasing remains one way companies continue to boost the bottom line and could realize further gains this year if a repatriation bill is signed into law.  Furthermore, corporate tax reform could be a boon for many companies, although a border tax might neutralize that benefit.  It’s simply too soon to say with any authority since so much is up in the air.

In boardrooms across this country, CEOs and their top management are trying to figure out how to please both their shareholders and this Administration.  Amazon announced a new air cargo hub at the Cincinnati International Airport (CVG) which should help boost this region.  This expansion will cost $1.5 billion, and the company is reportedly going to hire 2,000 employees.  Other companies, such as Honda Motor Company, are mulling over whether to build a new production facility in Mexico as planned, or whether to build those plants in the U.S. or Canada.

Insurance companies are analyzing 2016 and trying to determine whether they will participate in the Affordable Care Act (ACA) in 2018.  While they are locked in for the remainder of this year, companies such as Anthem are considering to what extent they will participate next year.  They are not alone in doing these calculations, and that’s assuming the ACA isn’t repealed later this year.  Steel companies initially thought to be beneficiaries of a protectionist agenda, are rethinking the landscape.  It turns out they collectively export a lot of steel, particularly of higher quality.  And then we have the Federal Reserve (Fed), which acts independently of politics, but who must be keenly aware of the tempest that has taken Washington D.C. by storm.  The Fed announcement this week paves the way for another interest rate hike in March.  They cite the moderate pace of expansion, “solid” job gains, and inflation still below the 2% target.  However, as we’ve experienced throughout 2016, nothing is a sure bet when it comes to the Fed.

So why did the market go higher this week?  It comes down to what we know today.  Jobs are returning at a faster pace, and wage growth is picking up.  Earnings announcements, for the most part, are modestly good and the early economic indicators show a resilience that is encouraging.  While we don’t know what is going to happen next week, next month or next quarter, we do know what is happening right now.  And for now, that’s the best we can do.

February 3, 2017

Nearshoring to Replace Outsourcing

Jan 27, 2017   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

The long wait is over as the Dow Jones Industrial Average (DOW) crossed over the 20,000 mark for the first time after trading so close for so long.  It took almost 103 years for the DOW to reach 10,000 in March 1999, and another 17 years to double.  But the last 1,000 points to reach the 20,000 milestone took just 42 days.  The blue-chip index has been propelled by President Trump’s moves to promote infrastructure projects and cut regulation.  As a whole, the U.S. stock market has gained $2 trillion in wealth since Election Day.

While the stock market managed to break new ground in the months leading to the end of 2016, the U.S. economy ended with a mild groan more than a rousing cheer.  Gross Domestic Product (GDP) came in at 1.9% in Q4, down from 3.5% in Q3 and below analysts’ expectations for 2.2% growth.  2016 will be the eleventh straight year without reaching 3% GDP growth.  For comparison, for all 2016, the economy grew just 1.9%, down from 2.5% in 2015.  Most responsible for the slowdown was lower exports and higher imports attributable to the strength of the U.S. dollar.  Consumer spending grew a modest 2.5% for the year, and inflation slowed to 1.3% from 1.7%.

While earnings announcements took center stage this week, there were a few company announcements worth noting.

Ford announced a novel idea to create an auto parts brand for all cars.  The brand will be called Omnicraft and is expected to launch next month.  What this means is car owners will have the opportunity to service non-Ford cars at Ford dealerships.  Ford also plans on selling directly to independent repair shops.  Perhaps a coincidence, but Amazon also announced it struck a deal with several of the largest auto parts suppliers to sell their products directly through the Amazon marketplace.  This move will put Amazon in direct competition with aftermarket auto parts retail chains like Autozone, Advance Auto Parts, and O’Reilly Auto Parts.

A battle over water is coming, and I’m not talking about California.  Bottled water is taking center stage in PepsiCo’s war against CocaCola.  With soda sales falling in the United States, the battle for healthier options is heating up.  PepsiCo has bought a 30-second Super Bowl ad to debut the company’s new premium bottled water brand, “LIFEWTR,” that is positioned to compete with its archrival’s SmartWater.  The product will be priced around $2.70 for a 1-liter bottle.

Kraft Heinz announced this week, instead of buying a 30-second Super Bowl ad for millions as it did in 2016, it plans on giving all of its salaried U.S. employees the day off following the Super Bowl believing this may generate more publicity.  Unlike those Kraft Heinz employees, we at Harvest Financial will be at work on that Monday.

In closing, I’d like to mention a phenomenon which is slowly taking place but is rarely reported in the media.  We hear a lot about outsourcing, particularly when it comes to jobs going to places like Mexico, India or China.  However, there is a movement afoot called “nearshoring.”  It is a trend to move operations away from expensive financial centers like New York City to places like Salt Lake City, or North Carolina, or Jacksonville Florida.  It’s a way to lower costs without heading out of the country – of particular importance given the new leadership in Washington D.C.  Office space in these locations is as much as 25% less expensive, and employees earn about 30% less than those in the Big Apple.  For workers, the cost of living is appreciably lower, commute times shorter, and a walk on the beach is possible during lunch.  Some of the companies that have taken this approach include Deutsche Bank, Bank of America, Citigroup, JPMorgan, and Wells Fargo.  This is a trend to watch.  Now you know.

January 27, 2017

A New Beginning or A Momentous End

Jan 20, 2017   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

For the second week now, the market has gone sideways while waiting for the inauguration of President Trump.  As I write this, the swearing in is done, and the inaugural parade is under way.  What is unknown, at least for now, is what President Trump wishes to accomplish in the days ahead.  We all have a rough idea based on the things he talked about on the campaign trail.  However, now that he is in office will his actions rise to the level of his rhetoric.  That’s what many people are wondering and why the market has temporarily stalled.

Companies continue to respond to the new president with promises of new investments and new jobs.  General Motors, feeling the pressure, announced it plans on investing $1 billion in U.S. factories while adding or retaining 1,500 U.S. jobs.  What can’t be known is if these are new investments or if they had been on the drawing board all along.  Hyundai and affiliate Kia Motors reported they will spend $3.1 billion in the U.S. over the next five years and may even build a new American factory.  And finally, Bayer and Monsanto (who are looking for merger approval), plan on spending approximately $8 billion or half of its agriculture R&D budget in the U.S. over the next six years after meeting with President-elect Trump earlier this week.  The companies also pledged to keep 100% of Monsanto’s 9,000 employees in the U.S.  If recent announcements are any indication, this may be the new norm going forward.

In other news, remember when Britain voted to leave the European Union (EU) last summer?  As we sometimes like to point out, there are sometimes unintended consequences even with the best of intentions.  We learned this week that several of the largest global banks would likely reduce their presence in London in the year ahead.  It seems, without the cross-border agreements facilitated by the EU, it may be harder for British banks to do business in Europe.  Goldman Sachs is considering moving half of its London workforce to Frankfurt, HSBC could relocate a substantial number of employees to Paris, and UBS says it is evaluating moving as many as 20% of its personnel to Europe.  If you think this may motivate a change in thinking, you’d be mistaken.  Prime Minister, Theresa May, made clear this week that the United Kingdom is not seeking a deal to leave it “half in, half out” of the EU.

In what may come as a surprise, global oil and gas discoveries dropped to a 70-year low.  Oil and gas discoveries around the world fell last year to just over 6 billion BOE (barrels of oil equivalent), the lowest since the 1940s.  It seems companies reduced their search for new resources amid falling oil prices.  The decline in new discoveries means companies are likely to struggle to offset the natural depletion of existing fields, reinforcing forecasts of a supply shortage by the end of the decade.  Companies were able on average to replace only 10% of their oil and liquid gas reserves last year, and the number of exploration wells drilled fell by 40% from 2014 when oil prices began their sharp decline.  What may not be included in these figures are a large number of new wells that were capped once the price of oil fell, but which are capable of being brought back online quickly as prices rise and profitability increases.

In closing, I looked for a funny inauguration story to share with you on this historic day.  However, all I came up with was Andrew Jackson’s family and friends trashing the White House during the celebration and William Henry Harrison dying of pneumonia thirty days into his presidency.  Neither seemed appropriately funny.  So instead I bring you the race to build the world’s fastest elevator.  At a ceremony in Tokyo in early December, the Shangai Tower elevators and the company that made them, Mitsubishi Electric, were officially awarded the title by Guinness World Records.  The top speed of one of its elevators can hit 45.8mph on its way to the top.  The Burj Khalifa in Dubai is the only skyscraper in the world taller than the Shangai Tower, but its elevators go barely half the speed.  The fastest elevator in the West, installed in 1 World Trade Center in Manhattan, runs a meager 23mph.  Elevators have come a long way since Otis invented the first one in 1857.  It was installed in a hotel in New York City and traveled five floors at a speedy half a mile per hour.  Now you know.

January 20, 2017


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