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

  • The Dollar’s Recent Decline
  • International Investing
  • A Little More on Tax Cuts

The Dollar’s Recent Decline

The dollar has declined in value rather significantly compared to other currencies, a function of complex interactions like the growth rate of the US relative to the rest of the world, Central Bank monetary policies, and expected rates of future inflation both here and abroad. The dollar has demonstrably been a safe-haven asset during times of financial risk, like the global financial crisis of 2007-09 and the historic downgrade of US debt in 2011. My sense is that the dollar’s decline this year (approximately 8% relative to a broad currency index) is mostly reflecting a reversal of this safe haven effect as investors globally seek higher returns by moving money into higher risk assets (e.g. global equities, junk bonds, etc.).

International Investing

An article in Monday’s Wall Street Journal talked about the divergence over the last 10 years between the equity markets and the economic performance of developed versus emerging markets. In short, equities (stocks) have been stronger in the developed markets than they have been in the emerging markets, even though economic growth in emerging markets over the past decade has been stronger. This “anomaly” seems to get rediscovered over and over again, i.e. “Over the past decade, China’s economy has more than doubled in size while its market has declined 35%” (WSJ).

One reason cited for this was corporate governance, or the rules that determine corporate control. I would argue that this is the main reason, and it is highly overlooked even among professional investors in the context of global investing. For example, in the United States corporate governance is very shareholder friendly, and companies often take actions that maximize shareholder value, even if it comes at the expense of workers (e.g. through massive layoffs). If they don’t work to maximize shareholder value, then executives in those firms will be subject to dismissal, or to be acquired (“taken over”) by an outside firm. As a result, US companies have the highest return-on-investment (ROI) in the world, with a mean ROI of 9%. That means each dollar invested by US firms earns about 9 cents per year. And over the past 10 years, US stocks have outperformed those of the rest of the world. In contrast, corporate governance in Japan has historically been the least impactful for shareholders (no takeover market, management not compensated with stock, Japanese people not encouraged to own stock). As a result, Japanese companies have the lowest ROIs in the world, and over the past 10 years (20 really) Japanese stocks have underperformed the rest of the world. Corporate governance in Europe is between the two; much more worker-friendly than in the US, much more shareholder-friendly than Japan. Not surprisingly, the performance of European equities has been between the US and Japan over the last 10 years. I know I have talked about this in prior Kee Points but it is important.

Looking to emerging markets, there are countries with widely disparate corporate governance systems. And just to get it out there, the MSCI (Morgan Stanley Capital International) Emerging Market Index’s countries include the following economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates. Looking at the median ROIs for companies in these countries over the past 10 years, emerging market ROIs fall between those of Japan and Europe. And sure enough, emerging market equity returns over the same period are above Japan’s but below Europe’s.

A Little More on Tax Cuts

Nothing new to report on the tax front yet, but I would reiterate that tax cuts are most effective when combined with some regulatory reform, which we are starting to see (e.g. “Trump vs. the Deep Regulatory State,” WSJ). Because they have more tangible, depreciable assets, older economy companies tend to have higher effective (i.e. what they actually pay) tax rates than newer economy or R&D intensive companies, and they would benefit most from a cut in the corporate tax rate. But newer-economy companies tend to have a high proportion of sales overseas, so they would benefit from a tax cut on repatriated income. Companies that are still reinvesting heavily would benefit from more generous depreciation allowances (i.e. “expensing” capital purchases), while more mature companies that are generating more cash than they can reinvest would benefit from a cut in the corporate rate. So there seems to be something for everyone with the current business tax proposals, which supports Jeanie Wyatt’s assertion (from our most recent webcast) that we expect a broadening of the market if these proposals are implemented. Whenever I am asked about tax consequences I am reminded of the words of economist Norman Ture, who supplied the intellectual underpinnings for both the Kennedy Tax cuts and the Reagan Tax cuts:

“The US­­­­­ economy is not a marionette dangling at the end of government policy strings, predictably reacting to each tug and twist. Changes in the tax structure alter the price signals confronting household and business decision makers and influence their decisions. So do a very large number of other factors, many of which originate in the private sector, not in public policy.”

So many things play a part by altering the price signals in the economy: monetary policy, spending policy, technological innovation and disruption, trade policy, etc. But it is the actions of individual household and business decision makers in response to these signals that determine changes in economic growth.