"Kee" Points with Jim Kee, Ph.D.

Each fall I submit some talking points to the media and would like to share the current ones with you (I’m sure it will sound familiar).


Slow global growth and rising risk spreads (geopolitical uncertainty): The big positive shock of China joining the World Trade Organization in 2011 has run its course, as has monetary policy in general. Slower global growth along with a stronger dollar have negatively impacted US exports, and lower oil prices have impacted business investment spending in the energy sector. Global risk measures have risen this year as well, including corporate quality spreads. Recent positive market performance has been more in anticipation of expected further policy responses rather than data.


China: All eyes are pretty much focused on today’s release of China’s third quarter GDP growth number which came in at 6.9%. That is pretty much in line with expectations in the 6.5%-6.8% range (e.g. Bloomberg consensus, BAC-Merrill Lynch, Goldman Sachs, Barclays, etc.). It was 7% in the first and second quarter. Since China releases GDP numbers with little delay and few revisions, investor confidence in official numbers is not high. Some have argued that actual GDP growth in China could be in the 4.5-5% range, but I’m quite confident you wouldn’t see that in the official release! China still has room to maneuver on the monetary and fiscal policy side, and I think that is what markets are expecting.


While most are familiar with China’s stated challenge of moving from an export-oriented economy to a more consumer-oriented economy, it is in my opinion that the move from government-directed investment spending to market-directed investment spending (i.e. the signals of profit and loss) is most challenging for China. China’s slowing has impacted emerging markets in a big way, and many are wondering whether China could lead us into a global recession. My answer is, “nobody really knows, but I doubt it given what we see right now.” It has already occurred in the materials and commodities sector, as the S&P World Commodity Index is down over 50% from its June 2014 peak. China is large, and growth rates in China do certainly affect the rest of the world. But I think China’s size is overstated (by official measures) somewhat, and I think GDP numbers in China with its strong state sector (it is still communist) aren’t quite comparable to GDP numbers of more market-oriented economies. Thinking that through, I conclude that China is important but perhaps a little overstated. That’s just conjecture on my part, but forecasting China’s economy is all about conjecture! China is notoriously hard to forecast, and US companies consistently say that China’s sales are the hardest to forecast of the regions in which they do business. A former Credit Suisse colleague of mine made an interesting point in this weekend’s Barron’s while discussing their global investment manager’s survey:


"Interestingly, U.S. investors are the most bearish, whereas Asian investors are less worried about China. The closer you get to China geographically, the less concerned investors are about China.”


Europe: The timing of European QE (quantitative easing) and the experience of equity markets in other countries (e.g. US, Japan) makes a case for European equities. Europe’s growth has been a slightly positive surprise as well, a function of the weak euro and lower energy prices.


The importance of buying individual securities over funds: The big three horror stories for investors this year have been the Energy Sector and commodities, emerging markets, and Puerto Rican bonds. Knowing and controlling exactly what you own allows you to know your exact exposure to these and other risks down to the business-segment level.


Corporate actions: Mergers and acquisitions imply less risk taking than major capital expenditures on plant and equipment, but more risk taking than building cash or buying back shares. As for the longer-term trend of public companies going private, this too makes sense. The main benefit of being a public company is access to cheap capital for growth, while the costs are increasingly onerous regulatory compliance and the alleged efficiency costs of an increasing separation of ownership (shareholders) from control (management). With a world awash with capital and hence plenty of capital for growth, this would predict that more companies would see a benefit from going private.




Capital spending: Extending or making permanent “bonus expensing” of capital purchases would increase capex in the other nine sectors to make up for the decline in energy capital spending.


Strong dollar and export challenges: Lowering US corporate tax rates, which stand as the third highest in the world (Tax Foundation), goes straight to the bottom line of US multinationals, helping them compete nationally. Of course, there is a difference between effective versus statutory rates, but at 39% US corporate tax rates are high.


Stock market: The value of an asset (e.g. company stock) is equal to the sum of the discounted (capitalized) expected future net cash flows or earnings from that asset. These earnings are taxed when (in the years) they are earned. To then tax the increase in value of this already-taxed stream of cash flows, which is what capital gains taxes do, is double taxation. Lower investor taxes (e.g. capital gains and dividend taxes) lower the market’s required rate of return (i.e. the discount rate) and increases equity values in a real and direct way.


Individual tax simplification and permanence: Individuals and companies can adapt to just about any level of taxes, once known, but complexity and uncertainty place a burden on taxable activity. Mere simplification and permanence would go a long way towards facilitating productive activity.