"Kee" Points with Jim Kee, PhD.

Italy: Rejected large changes to its political system in a referendum vote on Sunday. The victorious “No” campaign, led by the so-called “populist” (the term has so many meanings now!) Five Star Movement, is considered somewhat of an anti-establishment movement against Italian Prime Minister Matteo Renzi. Renzi won 80% of the vote in 2014 when he became Italy’s youngest-ever prime minister, pledging to reform entitlements, taxes, and labor laws. In Brexit-like fashion he said he would step down if he lost this referendum vote on his program. He did lose, but the interpretation of this outcome is a little complicated as it can be said to reflect many things, such as anti-immigration groups (e.g. the Northern League) as well as those who felt Renzi’s sweeping political reforms would weaken the Senate and strengthen future prime ministers.


My quick take: Italy’s political system reflects a decentralization of powers with a strong Senate and weak Prime Minister – all enacted after World War II in reaction to Benito Mussolini’s fascist dictatorship there. It is believed that this structure has, over time, led to excessive debt and miss-management of public spending, corruption, complex labor protection laws, high taxes, and growing entitlement spending. These are some of the things Renzi pledged to reform, and the referendum would have altered the political structure, which has been in place since 1948, in order to accomplish these things. Judging from the reaction of global markets and the euro today (up), this no vote was largely expected and already priced in. The type of fiscal reform that Renzi advocated is hard – every cost is a benefit to someone – which is why you see monetary responses enacted around the world far more frequently than fiscal (tax, spending, regulatory) reform.


US: Third quarter GDP growth for the US was revised upwards last week to 3.2%, and current “nowcast” estimates for the fourth quarter are above 2.5% (Atlanta/New York Fed), so it appears the second half of 2016 in the US will indeed be stronger than the first. This is corroborated in other data as well, like both manufacturing and non-manufacturing and services data (i.e. ISM manufacturing and services indices), which continued to improve in November.


China expansion and US profitability: A great topic that came up in a client meeting was foreign direct (business) investment in China. Back even before the big crash in 2008, I knew several astute retail analysts who claimed that China would allow firms to open just enough stores to break-even, i.e. to not lose money because of inefficient size or scale. China would then copy their business models and the Chinese versions would proliferate throughout China. It was a great story but hard to document and verify. I decided to test the concept another way. If you look at the top companies in the S&P 500 that earn 40% or more of their sales from China, 85% of them are in the Information Technology sector (Bloomberg). The median return-on-investment (ROI) for Information Technology companies in the S&P 500 is about 16.5% (Credit Suisse HOLT). If China investments were just earning break-even amounts, then Information Technology companies with a lot of China exposure should have much lower ROIs then their non-Chinese focused peers, and they do: 12.5%. That is an awfully rough test of the notion that China limits the amount of profitable investments there, but it does corroborate similar efforts that I have seen over the years. And by the way, here’s an interesting fact: About 2% of S&P 500 sales come from China (Bloomberg).