Friday Musings: US Political Brand Value vs Financial Asset Value

940 words – a 4 minute read.

One of the issues I have been musing over is the idea that the US political brand, which arguably reached a nadir on Jan 6th with the assault on the Capitol, is in an upswing, judging from polling on both the Biden presidency and its Go Big, Go Fast approach to governing. At the same time, US financial asset valuation, by far the most expensive globally, is starting to roll over.

This suggests that policies that raise the value of the political brand, especially around issues of fairness and equality, made manifest in the tax structure for both corporates & the wealthy, may have the opposite effect on US financial asset valuation.

One idea gaining some attention & support is to tax global free riders on two fronts – climate and corporate tax. Europe’s Carbon Border Adjustment Mechanism (CBAM) and the rapidly growing enthusiasm for a global minimum corporate tax are two very real examples that make a lot of sense. (Giles article)

Governments need new revenue & production sources while corporates and the wealthy have done very well over the past decade. Meanwhile the data suggests that improving equality tends to be positive for economic growth and social stability.

How does this impact my market view? It reinforces the Great Rotation & Golden Age of Asset Allocation thesis I laid out in my 2021 Outlook : from US to non US equity leadership, from Growth to Value, from Large Cap to Small Cap, from UST Bear Market to Commodity Bull Market. The recent pullback in the Value trade may well be the pause that refreshes.

More specifically, the Biden Climate Summit & the Capital gains tax proposal resonate in several ways.

The Climate Summit did not address a pan regional or even global CBAM, as I thought it might – it would be a real hit to China were the US, EU, UK, & others to impose such a system. As of now it remains the stick that is hiding just out of sight. Yet the many countries committing to larger carbon reductions by 2030 reinforces the climate change thematic embedded in our Model Portfolio Delivery Service.

The Covid Speed Model – the paradigm shift whereby global intellectual and financial capital is employed to fight singular global challenges like Climate change - will be in full bloom this decade in order to reach the 2030 goal. Investing thematically is the way to leverage this outcome and generate alpha.

To avoid that alpha being taxed away one has several options – the first is to trade less, which fits in with the thematic approach – this means more discipline to avoid being shaken out by the occasional “pothole market”. Another option is to swim with the non-US equity current. A third id to put more money into private investments (RE, Commodities) but here one wonders if that’s not where the bubble is – especially in the PE/VC space with tons of dry powder and bidding wars galore.

I favor the 1st two approaches: invest thematically to leverage the twin combo of the LT nature of thematic investing & the Covid speed model paradigm shift; look outside the US for investment opportunities with the understanding that global equity leadership changes tend to manifest for years, not months or quarters. Note also that the S&P rose 30% the last time US capital gains taxes rose back in 2013!

 I have long favored the non US DM but in this regard EM are starting to pop up on the radar. EMFX has been up 8 of last 10 trading sessions and up the past four weeks in a row (EMLC). The Brazilian Real, which I wrote about last week, just broke under 5.5 to the USD and MXN, the Mexican peso, is under 20 to the $. 

I have been a big believer in follow the leader and 1st in, 1st out behavior since Covid struck a year ago. Asia and China equity specifically has had a pretty healthy pullback while Russia has dealt with sanctions and is an oil beneficiary with some decent yield. Time to buy the laggards?

Europe also remains appealing – PMIs reflect a much more robust economy than headlines suggest, as do earnings with EU Q1 EPS up 47% y/y, 24% ahead of forecast. Vaccinations are starting to soar and the goal of 70% adults vaccinated by July is on track while the Joint Recovery Fund should start disbursements in coming months & the ECB has made it clear it will go slow. Don’t forget Japan – its Composite PMI broke just broke 50 for the 1st time since Jan 2020 while activist investors seek to drive change.

Does one expect a big selloff given tax fears and taper talk? No, I do not. Earnings are fantastic – US EPS for ex are up 64% y/y, 37% BTE… while some banks talk about a 7% hit to EPS bc of corporate taxes… US credit spreads remain tight, April was a record month for US HY issuance, default rates are forecast to be lowest since 2017, financial conditions remain very easy, technicals remain supportive. 

Let’s listen to Larry (Fink): “There is an incredible amount of money on the sidelines. Our clients are sitting on pools of money and they are underinvested” – this from a guy with $9T in AUM. Potholes, yes, messy markets for sure, BTC down roughly 25% (again) yes, run for the hills – no.

It’s a global, multi asset world with exciting ETF based, thematic opportunities – that’s where our investing attention needs to be.

TGIF!