This year started off like a roller coaster. Following the strongest performance of any January in recent history, the world stock markets, particularly the U.S., plunged steeply in February and since then on an almost daily basis. Volatility long since forgotten has returned with fervor. During the first quarter, the Dow Jones Industrial Average lost 2.5% while the technology laden NASDAQ index was up 2.9%. U.S. utility stocks, a bellwether for dividend paying companies in general, lost 4.2% as investors have now begun to worry about rising interest rates. It is unlikely that dividend stocks will keep pace with inflation if it returns in earnest.
The best-performing sector in the U.S. was telecommunications, up 4.8%, as the leading companies in the industry wait for judicial rulings about the proposed merger of some of their titans. Oil prices mirrored the volatility in the overall stock market, ending the last three months with a decline of 5.3%. Small companies gained 0.2%, as these firms had not run-up to the extent that mega- technology and consumer products firms had done last year. The gold and silver index declined 4.9% during the first three months of 2018. Overall, the crazy pattern of recent trading activity in stock prices has kept investors on the edge of their seats.
In Europe, the overall stock market was down 4.7% with Germany declining 6.4%, even though it remains the undisputed economic engine for both Eastern and Western Europe. Russia regained its footing with its stock market rising 8.2%. President Vladimir Putin was “reelected” with the opposition showing barely any sign of life, especially among Russia’s young people who seem to be fairly well adapted to the continuation of Putin’s authoritarian regime. Anxiety about the United Kingdom’s exit from the European Union ramped up as some companies have chosen to move their headquarters to calmer waters in Northern Europe. England’s stock market declined 7%, making it the worst performing of the European markets.
Resource rich economies such as Canada and Mexico saw their markets decline in line with the U.S. energy markets, since the bulk of their exports are made up of these kinds of commodities. Canada was down 5.2% while Mexico declined 6.5% due to the ongoing conflicts between various drug cartels and factions of the Mexican government. The Brazilian economy seems to have survived its political turmoil of successive waves of resignations over the past 18 months as it climbed 11.7% so far this year.
The bond market is far more important than the stock market in terms of predicting the future welfare of the general population and the prospects for the economy as a whole. Interest rates continue to rise in the U.S. and the specter of similar kinds of action in Europe and Japan served to weigh down bond performance globally. The U.S. government bond market declined 1.58%, with 30-year U.S. government bonds now yielding around 3%. U.S. corporate bonds declined 2.3% as they continue to earn only ¾ of 1% more than government bonds, which is not much given their increased risk.
The high-risk bond market, also known as high-yield or junk, declined the least with a -0.92% return. The average high-yield bond is paying 6.4%. There is normally an approximate 3% or 4% difference between U.S. Treasuries and junk-bond yields. Shorter-term corporate investment grade bonds declined 1.46% with the average interest rate of around 3.5%. Shorter term municipals lost 1.15% while paying out, on average, 2.5%.
From an ultra-long-term perspective, a study of the annualized returns of assets for the last 117 years shows that global stocks returned a whopping 5% per year, far outpacing the next highest category of fine wines! Art returned 2 percent annually over the last century while gold barely eked out a positive result – 1/2 of 1%. Silver was essentially flat, and the worst-performing asset was diamonds with a negative 1% return. None of these numbers factor in varying tax rates on different asset classes nor does it consider transaction costs which, in the case of collectibles, can be between 30% and 50%.
Real estate, the most commonly held asset worldwide, is estimated to be worth around $250 trillion versus $170 trillion in all stocks, bonds and other publicly traded assets. How did real estate perform relative to stocks? Probably around the same, without counting in the cost of repairs, maintenance, taxes, insurance etc. Investors thinking about acquiring rental property should keep these other expense items in mind.
The U.S. economy is running at close to full employment, according to government statistics, so why do our nation’s deficits continue to look like we are living on borrowed time? The biggest question on investors’ minds is, “When, how far and how quickly will interest rates go up?”. The last decade saw a dramatic drop in real interest rates which fueled the global stock market’s rise. The recent tax bill and budget deal passed by Congress is a huge bet on the U.S. achieving a 4% GDP growth rate going forward. If we grow at only 2%, our deficit level will go past the point of no return.
Worldwide, investors are still buying U.S. Treasury bonds despite the bourgeoning balance sheet in America. For all of President Trump’s talk about reining in the trade deficits with countries like China, the ongoing issuance of U.S. government bonds to fund our shortfall and the administration’s intent to weaken the dollar, all contribute to the U.S. negative balance of the trade situation.
Donald Trump sees himself as one of the world’s greatest negotiators of all time. We believe this is why anything that comes out in official announcements or via social media has very little to do with his true plans and is posturing in relationship to foreign governments and his political opponents. Nonetheless, the increased leveraging of present day America will, if his bet on 4% growth is wrong, come back to haunt us in the form of future spending on entitlements, infrastructure, and the military.
The Chinese economy is growing at approximately 6% a year, compared with the current rate of 2.5% growth in the U.S. and between 1% and 2% in Europe. One of the biggest beneficiaries of China’s centrally controlled economy is its military, whose expenditures are growing in line with their GDP growth. China is an innovator in military technology on land, sea, and in the air, and its huge commitment to quantum computing technologies is aimed to make the use of Artificial Intelligence widespread in both military and social control applications. The Chinese also aim to develop an unbreachable communications network for themselves while being able to penetrate Western systems.
They have invested heavily in strategic information gathering technology and the size of their technology economy is catching up with America’s. It’s two largest companies, Alibaba and Tencent, are about the same size as Google and Facebook. Overall, the Chinese goal is to lead the world in Artificial Intelligence by the end of the next decade. To that end, they are promoting infrastructure to support emerging technology companies by funding venture-capital spending in this area. China has almost pulled even with the U.S. in terms of investment funds spent since 2016. Some of these are private companies, but there are many government-backed funds which make starting companies relatively easy for Chinese and foreign entrepreneurs who are willing to live in China.
Chinese cities are competing against each other to attract new technologies from overseas. State-run incubators in various places offer almost everything for free including space, furniture, hardware and logistical help in setting up new companies. Chinese authorities are particularly interested in attracting foreign educated and foreign born ethnic Chinese. They hold international startup competitions, easing immigration and visa processes for foreign graduates from China’s top universities. This is in direct contradiction to the current U.S. policy of making it more difficult for foreign born students to stay in the U.S. following graduation.
Bureaucratic hurdles remain since China’s centrally controlled economy and the closed Internet environment inside “the great firewall” is distasteful to people used to unfettered access to information and open discussion of different political points of view. Like many countries, foreign nationals in China often need to partner up with local citizens to own new businesses, but they can be given a fast-track to sell their services to various niche markets inside China. Chinese computer science and business graduates are far more willing to take risks than their foreign counterparts, while low labor costs, preferential taxation policies and a huge supply of educated labor has fostered the beginning of a Silicon Valley type of “anyone with a great idea can get rich” mentality. At the present rate, the Chinese technology industry will be equal in size to America’s in 10 years. China and America are facing off in exporting their technology to other markets, but for now, America still has the upper hand due to its more open and cooperative attitude.
In the U.S., most of the benefit of the last 10 years’ rise in stock market prices have gone to shareholders and executives and not to employees. The number of U.S. listed companies has declined by almost 50%, and the ones that remain are larger and more powerful than ever, allowing them to dictate employment terms to applicants. This year, for the first time, companies are required to publish how much more their highest paid executives make versus the average worker in the company. In the U.S., the average multiple is in the hundreds while in Europe, it is measured in tens.
From 1978 to 2013, CEO compensation increased 937% while the average worker’s income grew by 10%. Other than Boards of Directors, there is no counterweight to the influence of highly paid CEOs. The divergence between rural and urban America is also increasing with urban workers earning nearly twice the average wage of rural residents. Unionized workers declined from 20% in 1983 to 6% of private-sector workers today.
Big company domination has given American consumers fewer choices as a small number of players dominate many markets. For example, two corporations control 90% of the beer and 75% of households have no choice of who will be their internet provider. Four airlines dominate domestic airline traffic and five banks control over half of the nation’s bankable assets. In most states, the two top health insurers control 85% of the local market. Four players control all the U.S. beef production and three companies control 80% of U.S. agricultural seeds. Mergers and acquisitions and the predominance of private equity money as opposed to public issuance of new stock have created quasi-monopolies.
While the unofficial employment rate is 4.1%, many of these are low-wage jobs, i.e., that is, they do not pay enough to cover basic expenses for a normal family. One in four U.S. jobs leaves workers below the poverty line. In Alabama, Arkansas, Louisiana, Mississippi, West Virginia and New Mexico, one in three jobs is in a low-wage occupation so that many workers must take on extra jobs. Ridesharing services such as Uber and Lyft seem to give people a way to make extra income but in fact, the median driver profit is $3.37 per hour before taxes, meaning 74% of ride service providers work for less than minimum wage.
Tax Reform and Quality of Life
The substantial decline in U.S. corporate tax rates and the moderate decrease in U.S. individual tax rates recently enacted are straightforward compared with the complexity of President Trump’s program that allows a special deduction for individuals who participate in pass through organizations. The Rikoon Group’s use of private investment vehicles is directly impacted by the 2017 Tax Reform Legislation. The Act allows individuals, trusts and estates to deduct 20% of qualified business income from certain partnerships like the Investor LLCs which are in common usage. Of particular interest are the benefits of owning real estate subject to depreciation.
Because of the tax cuts and increased defense spending, the U.S. budget deficit is expected to rise from $550 billion to over $900 billion during 2018. These kinds of numbers are generally not seen except during periods of extreme economic contraction or military conflict. If the U.S. does not grow at 4%, which is the target of the Trump administration, overall U.S. debt, which has already gone from $33 trillion up to $50 trillion over the last four years, will likely double by the time the next President is in office. In comparison to the size of the total global real estate market as noted above, the size of our nation’s debt will be 40% of the value of all real estate everywhere, and well above the value of real estate in the U.S. alone.
With the country’s economic future at stake in the Trump gamble on growth, how is it going with the pursuit of the “American Dream”? The rate of armed conflict and homicides in the world has been going downward over the last 70 years, and since 1992, the incidence of global disease, starvation, extreme poverty, illiteracy and people living under dictatorships all have decreased. Unfortunately, America is moving in the opposite direction with higher rates of domestic murder, prison sentencing, STDs, obesity and declining educational achievement levels. Premature death among non-college-educated white males is also going up. Let’s hope the next decade is better!
In the last commentary, I wrote about quantum computing, blockchain technology, and crypto- currencies. One conclusion was that the current infatuation with Bitcoin and other derivative speculative vehicles will likely give way to government-sponsored and controlled electronic currencies that can be tracked, taxed, and manipulated in the same way as central-bank reserves are done today.
A recent article in the New York Times describes one possible positive development from the new blockchain technologies. Blockchain refers to what are essentially non-hackable algorithms that are kept honest and current via decentralized computing facilities. Most people realize that we get a lot of free stuff on the internet because we are tacitly agreeing to the mining of our smartphone habits and web surfing patterns by advertising giants and other institutions. Blockchain technology may allow us to protect our individual identities with unassailable security while simultaneously allowing us to go outside of the commercial giants who dominate the internet today. Academic and government early users of the internet in the 1980s were able to exchange information with each other in a freewheeling way that ceased to exist from the late 1990s onwards, which is when private business interests came to dominate the applications used inside the Internet.
For example, there is an operating system that competes with Microsoft and Apple called Linux (started in 1991). It may be a “geek” haven, but it does allow independent developers to exchange information, ask for help and cooperatively solve problems without any money exchange or paying homage to corporate licenses. Some early users of blockchain technology feel that this kind of independent network will come alive again as a network of non-corporate servers comes to replace the Googles, Dropbox, Spotify, Netflix, and Amazons of the world. Individuals may regain their importance in an egalitarian information society made up of informed consumers/creators/business people. This would allow small businesses and local economies to take charge of their own destiny in ways not seen or even conceived of today. Imagine people conversing freely with their friends and relatives without Facebook’s snooping, urban dwellers transacting business free of Amazon’s grip on delivery services or surfing the web without Google or Microsoft’s information search engines.
Consider the possibilities of, let’s say, a complete restructuring of ride (sharing) services. As competitors to Uber and Lyft try to come to the marketplace, now they are kept out due to the hassle of users having to change their private information and then learn a new system. If each of us had an individual identity and the ability to call for services at will in an open marketplace, not through a format provided by a private company, it would be an entirely different kind of economic situation. At any time, you could put out a freely accessible signal that you want to go from location ‘A’ to location ‘B’. As soon as the signal goes out, competitors from all types of transportation services immediately can respond and offer alternative means and pricing for taking you there.
This might involve human powered bicycles, public transportation, or private cars. As choices for consumers expand, the price would drop. Profits would go directly to the provider who no longer needs to share with a corporate sponsor. Investors could invest in these new transportation services directly with the provider, as opposed to going through Wall Street’s expensive initial public stock offerings. The benefits of these new profit centers would not go to just a few early shareholders but could be spread among the creators of the transportation service itself, early funders and users. All of this would depend upon a deeply redundant transactional system that maintains unassailable digital identities with integrity. Our personal likes and dislikes could no longer be used without our permission to sell things and our credit history and financial resource database records would not be accessible to anyone for any action or time period that we do not explicitly allow.
While Facebook and Amazon may own your personal data at the present time, under a new blockchain technology scenario, only individuals would own their own data and other people would only be allowed to use it if they were providing a service or an opportunity for investment. This contemplates a very different structuring of the commercial architecture of the Internet.
It is an exciting time at The Rikoon Group, and those of you who have visited the office recently have gotten to see firsthand some of the changes that have occurred. Our lobby area feels like a bustling trading floor with four staff members occupying the space. Most of you know Anthony and Patrick, and they have been joined in the last twelve months by Contessa and Keren, who have both proven to be very capable in assisting clients. They look forward to getting to know all of you better.
In January, we welcomed Gayle Johnson to The Rikoon Group team. Gayle was a longtime advisor with Merrill Lynch and she came to our team out of her desire to operate as an independent Investment Advisor. The Rikoon Group acts in a sub-advisory role to provide Gayle investment advice as requested, as well as providing her with office space and administrative support. Gayle is a great addition to our office and we are pleased to have her here with us.
Personnel News and Events
Rob: The main event of the last quarter, outside of work, was the installation of the “Liminal State Panels” egg tempera series in the atrium of the Haywood Avenue Methodist Church in downtown Asheville. It took 12 days and $12,000 to install where it is protected by plexiglass. The congregation served by Haywood are the homeless, indigent and recently released institutional population along with a very large corps of volunteers who are called “companions”. There will be an opening on May 23rd from 3 p.m. – 8 p.m. Coming up, I plan to do an inaugural backpacking sojourn on the Pacific Crest Trail 110 miles from the Mexican border up to the Idlewild forest in Southern California.
Kyle: In January, I took a trip with my family to Los Angeles and we visited Universal Studios. My sons are in the middle of the Harry Potter book series and Harry Potter Land at Universal Studios did not disappoint them. Every detail imaginable is covered and my boys were completely mesmerized by all that was offered. With the start of spring, our sports season has begun, and this year looks to be busy with James and Johnnie participating in baseball, soccer, and swim team. I am fortunate that they are the same age and all their activities are together. This saves me and my wife extra driving time that many parents deal with when their children are different ages and involved in different activities.
Jeff: In the summer of 2016, my wife and I sold our house and downsized to a condo. We later realized that we prefer more space and have met several other people that said they did the same thing –downsized too much and then got another place between the two sizes. Barbara and I then decided we were up for one more house project and, not being able to resist a bargain, we put in an offer to buy a bank owned property. Several months later, the bank accepted our offer, but we had to close in 2 weeks – by March 31. We had to really hustle to get the house in shape to the various inspections. It was very challenging and stressful, but we made it! Now the real work begins with all the various house projects and we still need to sell our condo.
Anthony: In February, my wife and I got to take a much-needed vacation without our 2-year-old. We spent our 9th anniversary in the Bahamas on the Great Exuma Island. We enjoyed great food and drink and spent most of the days lying on the beach. One of the days, we took a boat excursion out for some sightseeing and stopped at a deserted island inhabited with wild pigs. This is one of the biggest attractions of the area referred to as “Swimming with the Pigs.” Snacks were provided to feed the pigs and as the boat docks, you enter the water and the pigs swim right up to you to feed and get petted. After spending four days there, we flew over to Miami to visit my brother in law where we were able to enjoy some more time on the beaches before coming back to the cold NM winter weather. Now, along with everyone else in the office, we are looking forward to spring in Santa Fe.
Patrick: During past few months, I decided to increase my involvement in local politics and so have been volunteering a lot to try to make a difference. This has given me the opportunity to serve as a delegate at county and state conventions in the upcoming NM gubernatorial race. It was an exhausting but rewarding experience. ARTsmart, the non-profit whose board I serve on, provides art education to underserved youth. We held our annual auction dinner at La Fonda and the Harvey House theme which was very well received, raising $130,000 to put to work expanding our reach to more young students. Through all this busy-ness, I managed to spend some time snowboarding, mountain biking, hiking, taking pictures, travelling down to the Gila to visit my parents, and relaxing with my girlfriend. We are very happy that the daylight hours are increasing and there is more light waiting for us after work.
Contessa: It’s hard to believe that we are a quarter of the way through the year. Thankfully, the spring weather has provided my family and I with the opportunity to spend some more time outdoors which has included some hiking and biking. We are approaching the end of the school year and the kids are excited for the summer. We plan on signing them up for some fun activities including swimming lessons, art classes and a gardening class. In addition, my husband and I will be backpacking down the Grand Canyon next month and are really looking forward to that experience – a first time for both of us. I am also praying that we get some rain here in New Mexico so that the forests stay open to the public and we can camp this summer as it is one of our favorite things to do.
Keren: Before joining the Rikoon Group in February 2018, I worked as a corporate recruiter and Executive Assistant for the Gerald Peters Organization, and prior to that, as a talent search executive for a Bay Area recruiting firm. I moved to Santa Fe in 2010 after living in NY, Chicago, San Francisco, and Los Angeles. I spent 10 years traveling and serving as Personal Assistant to an international opera singer. My son, Gryffen attends Acequia Madre Elementary School, and I serve as the school’s PTC Board Treasurer. I have an M.A. in English Literature, am an avid reader, and enjoy attending the opera and Lannan Readings, as well as jazz and live music events around Santa Fe.
Please join us for our quarterly gathering to discuss economic and market related events. It will be held at 2218 Old Arroyo Chamiso in Santa Fe on Wednesday, June 13th at 3:30 p.m. (MT). We generally go until 5:00 p.m. The open mike conference call, available to out-of-town clients and friends, will occur on Thursday, June 14th from 3:30 to 4:30 p.m. (MT). The call-in number is 719.234.7872, after which you will be prompted to enter the code: 470070#.