A series of insights into macro economics and geopolitics by Steve Malin, our practice leader for the fund management business.
12th January 2018
Corporate taxes are now lower but not simpler. Changes include reducing the corporate tax rate from 35 percent to 21 percent, mandating a one-time repatriation of offshore profits at a rate of 15 percent for cash and 8 percent for illiquid asset, and a new break for small businesses by creating a 20 percent tax deduction for sole proprietors and partnerships. In addition, businesses will be able to write off capital equipment immediately instead of depreciating it over a number of years.
The lowering of corporate rates is expected to stimulate US GDP which is already running at the 3 percent level. Expectations are that increased investment in the economy will drive corporate earnings during the next leg of the expansion. Analysts will be watching closely to see whether this investment materializes and whether employee salaries begin to rise after years of stagnating wages. This extra corporate cash could drive mergers and acquisitions in mid-market technology but high valuations may continue to put a damper on the largest transactions. Expect the added cash reserves to lead to executive pay increases, share buybacks and higher dividend yields. Enhanced cash reserves will also benefit corporate investment even if interest rates grind higher. Corporate borrowing will continue to fund growth but larger cash reserves should mitigate some borrowing needs.
The 21 percent corporate tax rate gives the US a comparative advantage and should, over the long term, drive increased international investment. Germany and Japan have corporate rates of 30 percent, while France is 34 percent. According to the OECD, among the larger economies only the UK has a lower rate of 19 percent. Skepticism concerning the new tax regime falls into three camps. The first group is concerned the tax decrease will blow the deficit out of the water. Expectations for 2018 and 2019 are deficits approaching 800 billion to 1 trillion per annum, extraordinary sums that will need to be paid as interest rates at the short end of the curve slowly move higher. The second group believes the tax benefits will end up in the hands of corporate executives taking massive salary and option packages. At a time of great income inequality there is fear of further alienating the large number of Americans just getting by. The third group of skeptics are concerned that lowering corporate tax rates could lead to tax competition and a global race to the bottom. How will Germany, Japan and other industrial countries react, will they lower tax rates in response, and could this lead to a decline in global tax receipts at a time of increasing government responsibility as our populations age.
The counter argument is that increased growth will be driven, in part by tax cuts, leading to an increase in national wealth. The argument is that innovation and productivity are driven by disruption and technological innovation. Lowering corporate taxes will provide the investment capital, according to this argument, to drive national prosperity. The ability to write off capital equipment immediately should lead to increased investment as well as corporations realize the tax advantages of locating factories in the US. In addition, the 20 percent tax break for individuals filing as a pass-through sole proprietorship or partnership will benefit this entrepreneurial class. A majority of new jobs in the US are created by small and medium size companies and, so the argument goes, increased cash flows will lead to new hires and new waves of innovation. Whether or not the new tax regime is a net benefit to the US economy will be an important factor in the November 2018 midterm elections. The Trump administration needs to show the American public that they are sound managers of the US economy. The midterms already look like tough sledding for the Republicans. They need to win the economic argument as they fight to maintain power in these divisive times. There is much to play for politically and we can be assured that the impact of tax reform will be center stage in the political battles to come.
January 09, 2018
24th September 2017
Our expectations are that Chinese corporate investment in the US will continue to grow rapidly in 2017. The strengthening economy continues to make the US...
The Trump administration’s attitude toward Chinese investment in the US is being watched closely by the M&A community. The question asked is whether the concern emanating out of Washington DC about US and Chinese trade relations will spill over into US investment policy. Chinese corporate acquisitions in the US have tripled since 2015 with Chinese companies investing a record 45.6 billion in 2016. To place this in context, today Chinese firms employ more than 100,000 people in the US while Chinese private investment now exceeds 100 billion dollars.
Our expectations are that Chinese corporate investment in the US will continue to grow rapidly in 2017. The strengthening economy continues to make the US an ideal home for international investors. In addition, access to US technology assets is an essential component of global corporate strategy. There are, however, real headwinds which need to be watched. The Chinese government is concerned that capital outflows will weaken the remimbi which is already trading at historically low levels against the dollar. In the US, the Obama administration and the Congress have blocked the takeover of two separate technology firms by Chinese private equity investors while Chinese companies are waiting for regulatory approval for acquisitions worth 21 billion dollars. President- elect Trump, meanwhile, has made the return of American manufacturing jobs lost to China and Mexico central to his economic argument. On many occasions he has decried the dumping of cheap goods from China, arguing for ‘fair trade’ and positing a
potential tariff scheme.
The fear that trade issues, capital concerns, and national security issues will lead to a deceleration in cross border investments is in our view inaccurate. The national interest of both the US and China benefit substantially through bilateral investment. Leaders of both nations are acutely aware of the economic value of the China US relationship. Since 2000 US multinationals have invested over 200 billion dollars in China while the Chinese government has purchased over 3 trillion dollars of US treasuries. National security issues will remain complicated. The transfer of technology from the US to China is a constant concern of the US Department of Defense .Chinese naval policy has also raised concerns in the Pentagon. This is mitigated by US reliance on China as a partner to help backstop its strategy to contain North Korea.
Chinese strategic and private equity firms are accelerating M&A activity in the US in 2017. Digital marketing and IT projects and staffing firms fit a number of important criterions.
Digital firms provide technical talent and branding skills essential to success in the US market. IT project and staffing firms access a group of employees difficult to find and to retain in an extraordinarily competitive workspace. Expectations are that valuations will increase in 2017 as demand for these essential services remain at decade highs.
September 24, 2017
24th September 2017
The cost of energy and the profits derived from its sale have endlessly fascinated economists, business analysts, journalists, investors and historians...
The cost of energy and the profits derived from its sale have endlessly fascinated economists, business analysts, journalists, investors and historians. American power, culture and foreign policy are entwined so closely with the rise of oil and gas as the world’s primary source of energy that it is almost impossible to envision what modernity would look like without this driver of industrial might, until now. It seems that we have reached the first stage in the disruption of an industry unrivaled in its impact on the fabric of modern life.
Disruption in the energy market is occurring due to dramatic changes in technology. The first change is within the oil and gas market itself with the rise of shale. The second is external, with the rise of Tesla and the electric automobile. The rise of Shale is well documented. Global oil production is 80 million barrels a year; the US produces 10 million barrels a year of which Shale accounts for 6 million barrels. The same holds in the natural gas market. The US will produce 74 billion cubic feet of natural gas in 2016 60 percent of which will come from shale. These statistics are remarkable. The acceleration of shale as a percentage of US production continues despite lower oil and natural gas prices. Private equity firms invested 57 billion dollars in shale producers in 2016. Oil giant BP is in talks to sell its North Sea assets where they have been production leaders since the 1960s in order to buy Shale assets. Tension among OPEC producers is high with Saudi Arabia and Russia (who is not a member) demanding compliance with
agreed to production cuts.
The rise of natural gas production from 8 billion cubic feet in 2008 to 44 billion cubic feet in 2016 also reflects on the decline of the coal industry. Coal and natural gas compete as fuel for the electrical grid. Utilities are moving at a rapid rate toward natural gas and away from coal and in 2016 natural gas surpassed coal in the mix of fuel used for US power generation. The electric automobile and the rise of Tesla is the second great technological disruption facing the energy industry. The rise of electric and potentially autonomous vehicles is disrupting the automotive and trucking industries as well as energy companies. 30 electric automobiles are now on offer. Less than 2 percent of cars are electric but growth is staggering. Growth in electric vehicles was 37 percent in 2016 and expected to be 70 percent in 2017. These numbers exclude the Tesla Model 3 which will move into mass production later this year and has a waiting list in excess of 400,000. Mercedes is this week allocated 1 billion USD to an Alabama plant to build their first electric SUV while BMW watches as the Model 3 take direct aim at the BMW 3 series.
In conclusion, the rise of the autonomous electric car will, over time, place a tremendous burden on oil manufacturers. The movement of legacy producers into shale is girded by shales dual role in both the oil and natural gas market. Coal, already in decline looks to decline further. The rise of solar power is an additional long term threat to both oil and coal. Environmental concerns over shale production are also a medium to long term consideration investors should be mindful of. Rapid technological change is upon us and the winners and losers are now being determined.
September 24, 2017
22nd November 2016
Expectations are growing that the Trump administration will attempt to move a 1 trillion dollar infrastructure bill through the new Congress this January...
Expectations are growing that the Trump administration will attempt to move a 1 trillion dollar infrastructure bill through the new Congress this January. Legislation of this size would reshape public spending priorities for the next decade. It would fulfill an important campaign pledge and place the needs of the working class front and center as a policy priority for the first time in a generation. Trump is, of course, a builder and it is assumed he would be deeply involved in the rebuilding effort. Questions surrounding an effort of this magnitude abound. What rebuilding infrastructure are we talking about? Is it our collapsing inner cities, our decimated manufacturing towns, our crumbling airports, our waste water and drinking water systems, our railways, our energy and electrical works? Or are we also speaking about our information superhighway and our move to G5 and beyond. You see the problem and the opportunity, there is an awful lot that needs fixing, but how many of us believe our government, factionalized and dysfunctional, could take on such an extraordinary task.
The Trump administration could pass this legislation though the tactic known in political circles as triangulation.
By working with the Democratic minority in the Senate and House he could smash the deficit hawks and take the prize. Republican deficit hawks will be furious but he can offer them a consolation gift, a right wing Supreme Court Justice.
At least, this is what the bond market is prognosticating. Since the election the 10 year US bond has moved 60 basis points, from 1.71 percent to 2.31 percent.
The market is also predicting with 95 percent certainty, that the Fed will raise rates 25 basis
points in December. Will all this come to pass? We believe a large infrastructure bill will pass Congress. As always, the devil will be in the details. Will an infrastructure bill become a tax cutting exercise for the private sector or will Trump deliver real dollars for real projects? If 1 trillion dollars, or any amount close to that, moves through the Congress we expect GDP to smash though 2 percent and move north of 3 percent in 2018. Inflationary expectations are another matter and will be weighed against gains in productivity. One area of increased merger and acquisition activity will be technology infrastructure. Cloud computing and data integration are central to project coordination. Those firms at the nexus of technology and infrastructure are expected to see increased profitability, accelerated buy side interest and enhanced valuation in the coming year.
November 22, 2016
22nd November 2016
The US dollar has rallied to 13 year highs against a basket of major market currencies.
While the causes of the rally vary two underlying themes have emerged. First, one must consider that the dollar began its climb years ago as interest rate differentials between US treasuries and international bonds began to widen. This process is now accelerating post-election. 10 year US treasuries yield 2.31 percent up 60 basis points since the election. German 10 year Governments in contrast are yielding 0.20 percent while10 year Japanese Governments are yielding only 0.03 percent. Second, the US business cycle has diverged from its trading partners. Expectations of US GDP are 2 percent for 2017 but can accelerate north of 3 percent on the back of a predicted United States fiscal stimulus. Fiscal stimulus in Japan has so far failed to improve economic output, while in the European Union governments already burdened by high debt are attempting to stimulate their economies though expansionary monetary policy with limited success .
It is our opinion that the US dollar will continue to rise in 2017, reaching parity with the Euro while increasing in value against the Chinese Yuan, Japanese Yen and Canadian Dollar. The US dollar has risen dramatically against the British Pound and should maintain these gains.
The strong dollar will attract foreign investment to the United States as global companies seek to align themselves with American partners. The combination of a growing economy and strong currency will place American companies in an advantageous position 2017, enhancing valuation metrics and benefiting shareholders.
In addition, US companies considering acquisitions will take advantage of the strong dollar. An appetite for technology assets in Europe and the UK will lead US strategics and financials to accelerate global partnerships. We see increased interest from US and Chinese technology providers as they compete across a variety of platforms. In particular firms that provide digital marketing, social media and collaborative media (which joins television, you tube and social) are prime acquisition targets as firms integrate technology and culture in order to provide an enhanced experience for the consumer.
November 22, 2016
22nd November 2016
Trump's domestic campaign policy includes lowering corporate tax rates while creating additional tax incentives for US firms to repatriate overseas income.
One of the central components of Trump domestic campaign policy is lowering corporate tax rates while creating additional tax incentives for US firms to repatriate overseas income. Republican control of both Houses of Congress makes tax reform likely and is one of the significant reasons US stocks have rallied post-election. The S&P 500 is at an all-time high led by Financial and Infrastructure companies who have been out of favour for years.
One of the ostensible reasons for lowering corporate taxes is stimulating corporate investment. In practice, however, corporates are already flush with free cash while borrowing costs are at record lows. So, what will companies do with the additional cash generated from lower taxes rates and repatriated overseas income? The answer, in our opinion, is twofold. First, companies will continue to buy back their own stock. Second, acquisition activity, now at record volumes will continue at an accelerating pace. Privately held tech companies will benefit as public companies stocks move higher. Competition among public companies for private assets will be fierce as they arbitrage public vs. private valuation.
Additional clarity on tax policy should be expected in the weeks leading up to the January State of the Union Address. In our opinion US equity markets will continue to move higher under these conditions. Regulatory reform is emphasized as a condition for economic growth. International corporations considering entering the US market have been concerned about high legal and consulting costs. Significant regulatory reform combined with lower corporate tax rates will accelerate an already vibrant middle market in mergers and acquisitions. Valuations will rise as lower taxes and less costly regulations benefit technology firms. Mergers and acquisition activity will increase as the financial arms of strategics and private equity firms reallocate resources due to enhanced metrics.
November 22, 2016
22nd November 2016
Prime Minister David Cameron's futile attempt to appease the Euro sceptic wing of the Conservative party has ended in calamity.
Prime Minister David Cameron’s futile attempt to appease the Euro sceptic wing of the Conservative party has ended in calamity. A year after winning a surprise second term as the UK’s Prime Minister he has been unceremoniously dumped. In the parlance of politics he resigned in order to spend time with his family. Which he will do, I understand, by going on a speaking tour at £150,000 per hour. You can’t make this stuff up. But there are lessons to be learned. Lessons involving arrogance, incompetence, carelessness, lack of preparation and on and on.
The UK, either the 5th or 6th largest economy in the world (they seem to swap places with France monthly) is , according to new Prime Minister Theresa May, going to exercise its option to leave the European Union, and formally announce that intention, by exercising something called clause 50, and will do so no later than March of 2017. The exercise of clause 50 will formally begin the process of leaving the Union. How long it will take to actually leave is anyone’s guess. The Europeans are saying there is a two year deadline, but that is extremely optimistic. UK law and EU law have become deeply entwined over forty years. The divorce will certainly take more than two. Someone once said, “Chaos is an opportunity”. Well, whoever said that, here is your chance. Fearing that the European Union has the upper hand in the negotiations to come, market traders have driven the Pound Sterling down over 30 percent.
Strategics and financials interested in acquiring UK assets in digital marketing, enterprise software and technology services now find themselves in the enviable position of buying on weakness at tremendous discounts. In our view, the opportunity to by strong companies at significant discounts is compelling. We cannot, however, recommend paying David Cameron £150,000 to deliver a speech, even if he recites Shakespeare.
Pound weakness is already peaking the interest of Chinese technology leaders Baidu, Alibaba and Tenement . These technology giants have led the way as Chinese firms spent a combined 64 billion dollars on mergers and acquisitions in the last 18 months. The top Chinese firms have brought their deal teams in house as they ramp up for 2017. UK companies specializing in enterprise software, cloud computing, data integration and digital marketing will benefit and be sort after as potential partners.
November 22 2016