SOM Macro Strategies State of the Markets: Strategies for Trumpanomics

Transcription

1 Presentation For Burridge Conference 2017 SOM Macro Strategies Alan Brazil November 2017

2 My Four Step Process My Four Step Process For Identifying High Sharpe Ratio Strategies 2

3 Step 1: Macro Theme US Economy is Normalizing. Trumpanomics: The US Economy Is Growing 2 US GDP and Employment Normalizing Unemployment Rate(%) Unemployment (LHS Reverse Order) GDP (RHS) GDP (Y/Y %) Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08 Mar-11 Mar-14 Mar-17-6 Federal Reserve Bank of St. Louis, Data Accessed Through FRED 3

4 Step 1: Macro Theme But Can Trumpanomics Push Growth Up To The Old Normal Of Reagan? But Can Trumpanomics Get Growth Back To The Old Normal Levels? Annualized 4-yr Percentage Change 6% 5% 4% 3% 2% 1% 0% Changes in Real GDP And Producticvity Over 4-year Periods Annualized Real GDP Per Capita Annualized Nonfarm Business Real Output per Hour Reagan Old Normal Trump New Normal -1% Jan-55 Jan-63 Jan-71 Jan-79 Jan-87 Jan-95 Jan-03 Jan-11 Jan-19 Federal Reserve Bank of St. Louis, Data Accessed Through FRED 4

5 Step 1: Macro Theme Trumpanomics Tax Cuts And Reform Act of 2017 Personal and corporate tax cuts Reform Regulatory Reform Reform Dodd-Frank American Energy and Infrastructure Act Nat Gas is the new coal 5

6 Step 2: Fundamental Economic Framework Without Substantial Changes, New Normal Seems The More Likely Future For the US Getting To Those Levels Means Reversing The Fall In The Growth Factors Annual Growth Rate (%) Labor Input Capital Input Multisector Productivity 3.2 Real Output US Non-Farm Private Buisness Annual Growth Rate (%) BLS, Multisector Productivity Data Base 6

7 Step 2: Fundamental Economic Framework But The Slowdown In Labor Will Be Tough To Reverse BLS and CBO Projections as of

8 Step 2: Fundamental Economic Framework Population Growth Is Not Enough to Offset Impact of Retiring Baby Boomers Munnell, The Impact of Aging Baby Boomers on Labor Force Participation, Center for Retirement Research, Boston College, February,

9 Step 2: Fundamental Economic Framework Investment has not recovered from the 2008 crisis Investment is Falling But With ZIRP, Why Invest Now? 10% Net Investment As % of GDP 9% Percent of GDP (%) 7% 6% 4% 3% Net Fixed Investment Average % Federal Reserve Bank of St. Louis, Data Accessed Through FRED 9

10 Step 2: Fundamental Economic Framework Impact of Tech On Productivity Was Substantial But Productivity is Falling As The Tailwind From Tech Is Slowing Ferrnald, Reassessing Longer-Run U.S. Growth: How Low, Federal Reserve Bank Of San Francisco, Working Paper, Aug

11 Step 2: Fundamental Economic Framework Technology Has Create a Winner-Take-All Economy In The Tech Economy Winners Win More But At The Cost of More Losers Mckinsey Global Institute, Playing to Win, September

12 Step 2: Fundamental Economic Framework And Create Growing Wealth Inequality Winer Take All Economy Has Also Increasing Inequality IMF, Article IV, USA, June

13 Step 2: Fundamental Economic Framework And Created The Ability To Offshore Jobs Employment (000) Real Manufacturing Output (RHS) Manufacturing Employment (LHS) Jan-87 Jan-91 Jan-95 Jan-99 Jan-03 Jan-07 Jan-11 Jan Index (2009 = 100) Federal Reserve Bank of St. Louis, Data Accessed Through FRED 13

14 Step 2: Fundamental Economic Framework Tech Economy Has Also Hallowed Out The Rust Belt Economies Median Personal Income City Change Job Loss By State 2015 Pittsburgh % -62% Cleveland % -60% Buffalo % -70% Detroit % -50% USA % -25% Census 14

15 Step 3: Find Potential Catalysts Trumpanomics Tax Cuts And Reform Act of 2017 Personal and corporate tax cuts Reform Massive tax reduction regulatory relief and lifting restrictions on American energy s 15

16 Step 3: Find Potential Catalysts Personal Tax Cuts Paid For With Repealing Deductions And Exceptions Total ($bil) Provision Static GDP Dynamic Personal Tax Reform Tax Cuts & Move From 7 to 4 Brackets -$1, $800 Double Standard Deduction -$1, $1,300 Eliminate AMT -$ $500 Increase Child Credit -$ $700 Repeal Estate Tax -$ $100 Repeal All Itemized Deduction Except Mort & Charity $1, $1,300 Repeal Personal Exemptions $1, $1,700 Other Reforms $ $400 Total Personal -$ $0 1. House Ways and Means, 2. Tax Foundation, "Details and Analysis of the 2017 Tax Cuts and Jobs Act, Special Report, November

17 Step 3: Find Potential Catalysts Not A Cut Rather Moving the Brackets Changes in The Cut In Personal Tax Seems Small Versus That of Reagan 50% Comparison of Trump Tax Plan Vs Current 40% Marginal tax Rate (%) 30% 20% 10% Trump Marginal Personal Tax Rate Current Marginal Personal Tax Rate 0% Single Filer Personal Income ($000) IRS, House Ways and Means 17

18 Step 3: Find Potential Catalysts Tax Reform Is A Middle Class Tax Cut Increase in After Tax Income Income Personal Changes Personal and Group Only Corp Changes 0-20% 0.1% 0.8% 20-40% 0.7% 1.4% 40-60% 1.4% 2.2% 60-80% 1.6% 2.4% 80-90% 1.4% 2.4% 90-99% -0.2% 1.5% Top 1% -2.0% 7.5% Tax Foundation, "Details and Analysis of the 2017 Tax Cuts and Jobs Act, Special Report, November

19 Step 3: Find Potential Catalysts Tax Reform Is Simplified Tax Form For 90% of Taxpayers House Ways and Means 19

20 Step 3: Find Potential Catalysts /5/2017 Trump, Republican tax plan may hit the states and counties that voted for Clinton hardest Middle Class Tax Cuts Funded From Non-Trump States: Repeal of SALT CNBC,

21 Step 3: Find Potential Catalysts Middle Class Tax Cuts Funded From Non-Trump States: Property Tax Limits Zillow,

22 Step 3: Find Potential Catalysts Corporate Tax Cuts Are Substantial But Could Create Growth Total ($bil) Provision Static GDP Dynamic Total Personal -$ $0 Business Tax Reform Cut Tax to 20% -$1, $700 Max Tax Rate of 25% For PT Businesses -$ $500 Cap on Net Interest Deduction and 100% Capital Dep -$ $100 Eliminated Credits and Deductions $ $400 Move to a Territorial Tax On Foreign Earnings $ $300 Total Business -$1, $600 Total -$1, $ House Ways and Means, 2. Tax Foundation, "Details and Analysis of the 2017 Tax Cuts and Jobs Act, Special Report, November

23 Step 3: Find Potential Catalysts Corporate Tax Cuts Puts The USA Statutory Rate Closer To Other Economies USA Statutory Corporate Rates Vs Other Advanced Economies 35 USA Marginal Tax Rate (%) Japan UK Germany Canada Switzerland OECD 23

24 Step 3: Find Potential Catalysts Reform Is Needed To Deal The Ability Of Corporates To Shelter Profits Corporate Profits and Taxes (4-yr Moving Averages) Effective Corporate Tax Rate (RHS) Corporate Profits Pre Tax (LHS) 60% 50% Percent of GDP (%) % 30% 20% 10% Taxes Rate (%) 0 Jan-50 Jan-56 Jan-62 Jan-68 Jan-74 Jan-80 Jan-86 Jan-92 Jan-98 Jan-04 Jan-10 0% 1.Federal Reserve Bank of St. Louis, Fred Data Base 2. Factset 24

25 Step 3: Find Potential Catalysts And The Use of Pass-through Entities to Avoid Double Taxation 1 90% 80% 70% Percent of US Total Business Net Income By Corporate Type Partnerships (PT) S-Corp /LLC and Limited Part (PT) C Corporations 60% Percent (%) 50% 40% 30% 20% 10% 0% -10% IRS 2. GAO 25

26 Step 3: Find Potential Catalysts Lower Corporate Rates Reduces The Tax Advantage of Pass-through Entities 100% 90% Tax Difference Between Personal and Corporate Income 80% 70% Incentive to Move Income From Corp to Personal Marginal Rate (%) 60% 50% 40% 30% 20% Combined Top Tax Rate On Corporate Profits (Double Taxation) Top Marginal Personal Income Tax Rate 10% Corporate Tax Reform 0% IRS 26

27 Step 3: Find Potential Catalysts Reform And a Territorial System Reduces The Incentive to Keep Profits Overseas Kimberly A. Clausing, The Nature and Practice of Capital Tax Competition, April 5, 2015, pg10 27

28 Step 3: Find Potential Catalysts Corporate Tax Reform Could Spur Growth By Increasing Investment 6% Five-Year Growth Rates Of Producitivty and Investment 4% Annual Growth Rate (%) 5% 4% 3% 2% Net Fixed Investment (LHS) Real Output Per Hour (RHS) % 2% 1% 0% Annual Growth Rate(%) Federal Reserve Bank of St. Louis, Data Accessed Through FRED 28

29 Step 3: Find Potential Catalysts Reform Could Rev Up The US Economy 1,200,000 1,000,000 Impact of Tax Reform Over Next 10 Years ,000 8 People 600, , Percent (%) 200, Debt/GDP Growth In Capital Stock Change In Long Run GDP Wages Employment (LHS) 0 Tax Foundation, "Details and Analysis of the 2017 Tax Cuts and Jobs Act, Special Report, November

30 Index (100 = 10/7/16) SOM Macro Strategies Step 4: Find Asymmetric Strategies Buy US Equities: Investors Have Not Fully Priced In Tax Reform Euro Stoxx Nikkei S&P Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Oct-17 Dec-17 Bloomberg 30

31 Step 4: Find Asymmetric Strategies Buy Corporate Spreads: Corporate Debt Growth Has Surged 10,000 9,000 Nonfinancial Business Credit Outstanding 8,000 7,000 6,000 $bil 5,000 4,000 3,000 2,000 1,000 0 Oct-51 Oct-56 Oct-61 Oct-66 Oct-71 Oct-76 Oct-81 Oct-86 Oct-91 Oct-96 Oct-01 Oct-06 Oct-11 Oct-16 Board of Governors Federal Reserve, Z1 Data 31

32 Step 4: Find Asymmetric Strategies Equity Market Cap Has Grown Faster Which Has Pushed Down Leverage Nonfinancial Corporations Have Been Deleveraging 46% 26,500 Leverage : Debt /( Debt + Market Cap) (RHS) Equity Market Cap (LHS) Total Debt (LHS) 21,500 40% $bil 16,500 34% Ratio (%) 11,500 6,500 28% 1, Q4 1996Q1 1998Q2 2000Q3 2002Q4 2005Q1 2007Q2 2009Q3 2011Q4 2014Q1 2016Q2 22% 1. Board of Governors Federal Reserve, Z1 Data 2. Federal Reserve Bank of St Louis, FRED Data 32

33 Step 4: Find Asymmetric Strategies Leverage Could Fall As Reform Reduces The Value of The Tax Shield Debt Tax Shield Major Driver of Leverage Marginal Benefit of Debt Tax Shield (LHS) Marginal Benefit After Corporate Tax Reform (LHS) Leverage (RHS) 60% 50% 6.5 Incentive (%) % 30% Ratio (%) % Federal Reserve Bank of St. Louis, Data Accessed Through FRED 33

34 Step 4: Find Asymmetric Strategies Buy Corporate Spreads: Spreads Could Tighten As Corporations Deleverage 75% 65% Leverage, Corporate Spreads And Tax Reform Leverage (LHS) Potential Leverage After Tax Reform (LHS) Ratio (%) 55% 45% 35% Spread (bps) 25% % Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan Board of Governors Federal Reserve, Z1 Data 2. Federal Reserve Bank of St Louis, FRED Data 34

35 Step 4: Find Asymmetric Strategies Position For Higher Rates: The Economy Has Normalized But Not So Yields Interest Rates Still At Historical Lows Yield (%) yr Treasury Fed Funds Jul-54 Jul-59 Jul-64 Jul-69 Jul-74 Jul-79 Jul-84 Jul-89 Jul-94 Jul-99 Jul-04 Jul-09 Jul Federal Reserve Bank of St. Louis, FRED System 35

36 Step 4: Find Asymmetric Strategies QE Explains The Lower Than Normal Yields 14% Historical Relationship Between Nominal GDP Growth And Treasury Yield 5-yr Treasury Yield (%) 12% 10% 8% 6% 4% 1985 Q Q Q Q2 2-yr Annualized Growth As Of 2017 Q Q2 Nominal GDP Growth 2% 0% -2% 0% 2% 4% 6% 8% 10% 12% Annualized Nominal 2-yr GDP Growth 1. Federal Reserve Bank of St. Louis, FRED System 2. Authors Calculation 36

37 Step 4: Find Asymmetric Strategies QE Is Being Reverse And Could Accelerate With New Fed Chair WSJ 37

38 Step 4: Find Asymmetric Strategies The Other Parts of Trumpanomics Regulatory Reform Reform Dodd-Frank American Energy and Infrastructure Act Nat Gas is the new coal 38

39 Step 3: Find Potential Catalysts Financial Reform Could Reverse the Decline in Bank Lending Total Capital Ratio (%) Total Capital Ratio (LHS) 0 Annualized 2-year Asset Growth (RHS) q1 2000q1 2002q1 2004q1 2006q1 2008q1 2010q1 2012q1 2014q1 2016q Annualized Asset Growth (%) FDIC 39

40 Step 3: Find Potential Catalysts Energy Reform Means Nat Gas In the Rust Belt API, Hydraulic Fracturing: Unlocking American s Natural Gas Resources July

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