CC-BY-SA-2.0, FlickrPhoto: Grempz
. Entrepreneurship and VC Investing in Florida – Ready for Lift-Off
Florida is one of the most exciting stories on the U.S. venture capital scene right now, with the state being the third fastest growing startup state overall and Miami the number one fastest growing U.S. metro area for new startups. And yet Florida still receives less than 1% of global venture capital dollars. Why? And what will change this?
The key role of entrepreneurs is to bring together resources for success. The fundamental ingredients of a successful startup are experienced entrepreneurs with new ideas, great people to join the team, investment capital, support from mentors and peers, and strong team of advisors – sophisticated lawyers and accountants are essential. In addition to creating high-growth businesses and new jobs, a flourishing entrepreneurial ecosystem has an exponential effect on the local economy.
Florida has many of these ingredients in abundance already. By any measure, the Sunshine State is filled with smart capable people and a tremendous amount of capital. Record numbers of people are moving to Florida from major tech industry hubs like New York, California and Boston. There is growing awareness of angel investing thanks to local groups like AGP Miami, New World Angels, Florida Angel Nexus and the Tamiami Angel Fund. Members of these groups are pouring millions in investment into new startup companies every year. The local startup community is growing rapidly and becoming better organized. According to 2017 edition of the Kauffman Foundation Index of Startup Activity, Miami is the number one fastest growing U.S. metro area for new startups being created, with Florida being the third fastest growing startup state overall.
However, that same Kauffman Foundation report goes on to say that Miami is also second-to-last in the U.S. for scaling startups, defined as growing beyond 50 employees and $2 million in revenue within 10 years. Other Florida metros fare a bit better, with Jacksonville, Tampa, and Orlando all placing higher on the list. The reason for this discrepancy is obvious when you ask any entrepreneur – there are not enough professional investors at each funding stage to support a high-growth business in Florida. While Florida has done an excellent job in creating an environment that encourages entrepreneurial ideas to germinate, much remains to be done in creating a genuine ecosystem that will encourage more of these startups to reach their full potential.
Breaking into the Major League
So far, Florida has yet to seriously capture the eye of venture capitalists. The state receives less than 1% of global venture capital dollars. To large investors in Silicon Valley and elsewhere, Florida is still the “farm team” compared to the “major leagues” of California. Some new companies are bucking this trend. Most notably, companies like Magic Leap, Modernizing Medicine, and others are drawing in marquee investors and hundreds of millions in investment – but not from Florida investors.
One of the principal factors that led us to start Las Olas Venture Capital in Florida was the lack of professionally-run venture funds based in the state. All Florida entrepreneurs quickly realize that while there is plenty of angel investment money to get them off the ground, there is almost nowhere local to turn for their next round. Companies face a hard choice of trying to raise funding outside of the state or scrape together enough small angel checks to stay afloat. Without several more funds, focusing on each stage of a company’s life cycle, Florida will remain a tough place to successfully scale a company. To date there are not enough local success stories – companies achieving large exits and realized returns for their investors – that truly attract more companies, talent, and investment dollars. Dania Beach-based Chewy.com’s sale to PetsMart for $3.3B is a big step in the right direction, and an emerging sign that tech companies can be successful locally.
There are many emerging startup companies in Florida that we are excited about. For example, our portfolio company CarePredict, based in Plantation, is revolutionizing the elder care market with their Tempo platform. ReloQuest, another LOVC portfolio company based in Weston, is now the go-to technology solution for corporate relocation managers. We at Las Olas VC are seeing tremendous opportunities in the Florida market and believe that with proper infrastructure and support, the market will only continue to improve.
Good Times Ahead
The missing piece of the puzzle for Florida’s entrepreneurs is finding the “glue” that brings these startup ingredients together. The “glue” is strong investors, advisors, mentors, and peers to share experiences that bring founders together and enable their success.
Often times the quality of advice founders get is mixed at best. Most investors and advisors have good intentions, but their lack of experience in early stage investing can be a challenge. At LOVC we strongly encourage founders to do exhaustive due diligence on their prospective investors and advisors — as the ecosystem develops, participants that do not meet the rising level of professionalism will be winnowed. We believe in promoting a culture of candor and transparency and pushing our startup community in Florida to new and greater heights.
The good news is that the environment is improving with the recent growth in the number of professional investors – run by experienced entrepreneurs, operators and financial experts. At the same time, we are seeing more professional service providers who bring invaluable expertise and experience to the table. A great example is our administrator Trident Trust, a globally recognized name, which established a dedicated South Florida desk in Miami last year in response to the rapidly growing demand in the state.
All these factors are driving the opportunity for LOVC to play a major role in an emerging and growing technology startup ecosystem. Being an early mover in a large underserved market allows us to work with great entrepreneurs at mutually favorable terms. We’re entrepreneurs at heart, and we’re building LOVC as such. Our ultimate goal is to make Florida a viable place to scale technology startups. Timing is good, and we’re making progress together.
Column by Mark Volchek, Founding Partner, Las Olas Venture Capital
Foto: StockSnap. ¿Cuáles son los factores en los que los inversores se deben enfocar?
Today’s low-return environment poses a challenge to investors. We believe investing through a lens of equity style factors—broad, persistent characteristics driving returns—can potentially help investors increase diversification and enhance returns relative to broad market exposure, as we write in our June Global Equity OutlookFocusing on factors. So which equity factors should investor focus on today?
Investors can potentially benefit from exposure to all five major equity style factors for diversification purposes, but returns can be enhanced by tilting or adjusting these exposures through the economic cycle, research from BlackRock’s Factor-based Strategies Group suggests.
The major equity style factors—value, quality, momentum, size and minimum volatility (min vol)—have behaved differently depending on the phase of the economic cycle. We believe there may be years left in the current expansion, as detailed in our latest Global macro outlook. Investors have historically been best rewarded for exposure to momentum in such phases, our analysis of factor performance since 1990 suggests. See the chart below.
We prefer momentum (stocks trending higher) in today’s economic environment. We also see the value factor (the cheapest corners of the market) potentially performing well in coming quarters against a backdrop of stable cyclical expansion. In periods of stable growth, market trends have historically tended to persist while confidence in value stocks rises. Today’s expansionary economic regime favors risk-seeking factors over defensive ones, we believe.
Momentum and value have had a small negative correlation over the past two decades, our analysis of MSCI index data shows. Yet the relationship is not static—and we see the current economic regime supporting both factors in coming quarters. We see the valuations of both factors as fair. Quality and min vol have historically tended to outperform in economic decelerations, as the chart above shows. But we believe these factors can provide some diversification throughout the cycle to cushion against volatility. The performance of size may depend on U.S. politics. Further delays in tax reform could dampen interest in these more domestically geared companies.
So what are the risks? Momentum investors should keep an eye on market breadth, we believe. This is a measure of the sustainability of the market trend, which measures the number of advancing stocks relative to the number declining. Our analysis shows that nearly 80% of the names in the each of the major U.S., European and Japanese markets were trading above their one-year moving average as of mid-May. U.S. equity markets have posted solid gains in the six to 12 months following this level of breadth, our analysis of S&P 500 data since 1990 shows. We find similar results for other markets. Robust earnings growth in the first quarter reinforced our view that the breadth of equity performance can be sustained.
We see an unexpected economic regime change as the major risk to value. Lower growth and inflation would weaken the fundamental outlook for cheaper stocks. Factor tilting, rather than short-term in-and-out timing, can help balance opportunities with the aim to improve returns without disrupting the long-term benefits of a diversified factor portfolio, in our view. Finally, the economic regime is the biggest driver of factor performance, although combining this with other indicators such as relative strength, valuation and dispersion can produce better results, we find.
Bottom line: We prefer the momentum and value factors in the current environment, but caution that how investors implement them could lead to different outcomes. Read more in our full Global Equity Outlook.
Build on Insight, by BlackRock, written by Kate Moore
Investing involves risks, including possible loss of principal. Investing in small cap companies may entail greater risk than large-cap companies, due to shorter operating histories, less seasoned management or lower trading volumes.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2017 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
. European High Yield: A Tale of Low Defaults and Diversification
Following a strong start to 2017, valuations in European high-yield (EHY) look less attractive than they did six months ago. However, while some volatility in the short term is to be expected, the asset class has proven its work in testing economic times.
Recent years have seen strong growth trends in the European corporate debt markets. This has provided a solid base for EHY to grow, becoming increasingly diversified with improved overall credit quality. Rather unsurprisingly, it is more appealing to investors as a result. With two full credit cycles since the late 1990’s behind it, the EHY sector is now an integral part of the global leveraged finance market. It may still be perceived as the smaller sibling of US High Yield, but that masks how fast it is growing and maturing.
This maturity can be seen in both size – the market has grown from €41 billion in January 2002 to €286 billion in January this year – and the decreased volatility relative to US High Yield that has occurred since 2012 (according to Bloomberg data), albeit a reasonable proportion of the latter trend has been down to stresses in the US energy market.
Relative to historic levels, yields are low. Yet with income and yield increasingly hard to come by a distribution of 5% is not to be sniffed at. And with yields on government bonds often negative, as is the case of 5-year German debt, the overall spread of yield over government bonds is even higher.
Although always important, with yields at relatively low levels, the role of defaults becomes heightened. The overall outlook is encouraging. Moody’s predict that rates will be 2% in Europe, compared to 4% in the US. Even so, rigorous security selection is required to weed out the companies most likely to default.
High yield’s equity-like qualities are well known. Its correlation with government bonds is low. To reinforce this point, we singled out instances where US 10-year Treasury yields rose by 1% and compared high yield returns over this period. The results are below, and are illuminating.
Past performance is not a guide to future results.
As you can see, high yield offers particular good diversification during these periods. Having an allocation makes sense as part of a broadly diversified portfolio.
In times of uncertainty, investors traditionally flock to the ‘safe haven’ assets, such as government and investment grade bonds. In normal economic conditions, these would offer a relatively safe spot to park your cash. But these aren’t conventional times; central banks have exhausted their weaponry, and as of 28 February 2017 45% of developed market bonds now yield less than 1%, and 20% of those offer negative yields, according to JP Morgan data. Brexit, key elections in Europe and Donald Trump don’t help matters either.
It is likely to be a bumpy road ahead for European high-yield bonds, as it will be for markets globally, but the combination of yield and relatively low duration in return for its credit risk remains compelling. EHY certainly warrants the increased interest among income-seeking investors.
Column by Aberdeen AM written by Ben Pakenham.
Risk Warning
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks may be enhanced in emerging markets countries.
For more on how Aberdeen can help meet the income needs of investors, visit http://international.aberdeen-asset.us/income.
Photo: Ian L / www.publicdomainpictures.net. What the Bond Markets Tell Us About Reflation
Global fixed income markets are flashing caution on “reflation trades” predicated on an expansionary economic environment. Positions that have recently come undone include betting on steepening yield curves and inflation expectations (inflation-linked over nominal bonds)—and in equity markets, picking value over growth shares. Yields have halted their late-2016 climb, curves have flattened, and market-based inflation expectations have waned.
Yet we believe these market moves mostly reflect a temporary flight to safety in the face of political uncertainties—rather than a breaking down of the underlying reflationary dynamic. We see this dynamic as alive and well, with the global economy moving from acceleration to a phase of sustained growth, as I write in my new Fixed Income Strategy piece Reevaluating reflation.
A recent pullback in headline consumer price inflation across developed economies has challenged the notion of steady, if unspectacular, increases in inflation from depressed levels. Yet core inflation in the U.S.—which strips out volatile food and energy prices—appears to be broadening, our analysis suggests, with an increasing share of Consumer Price Index components clocking gains. Global Purchasing Managers Indexes (“PMIs”) stand at six-year highs. And our BlackRock GPS, which combines traditional economic indicators with big data signals such as Internet searches, still points to above-trend growth as the global economy transitions from catchup to steady expansion.
We see steady economic growth and inflation extending the lifespan of the reflation theme without the need for further rises in the pace of those measures. Reflation is alive and well according to our definition: rising wages (albeit slowly this cycle) feeding stronger nominal growth, allowing lingering slack from the last recession to be gradually eliminated, and stirring higher inflation over time. And to be sure, many financial asset prices still reflect a dominant reflationary view. Equity markets overall are buoyant. Global financials are holding up, despite a recent bout of underperformance, and credit markets are looking robust.
Credit spreads today look to be roughly where you would expect based on their historical relationship with global PMI levels, our analysis shows. See the chart below. Investment grade and emerging market debt spreads are right in line with the historical trend line since 2006.
High yield bond spreads are a little tighter than they should be according to the analysis. This highlights rich valuations, which contribute to our “up-in-quality” preference in credit. It implies today’s strong PMI levels are already priced in, with future returns in credit likely to be more muted than in the recent past. Returns will likely come mostly from income (or carry), not from further spread tightening, we believe.
Credit conundrum
The divergence between sovereign debt and the credit market’s pricing of reflation is on the surface a bit of a conundrum. One possible explanation is that when market uncertainty increases, investors have two choices as to how to reduce risk in their portfolios. They can sell risky assets such as credit, or buy less risky assets such as government bonds, adding a buffer to their portfolios.
Investors tend to choose the latter of these two options, since government bonds are a much more liquid asset class than credit, with lower transaction costs. U.S. Treasuries are also regarded as the ultimate hedge against geopolitical risks. Jitters around the recent French presidential election—not fears that reflation is dead—likely lie behind the recent flows into U.S. Treasuries, we believe, as risk-on and risk-off episodes are becoming increasingly global, our research suggests.
Bottom line
We see stable global growth and inflation helping the Federal Reserve make good on its promise to normalize normalization. Global developed bond yields appear vulnerable to further increases as French political risk has faded, leaving improving fundamentals as a longer run driver for eventual global policy normalization. We remain overweight U.S credit for its income potential, but prefer investment grade debt given elevated credit market valuations. We are underweight European credit and sovereign debt amid tight spreads and improving growth.
Build on Insight, by BlackRock, written by Jeffrey Rosenberg, Managing Director, and BlackRock’s Chief Investment Strategist for Fixed Income.
In Latin America and Iberia, for institutional investors and financial intermediaries only (not for public distribution). This material is for educational purposes only and does not constitute investment advice or an offer or solicitation to sell or a solicitation of an offer to buy any shares of any fund or security and it is your responsibility to inform yourself of, and to observe, all applicable laws and regulations of your relevant jurisdiction. If any funds are mentioned or inferred in this material, such funds have not been registered with the securities regulators of Brazil, Chile, Colombia, Mexico, Panama, Peru, Portugal, Spain Uruguay or any other securities regulator in any Latin American or Iberian country and thus, may not be publicly offered in any such countries. The securities regulators of any country within Latin America or Iberia have not confirmed the accuracy of any information contained herein. No information discussed herein can be provided to the general public in Latin America or Iberia. The contents of this material are strictly confidential and must not be passed to any third party.
Photo: Max Pixel / Creative Commons Zero - CC0. 12 Foreign Currency Funds in Mexico Doubled Their AUM
The rise in rates, and the dollar exchange rate, between September 2016 and January 2017, caused outflows from Mexican debt funds. Investors made precautionary withdrawals to avoid additional losses, anticipating to greater volatility. Tenure decreased by 4.81%, to 72.93 billion pesos (mdp). Are more outflows expected?
Exits at National Currency Funds and Inflows in Foreign Currency ones
Five managers accounted for 77.8% of total outflows: Santander, BBVA Bancomer, Impulsora, Banorte-IXE and Interacciones. In percentage terms, the ones with the highest outflows were Monex, Interacciones, Multiva, CI Fondos and Santander. Despite the adversity, there were some managers that attracted inflows, such is the case of Franklin Templeton, Compass, Value and Sura. Finamex and BNP are excluded, given their percentage increases can be explained by their recent creation.
Of 275 funds, 177 showed outflows and 98 showed inflows. Short-, medium- and long-term funds in local currency securities reduced their assets by 109,460 mdp, 7.22% of the sector’s absolute value as of September. A total of 29 funds reduced its assets by more than 30%. In contrast, 26 funds increased them by more than 30%. Eight funds decreased their AUM by more than 60%.
The resettlement meant unusual increases for a long list of funds, which excludes those of new creation and/or a different regime. AUM of 12 foreign currency funds grew more than 100%, while only a single national currency fund increased in that proportion.
Medium and Long Term Funds with the Biggest Outflows
The medium and long-term funds, in all their modalities (discretionary, governmental, indexed, etc.), were the most affected. Its inflows totaled 18,070 mdp and its outflows, 60,160 mdp, for a negative net variation of 42,090 mdp, 57.7% of the total reduction. Short-term funds, given their less vulnerable nature, reflected inflows of 46,900 mdp and outflows of 77,800 mdp, for a net negative flow of 30,800 mdp, 42% of the total.
In some cases, the resources were partially transferred to other funds of the same manager, regardless of their profile. At BBVA, 22,510 mdp came out of BMERGOB and BMERPZO, while 7,730 mdp went to BBVADOLL and BMRGOBP. In Santander, 9,380 mdp came out of STERGOB and ST & ER-7, while 6,020 mdp went to ST & ER-5. In Banamex, 9,850 mdp came out of BNMDIN and BNMPZO, while 8,050 mdp went to BNMCOB + and BNMREAL. In Banorte-Ixe, 6,606 mdp came out of NTEGUB and IXEMPM +, which were offset with inflows of 6,850 million pesos to IXEUSD, NTERTD and IXEDINT.
The only fund group with net growth (36,540 mdp, 120% of its value in September) was that of foreign currency instruments, in all its variants, but mainly in the short term sphere. The increase underlies the fear that the Mexican peso’s devaluation will intensify and the preference for cash to change strategies if conditions warrant so.
Regarding managers, the generalized negative flow reveals that the public took refuge in, for example, bank branches products, notes and foreign currencies in cash, as well as metals and real estate.
While the 10 years and longer bond rates did not evolve in January 2017 as they did in previous months, traders are worried and estimate that investors will remain expectant for at least two more months. As a result, some predict additional marginal outflows and estimate that, if volatility remains contained, assets could stabilize in April.
Whilst the equity research industry worldwide has endured substantial declines since 2007, there are still roughly 10,000 analysts employed by investment banks, brokerages, and boutique research firms. And even more analysts offer their services independently or on a freelance basis, and there are still more voices in the crowd contributing to blogs or sites like SeekingAlpha.
The reason for the above is clear: equity research provides a very useful function in our current financial markets. Research analysts share their insights and industry knowledge with investors who may not have them, or may not have the time to develop them. Relationships with equity research teams can also provide valuable perks, such as corporate access, to institutional investors.
Nevertheless, despite its obvious importance, the profession has come under fire in recent years.
Analysts’ margin of error has been studied, and some clear trends have been identified. Some onlookers bemoan the sell-side’s role in stimulating equity market cyclicality.
In some cases, outright conflicts of interest muddle the reliability of research, which has prompted regulation in major financial markets. These circumstances have generated distrust, with many hoping for an overhaul of the business model.
With the above in mind, I’ve divided this article into two sections. The first section outlines what I believe the main value of equity research is for both sophisticated and retail investors. The second looks at the pitfalls of this profession and its causes, and how you should be evaluating research in order to avoid these issues.
Why Equity Research is Valuable
Sophisticated Professional Investors
As sophisticated or experienced investors, you likely have your own set of highly developed valuation techniques and qualitative criteria for investments. You will almost certainly do your own due diligence before investing, so outside parties’ recommendations may have limited relevance.
Even with your wealth of experience, here are some things to consider.
To maximize the use of your time, buy-side professionals should focus on the research aspects that complement their internal capacities. Delegation is vital for every successful business, and asset management is no different. External parties’ research can help you:
Secure enhanced corporate access
Gain deeper insights
Outsource tedious, low-ROI research
Generate ideas
Gain context
Enhanced Corporate Access
Regulations prevent corporate management teams from selectively providing material information to investors, which creates limitations for large fund managers, who often need specific information when evaluating a stock.
To circumvent this, fund managers often have the opportunity to meet corporate management teams at events, hosted by sell-side firms that have relationships with executives of their research subjects.
Buy-side clients and corporate management teams often attend conferences that include one-on-one meetings and breakout sessions with management, giving institutional investors a chance to ask specific questions.
Language around corporate strategies, such as expansion plans, turnarounds, or restructuring, can be vague in conference calls and filings, so one-on-one meetings provide an opportunity to drill down on these plans to confirm feasibility.
Tactful management teams can confirm the legitimacy and plausibility of strategic plans without violating regulations, and it should quickly become obvious if that plan is ill-conceived.
Institutional clients of sell-side firms also have the opportunity to communicate the most relevant topics that they want to see addressed by company management in quarterly earnings conference calls and reports.
Deeper Insight
The sell-side analyst’s public role and relationship with corporate management also allows him to strategically probe for deeper insights. Generally, good equity research demonstrates the analyst’s emphasis on teasing out information that is most relevant to institutional clients. This often requires artful posing of incisive questions, which allows management teams to reach an optimal balance of financial outlook disclosure.
Buy-side analysts and investors have a massive volume of sell-side research to comb through, especially during earnings season, so succinct, analytical pieces are always more valuable than reports that simply relay information presented in press releases and financial filings. If these revelations echo the interest or concerns of investors, the value is immediately apparent.
Outsourcing Tedious or Low-ROI Aspects of Research
Smaller buy-side shops may lack the resources to monitor entire sectors for important trends. These asset managers can effectively widen their net by consuming research reports. Sell-side analysts tend to specialize in a specific industry, so they closely track the performance of competitors and external factors that might have sector-wide influence. This provides some context and nuance that might otherwise go unnoticed when concentrating on a smaller handful of positions and candidates.
Research reports can also be useful ways for shareholders to spot subtle red flags that might not be apparent without carefully reading through lengthy financial filings in their entirety. Red flags might include changes to reporting, governance issues, off-balance sheet items, and so forth.
Buy-side investors will of course dig into these issues on their own, but it’s useful to have multiple eyes (and perspectives) on portfolio constituents that may number in the hundreds. Likewise, building a historical financial model can be time consuming without providing the best ROI for shops with limited resources. Sell-side analysts build competent enough models, and investors can maximize their added value by focusing entirely on superior forecasting or a more capable analysis of the prepared financials.
Idea Generation
Identifying investment opportunities falls under the umbrella of tedious activities since effectively screening an entire market/sector can be overwhelming for a smaller team at some buy-side shops. As such, idea generation has become an important element of some sell-side firms’ offerings. This is especially pronounced regarding small and medium cap stocks, which may be unknown or unfamiliar, to institutional investors.
It’s simply impractical for most buy-side teams to cover the entire investable universe.
Research teams fill a niche by identifying promising smaller stocks or analyzing unheralded newcomers to the market.They can then bring this to the attention of institutional investors for further scrutiny.
Creating Context
Reports might be most useful for sophisticated investors as an opportunity to develop a meta perspective. Stock prices are heavily influenced by short-term factors, so investors can learn about price movements by monitoring the research landscape as a whole.
Consuming research also allows investors to take the temperature of the industry, so to speak, and compare current circumstances to historical events. History has a way of repeating itself in the market, which is driven in part by the industry’s tendency to shake during crashes, and pull in new professionals during bull runs.
Having a detached perspective can help shed light on cyclical trends, making it easier to identify ominous signals that might be lost on the less acquainted eye. In turn, this drives idea generation for new investing opportunities.
With that being said, investors should not consume research that only confirms their own bias, a powerful force that has clearly contributed to historical booms and busts in the market.
Retail Investors
The value of equity research is much more straightforward for retail investors, who are usually less technically proficient than their institutional counterparts.
Retail investors vary substantially in sophistication, but they mostly lack the resources available to institutional investors. Research can supplement deficiencies on some basic levels, helping investors with modeling guidance, framing an investment narrative, identifying relevant issues, or providing buy/sell recommendations.
These are great starting points for retail investors seeking value out of research. Individuals probably can’t consume the sheer volume of reports that asset managers can, so they should lean on the expertise of trustworthy professionals.
What are the risks associated with equity research?
Despite the above, there are clear risks to over-relying on equity reports to make trading decisions. To properly assess the dangers of equity research, one must consider the incentives and motivations of research producers.
Regulations, professional integrity, and scrutiny from clients and peers all play significant roles in keeping research honest, but other factors are also at play. Research consumers should be mindful of the producer’s business model. I highlight the five key issues below.
Equity research can be exaggerated due to the need to drive trading volumes
Reports that are produced by banks and brokers are usually created for the purpose of driving revenues. Sell-side equity research is usually an add-on business to investment banks that earn significant fees as brokers and/or market makers in traded securities and commodities.
As a result of this, research tends to focus on highlighting opportunities for buying and selling stocks. If research reports only included forecasts of “steady” performance, this would result in less trading activity. The incentive for research analysts is therefore to come out with predictions of a change in performance (whether up or down).
This isn’t to say the content of the research is compromised, but that opinions on directional changes in performance may be exaggerated.
Numerous academic studies and industry white papers are dedicated to estimating the magnitude of analyst error. The findings have varied over time, between studies and among different market samples. But all consistently find that analyst estimates are not particularly accurate.
Andrew Stotz indicates an average EPS (earnings per share) estimate error of 25 percent from 2003 to 2015, with an annual minimum under 10 percent and annual maximum over 50 percent.
Research analysts may avoid criticizing companies they cover due to the need to maintain a positive working relationship
Another important point to consider is that analysts generally benefit from having a positive working relationship with the executive management and investor-relations teams of their research subjects.
Analysts rely on corporate management teams to provide more specific and in-depth information on company performance that is not otherwise publicly provided.
Brokers also provide value to investors by providing seminars and one-on-one meetings that are attended by those executive teams, so a strong roster of presenters at conferences can be dependent on the relationships built by the research teams.
I’ve witnessed the negative impact of a souring relationship: One of the tech analysts at a company I worked for was covering a small-cap stock and built up a good relationship with both the corporate management team and the investor relations person who worked with them. Being a small company, this visibility was valuable to the research subject.
Poor results one quarter were downplayed by management as a temporary speed bump, but the analyst had concerns that these were longer-term problems.
The executive team was upset when the subsequent report negatively portrayed the recent events, and soon thereafter withdrew from an upcoming conference our research firm hosted. The analyst’s bonus compensation suffered as a result as well.
Obviously, this all has very serious implications.
Sell-side analysts tend to produce reports that portray their subjects favorably, and they are more likely to set attainable expectations. It also means that analysts may hesitate to downgrade a company’s stock. This is especially true when poor executive management would be the primary culprit causing a downgrade. All of this may help explain why EPS estimates are disproportionately bullish (see chart 2).
Research analysts may avoid making contrarian calls due to the need to maintain good reviews and a trusted reputation.
Equity research reports are influenced by the means by which analyst quality is measured. Analysts compete with peers at rival banks.
Taking a contrarian stand that results in bad recommendations could genuinely harm an analyst’s compensation and career prospects. These mechanisms create a herd-like mentality.
This can be extremely detrimental if it goes unnoticed or unaddressed by research consumers. These are precisely the sorts of circumstances that fuel bubbles. It’s hard to look especially foolish if everyone else looks foolish too.
Independent equity research may be sensationalized due to the need to stand out.
Research produced by independent firms, which substantially derive all revenues from the sale of research and do not maintain a brokerage business, is not meant to motivate trading.
This eliminates some of the conflicts of interest inherent in the sell-side banks, putting extra emphasis on accuracy. However, independent and boutique analysts are tasked with creating income by selling something that’s been largely commoditized, and they compete with banks that have vast resources.
To survive, they have to offer something specialized or contrarian. Their philosophy must radically depart from the herd. They have to claim special industry knowledge through independent channels, or they must cover stocks that are largely uncovered by the larger powers in the research space.
This creates the incentive for sensationalized research that can attract attention amongst the sea of competing reports.
Putting it all together
As we have seen, there are important facets of the equity research profession that often lead to skewed incentive mechanisms, and may ultimately compromise the quality of research being done.
To be fair, the practice of making complex and precise forecasts is necessarily flawed by the requirement to make assertions about future conditions, which by definition are unknowns.
Nevertheless, whilst this might be acceptable if the errors appeared random and with a predictable margin of error, this is not the case.
According to Factset research, consensus 12-month forward EPS estimates for S&P constituents were about 10 percent higher than the actual figures for the years 1997-2011. These numbers are skewed by large misses, and the median error is only 5.5 percent, but several important conclusions can be drawn:
Analysts tend to be too bullish. In 10 of those 15 years, consensus estimates were higher than the reported figures.
Analysts were especially bad at navigating recession periods, overcooking their numbers by 36 percent in 2001 and 53 percent in 2008. The error is less extreme for years with rapid EPS growth. Forecasts only lagged actual results by eight percent in 2010, indicating asymmetric tendencies to misforecast earnings.
How can you avoid equity research pitfalls?
There are several ways that consumers of research reports can judge the validity and quality of such reports,in light of what’s been discussed above.
Analyst Credentials
Analyst credentials are an obvious method for vetting quality. CFA designations don’t necessarily guarantee quality, but it indicates a baseline level of competency.
Research produced by reputable banks ensures that it was created and reviewed by a team of professionals with impressive resumes and highly competitive skills. Likewise, veterans of big banks who leave to start an independent shop have been implicitly endorsed by the HR departments of their former employers.
Producers can also be distinguished by specialized backgrounds, for example former doctors turned healthcare analysts or engineers weighing in on industrial/energy stocks. If the analyst has been recognized in financial media, it usually indicates extremely high quality.
Analyst Track Record
Investors can also look at historical analyst recommendations and forecasts to determine their credibility.
Institutional Investor provides a service that tracks analyst performance, and there are similar resources available, especially for investors with deep pockets.
Fintech startups, such as Estimize, actually focus on attracting and monitoring analyst recommendations to identify the most talented forecasters.
However, while third-parties and financial media offer helpful ranking systems based on earnings forecasts or performance of analyst recommendations, these tend to put a lot of emphasis on short-term accuracy. This might therefore be less useful for consumers with a long-term approach or emphasis on navigating black swans.
Investors should consider these factors and look for red flags that an analyst is hesitant to turn bearish. These could include shifting base assumptions to maintain growth forecasts and target prices, suddenly shifting emphasis away from the short-term to the long-term outlook, or perhaps an apparent disconnect between the material presented in the article and the analyst’s conclusions.
Investors should also consider context.
Some stocks simply don’t lend themselves to reliable research. They might have volatile financial results, an unproven business model, untrustworthy management, or limited operating history, all of which can lead to wide margins of error for earnings growth and intrinsic value.
The business cycle’s phase is also extremely important. Research shows that forecasts are less reliable in downturns, but investors are also more likely to rely most heavily on research during these times. Failure to recognize these issues can severely limit one’s ability to glean full value from research.
Research consumers should also make sure they know their own investment goals and be mindful about how these differ from those implied by research reports. A temporal mismatch or disconnect in risk aversion could completely alter the applicability of reports.
Consume a lot of research, and hold analysts accountable
For those fund managers wishing for a more reliable research product, the most effective move is to vote with your wallets, and buy reports from the most accurate and conflict-free sources.
It might be expensive to source research from multiple sources, but there’s value in diversifying the viewpoints to which you are exposed. It’s unlikely that you will move on from low-quality research if that’s all you are reading.
Additionally, consuming a large volume of research from different sources helps forge a meta perspective, allowing investors to identify and overcome worrisome trends in research.
Equity Research Continues to be Useful, but Should be Consumed Thoughtfully
The equity research industry has undergone profound changes in recent years, due to regulatory changes, the emergence of independent research shops, as well as more automated methods of analyzing public company performance.
At the same time, smart investors are looking at broader sets of investments and taking a more active approach to research. This is facilitated by the increasing quantity of publicly available information on listed companies.
Nevertheless, good research continues to be extremely valuable. It lets you manage a wider pipeline of investment opportunities and be more efficient.
An informed and thoughtful approach can enhance the value of research reports for investors, so asset managers can better serve clients (and their own bottom lines) by considering the content above.
Research consumers need to be wary of predictable errors, analyst incentives, conflicts of interest, and the prevalence of herd-like mentality.
If you can adjust your interpretation of research along these lines, then you can focus on the most valuable aspects of research, namely idea generation, corporate access, and delegation of time-consuming activities.
Ecuador appears to be in the mood for change. Lenin Moreno, anointed successor to President Rafael Correa, was predicted to win but now looks unlikely to avoid a run off in elections this weekend. The polls have been narrowing and now even more so after Moreno’s running mate Jorge Glas was implicated in the Petrobas scandal.
A poll last week by Quito-based CEDATOS gave Moreno just a 32 percent share of the vote. He would need to secure a majority of all valid votes or win over 40 percent and a 10 point difference with the closest rival.
Moreno’s threat comes from conservative candidates Guillermo Lasso and Cynthia Viteri. The CEDATOS poll gave Lasso, a banker, 21 percent share of the vote and centre-right lawyer Viteri 14 percent. Another poll is due later this week and one of them is likely to join Moreno in the second round.
Both Lasso and Viteri would be broadly welcomed by international investors. They would represent a pro-business break from the market unfriendly policies of Correa.
But the drop in oil prices has hit the country hard. Oil accounts for over half of Ecuador’s export revenue and nearly a third of government revenue. Unfortunately, the country did not use the good years of high oil prices to sufficiently diversify its economy. Industry and manufacturing are taxed heavily, companies have not invested enough and so remain uncompetitive. The state has swollen even as the private sector has failed to flourish. An inflexible labour market hinders growth.
All of this has seen the country’s external and bilateral debt to China grow again. Last year’s earthquake has compounded the effect of the decline in oil revenue. The upshot is that Analytica estimates that the economy contracted 2.5 percent in 2016 and it is predicted to decline by 1 percent this year.
One of Correa’s legacies is the establishment of a middle class which grew as oil revenues created growth. But that middle class has now grown weary of corruption, inefficiency and stagnation. The election victor will have to prescribe tough medicine to them, and the rest of the country, but who does the prescribing remains to be seen.
Column by Edwin Guttierez, Head of Emerging Market Sovereign Debt at Aberdeen Asset Management.
Faced with a Tweeter-in-chief, how are investors to navigate what’s ahead? Is there a strategy behind President Trump’s outbursts; and if so, how shall investors position themselves to protect their portfolios or profit from it?
With all the outrage about Trump’s style, we have all seen equity markets rally in the aftermath of the election. Is the rally due to investors loving the policies proposed in Trumps’ tweets? We argue no, if only because one can hardly call most of his tweet storms policy proposals.
Before I expand further, I need to point out that discussing portfolio allocation in the context of politics is bizarre, as, in my experience, today’s breed of investors – and this may well include you – are looking for an “investment experience.” In an era where stocks have gone up and up for years, where buying the dips has been a profitable strategy, does it really matter what you invest in? So, it appears to me, many invest in what appears warm and fuzzy to them. The days are gone where investors bought shares of tobacco companies because they were good value; instead, they buy solar energy companies if they want to save the planet. Similarly, my own anecdotal research suggests investment portfolios of Clinton supporters look distinctly different from those of Trump supporters. It’s incredibly difficult for investors to put emotions aside. That said, I have no problem with an environmentally conscious investor specifically avoiding coal companies because they don’t want to support it even if it might churn out more profits in a Trump administration – as long as he or she does it with open eyes. Such investing, in my humble opinion, means gathering the facts, then making a conscious decision. To gather facts in a politically charged investment environment, here are some of the steps you might want to consider when you hear stories that might affect your investment decision:
Get multiple perspectives. That means, embrace news outlets that disagree with your political views. If that’s too unbearable, at least follow journalists of those outlets on Twitter that write coherently, even if you disagree with their views. Get an outside perspective by reading (or listening to) foreign news services from the UK, Europe (I mention Europe separately from the UK, as news coverage is different on the continent), the Middle East and Asia. What does German chancellor Merkel think of Trump’s recent assault on Germany? Look it up to gauge how the dynamics might unfold.
Go to the sources. In our office, we listened to hours of confirmation hearings to get a better handle of what policies the new administration might pursue. We listen to or read speeches of central bankers, policy makers and influencers around the world; News breaks on Twitter. With a Tweeter-in-chief, it’s not a matter of political preference, but one of staying on top of the news to follow @realDonaldTrump (he now tweets under the handle @POTUS as well; Obama’s Twitter handle has been moved to @POTUS44). Following policy makers allows you to stay on top of breaking news. Following influencers allows you to receive close to instantaneous interpretation of the news. On that note, please ensure you follow @AxelMerk.
So what have we learned from our Tweeter-in-Chief?
Trump likes to take credit, but does not like to own problems There’s method to what appears to some as madness New policies may be hiding in plain sight
Not owning problems
Trump says he is a “winner.” To defend this brand, he disavows any potential problems. He throws Schwarzenegger under the bus for not-so-great ratings on his first appearance on the Apprentice, so any decline on the program doesn’t reflect badly on him. He cautions Republicans to be careful not to own “Obamacare” when it’s pretty obvious that Trump himself might be “owning” it; the cost of healthcare will continue to rise independent of the healthcare system we will have; as a result, odds are high than there will be lots of unhappy folks. He publicly denounces Paul Ryan’s tax reform proposal as being too complicated (he singled out the concept of a ‘border adjustment tax’), even as his nominee for Treasury Secretary Mnuchin all but admitted that Trump’s tax proposal was written on the back of an envelope (he didn’t quite say that, but he did say that they had a very small staff and that it would take substantially more work).
There’s method to what appears to some as madness
All Presidents have the bully pulpit at their disposal, even as Trump’s use of it may elevate it to new highs (lower it to new lows?). Trump’s nominee for Commerce Secretary stated it succinctly in his nomination hearings: “When you start out with your adversary understanding that he or she is going to have to make concessions, that’s a pretty good background to begin.” The Financial Times recently published an OpEd that discusses how Mr. Ross thrived in his career employing this principle. From the article: “The first step in such negotiations is to get everyone to admit to the problem, perhaps even to create an exaggerated sense of it, so that no one thinks it can be ignored until tomorrow.”
In reality, keep in mind that it is the House that initiates new tax legislation, not the President. Would President Trump really veto a tax bill with a border adjustment tax? To a significant degree, Trump’s success in implementing his agenda may well be directly dependent on how seasoned the politicians are at the other side of the negotiating table.
In my view it is no co-incidence that German Chancellor Merkel shrugged off Trump’s recent assault on German trade policies suggesting to wait and see what the actual policies of the new administration will be. She is a battle-proven politician who has dealt with rather eccentric partners in the Eurozone debt crisis (remember Greek finance minister Varoufakis?).
But do not under-estimate the power of the bully pulpit: we all “know” that the banks are responsible for the financial crisis, right? While I don’t want to downplay the role financial institutions played, where is the ire at the politicians that put rules and regulations in place that incentivized bad behavior? Politicians own the bully pulpit, not bank CEOs. In that context, it is in my view no coincidence that Facebook CEO Mark Zuckerberg has as this year’s project to travel the country to get to know the people better. With pictures of him with firefighters, farmers and other “regular” people, he either sets the stage for running for President, or he is taking steps to fight the image that Facebook is responsible for fake news, the rise of terrorism or other ills of the world, a perception that might be promoted by the Tweeter-in-chief. The bully pulpit is effective when there’s an overlap of perception and reality.
New policies may be hiding in plain sight
So are Trump’s tweets merely an opening salvo to negotiations? In some ways yes, as we see Trump more like a third party President. Trump may well need to reach across the isle if he wants to have a substantial infrastructure spending program, as there are more than a few budget hawks amongst Republicans that scoff at a trillion dollar infrastructure spending program. Although divided over a ten-year horizon as stipulated, $100 billion a year ain’t what it used to be. More than a few people are scratching their heads about how Trump wants to succeed in replacing Obamacare, as any new rules will require a sixty person majority in the Senate.
What is striking to us is the juxtaposition between what at times appears to be off-the-hip shooting by Trump on Twitter and the clear policy path his cabinet nominees have presented in their hearings. Be careful, by the way, not to confuse “clear path” with agreement or disagreement: as an investor, understanding the proposed policy takes priority over one’s own conviction as to what the better policy ought to be. To me, it means Trump delegates. I don’t think he could have built his sprawling empire if he micro-managed. Whereas former President Jimmy Carter at some point managed the schedule for the White House tennis court, Trump is at the other extreme. So much so that he has time to tweet, so much so that he doesn’t listen to each and every security briefing.
A common theme in the nomination hearings I listened to has been the importance of clear policies; the importance of consistent policies; and the importance of adhering to agreements. If you aren’t scratching your head on how to reconcile this with Trump’s comments, you aren’t paying attention.
So what does it all mean for investors?
To gauge what it all means for investors, keep in mind the backdrop: stocks have appreciated for years, including a post-election rally. Bond yields not long ago reached historic lows. And the dollar index was up four calendar years in a row. So if you are bullish on stocks, keep in mind that stocks might be expensive. If you are bearish on stocks, will bonds provide the refuge even if inflation ticks up? And that dollar, will the greenback really soar?
With regards to stocks, we don’t have a crystal ball, but are concerned about high valuations. Without giving a specific investment recommendation, we would not be surprised if small caps (as expressed in the Russell 2000) outperform large caps (as expressed in the Nasdaq). The reasons include:
Just as larger firms tend to relatively benefit from more regulation as they have more economies of scale, a reduction in regulation may well benefit smaller firms disproportionally.
The Nasdaq companies tend to be more internationally active and, as such, be more vulnerable to retaliation on any policies by other governments. Historically, in the stock market declines we have studied, the Russell 2000 has outperformed the Nasdaq. The reason may be that the Nasdaq has the more popular (and thus pricier) firms. While I believe this may well apply, a caution to this theory: in 2016, the Russell outperformed the Nasdaq already. To protect against a general decline in stocks, one may need to look further. In that context, cash is an option that is often not mentioned. As investors ponder ways to diversify – or even just a rebalancing of portfolios as equities have outperformed other asset classes – keep in mind that equities tend to be more volatile than some alternatives; as such, to be protected in a downturn, one might need to load up quite substantially on alternatives. As an extreme example: to protect a 100% stock portfolio against a broad market downturn, it would really need to go to almost 100% cash if one wanted to avoid the risk of losing any money. As most investors don’t want to do that, investors are looking for diversification, i.e. for investments that have a low correlation. To the extent that one finds such investments, a similar test should be performed though: how much does one need to add to attain the desired diversification?
Bonds should prove interesting in 2017. My personal opinion is that we saw historic lows in 2016. However, if stocks were to tumble, wouldn’t bonds rally? Possibly. What I’m concerned about is that bonds will fall for different reasons than in 2016: in late 2016, more real growth was priced in; I happen to believe that some of those higher real growth expectations will be replaced with higher inflation expectations.
If that happens, bonds can lose money even if stocks fall. More so, the dollar might not be so shiny after all, if higher inflation is priced in. Fed Chair Yellen recently (at Stanford on January 19) gave a speech in which I interpreted her argument as to suggesting “this time is different” as rising inflationary pressures e.g. in wages are really not as strong as some say.
That’s not to say other currencies can’t suffer in a trade war – the Mexican Peso has been particularly vulnerable as the Mexican economy is particularly dependent on exports to the U.S.; China’s currency may also be vulnerable as speculators could increase their attack on the currency should China be pushed into a corner. That said, I am more optimistic on how major currencies will perform versus the greenback, as we may have seen the low in interest rates in much of the world. Last week, European Central Bank President Draghi fought against that perception, but it was a fight in words only which I characterized as “huffing and puffing” to pressure the currency lower – a strategy that worked for a few hours that day.
What about gold? As we have indicated in the past, gold may be the “easiest” diversifier. Easy because it’s easier to understand than other investments that might be able to perform well when both stocks and bonds are vulnerable (e.g. a long/short equity or long/short currency strategy). We believe gold is a good diversifier over the medium to long-term, as its long-term correlation to equities, in our analysis, is near zero; that said, the price of gold can have an elevated correlation to either stocks or bonds over shorter periods. If I am right that inflationary pressures will increase, then gold may benefit. If, however, Trump’s policies will foremost boost real growth, gold might suffer. One reason why I am optimistic on gold is that I haven’t seen any proposal to get long term entitlement spending under control which is, in my view, key to long-term fiscal sustainability. The link to gold is that a lack of long-term fiscal sustainability may lead to negative long-term real rates which, in turn, would be a positive for gold which has a cost of holding and doesn’t pay interest.
Microsoft recently became the latest big name to officially associate with Bitcoin, the decentralized virtual currency. However, the Redmond company did not go all out, and will only support bitcoin payments on certain content platforms, making up a tiny fraction of its business.
What’s The Big Deal With Bitcoin?
Like most good stories, the bitcoin saga begins with a creation myth. The open-source cryptocurrency protocol was published in 2009 by Satoshi Nakamoto, an anonymous developer (or group of bitcoin developers) hiding behind this alias. The true identity of Satoshi Nakamoto has not been revealed yet, although the concept traces its roots back to the cypher-punk movement; and there’s no shortage of speculative theories across the web regarding Satoshi’s identity.
Bitcoin spent the next few years languishing, viewed as nothing more than another internet curiosity reserved for geeks and crypto-enthusiasts. Bitcoin eventually gained traction within several crowds. The different groups had little to nothing in common – ranging from the gathering fans, to black hat hackers, anarchists, libertarians, and darknet drug dealers; and eventually became accepted by legitimate entrepreneurs and major brands like Dell, Microsoft, and Newegg.
While it is usually described as a “cryptocurrency,” “digital currency,” or “virtual currency” with no intrinsic value, Bitcoin is a little more than that.
Bitcoin is a technology, and therein lies its potential value. This is why we won’t waste much time on the basics – the bitcoin protocol, proof-of-work, the economics of bitcoin “mining,” or the way the bitcoin network functions. Plenty of resources are available online, and implementing support for bitcoin payments is easily within the realm of the smallest app developer, let alone heavyweights like Microsoft.
Looking Beyond The Hype – Into The Blockchain
So what is blockchain? Bitcoin blockchain is the technology backbone of the network and provides a tamper-proof data structure, providing a shared public ledger open to all. The mathematics involved are impressive, and the use of specialized hardware to construct this vast chain of cryptographic data renders it practically impossible to replicate.
All confirmed transactions are embedded in the bitcoin blockchain. Use of SHA-256 cryptography ensures the integrity of the blockchain applications – all transactions must be signed using a private key or seed, which prevents third parties from tampering with it. Transactions are confirmed by the network within 10 minutes or so and this process is handled by bitcoin miners. Mining is used to confirm transactions through a shared consensus system, and usually requires several independent confirmations for the transaction to go through. This process guarantees random distribution and makes tampering very difficult.
While it is theoretically possible to compromise or hijack the network through a so-called 51% attack the sheer size of the network and resources needed to pull off such an attack make it practically infeasible. Unlike many bitcoin-based businesses, the blockchain network has proven very resilient. This is the result of a number of factors, mainly including a large investment in the bitcoin mining industry.
Blockchain technology works, plainly and simply, even in its bitcoin incarnation. A cryptographic blockchain could be used to digitally sign sensitive information, and decentralize trust; along with being used to develop smart contracts and escrow services, tokenization, authentication, and much more. Blockchain technology has countless potential applications, but that’s the problem – the potential has yet to be realized. Accepting bitcoin payments for Xbox in-game content or a notebook battery doesn’t even come close.
So what about that potential? Is anyone taking blockchain technology seriously?
There was a significant outburst of enthusiasm from the financial markets, especially the equity markets, following the U.S. election result last November. The S&P 500 rallied by 3.5%, led by financials, industrials and cyclical stocks, and many other markets around the world also enjoyed a rebound.
Today, expectations are, as Donald Trump would say, “Huge.” The “animal spirits,” famously described by economist John Maynard Keynes, have been unleashed, or so it seems. Indeed, at the end of last week the Dow Jones Industrial Average broke through the 20,000 mark for the first time. And the VIX volatility index fell to its lowest level since July 2014. Is this the triumph of hope over fear, or are investors getting carried away with themselves?
Paradigm Shift
To be sure, there’s much to be positive about. Change is in the air and there’s a paradigm shift in the U.S. economy that’s almost palpable. Consumer confidence in the U.S. is ticking up, as is CEO confidence. U.S. small business confidence, for example, is at its highest level since 1994. This higher confidence, if translated into action, should lead to greater economic risk-taking as CEOs look to reinvest in their businesses after years of keeping their powder dry.
The much-vaunted U.S. infrastructure spend is also grabbing headlines, with excited talk of new investment in transport, telecoms and energy, among other areas. Again, this should lead to meaningful growth. And the planned reform of both corporate and individual tax rates should prove a boon for both companies and consumers.
Elsewhere, CEOs have long complained about the growing financial regulatory burden and the role of the Environmental Protection Agency. Both are in the new administration’s sights.
Turning to monetary policy, central banks have already done much of the heavy lifting, but their impact has diminished in recent years. What we’re seeing now is a gradual shift away from monetary stimulus to fiscal stimulus. The knock-on effect of this is the return of inflation and higher interest rates. Indeed, there is an expectation of two, maybe three, interest rate rises by the Federal Reserve this year. In short, we’re beginning to see the return of the business cycle and economic expansion – something we last saw way back in 2007/2008.
Tough Medicine
So what‘s the downside?
Without wishing to pour cold water on the current market exuberance, it’s worth noting that, after the November bounce, markets were relatively flat in December and the first three weeks of January. While U.S. asset prices may have risen, the real economy has not done quite as well. Indeed, amidst all the enthusiasm, there’s an underlying anxiety about how much the new Trump administration can actually accomplish. The implementation of new tax laws, regulatory reform and infrastructure policy, for example, will take much time and effort, and the process may run well into 2018. That said, we do believe these policy changes will have a positive long-term effect on GDP growth, and, importantly, earnings growth.
One of the most challenging issues, however, will be health care reform. It’s an important item on President Trump’s agenda and his administration will focus meaningful efforts on it. However, it won’t be easy to repeal and replace Obamacare. It’s an enormous piece of legislation to unwind and it’s not yet clear quite how they’re going to do it. Nor do we know what impact, if any, it will have on the health and pharmaceutical sectors.
Meanwhile, the surge in nationalism doesn’t bode well for global trade. Protectionism has been on the rise for a number of years and looks set to continue. The developments in Europe, in particular, concern us and the elections in France and Germany later this year could yet spook markets. Few investors predicted the U.K.’s “Brexit” vote, for example, and a year ago Donald Trump was viewed as a long shot.
Taken collectively, these issues raise the possibility of setbacks and disappointments along the way. Indeed, this year we’re likely to experience a bumpy ride. But my advice to investors is to focus on the long term, while remaining mindful of the risks and possible setbacks along the way.
