WONGIN’ THE POG
It took The Rolling Stones’ guitarist, Keith Richards, to define Federal Reserve policy of late. It is clearly outlined in his book “Life”, where he describes the band’s early nightclub engagements. Mr. Richards describes; “Wongin’ the pog was when we’d look at all these people dancing around, hanging from rafters, going crazy. What are they doing? They’re wongin’ the pog ain’t they? At least we got them wongin’ the pog. It meant you got paid” A more precise definition of Fed policy is hard to find. Indeed, for years, zero rate interest rate policy (ZIRP) has had markets going crazy, hanging from the rafters. Financial assets were bid up, share buybacks exploded, dividends bolstered, all in response to ZIRP. The Fed then awaited inflation, which never surfaced, and searched for strong economic indicators signaling a post 2008 rebound, which also never surfaced, and so, rates were hiked nevertheless. Such long periods of ZIRP can promote poor allocations of capital, and it appears we have been through such a period. Now, with rates rising, at least in December 2015, we can hope for more productive uses of money.
Wongin’ the pog will likely be scarce in 2016. The environment does not easily lend itself to unrestrained economic expansion. For one, it is an election year, a strange one at that, with a growing reality show feel to the affair. This election will see an estimated $11 billion spent on advertising spots for the candidates. Imagine if only half of that amount flowed into public education, or bridge repair. Congress and the President are unlikely to press for anything so bold. Rule out tax reform for starters. This takes far too much courage for anyone currently in Washington to muster; remember Bowles Simpson? The commodity complex has collapsed. From agriculture to energy there is nothing but scorched earth. Prices have declined to extreme levels, traders have retreated to lick their wounds. The Bloomberg Commodity Index, shortly before Christmas, registered declines, year-to-date, in 21 of 22 futures contracts; only cotton showed gains in 2015. With the energy price declines have come the corporate bond devaluations, largely over default fears. Some bond funds have ceased allowing immediate redemptions, bringing unsettling reminders of 2008. Seems too many companies ventured into the drilling surge of the past decade with borrowed money. Prices no longer support the drilling, and interest payments on debt start to lag. It is difficult to determine whom the Saudis wish to harm the most with their unrestrained oil production; Iran, Russia, or US shale companies? All are certainly feeling the pain.
Banking in the United States is also seeing a transformation. Small online lenders are springing up to offer services to small business, sometimes at mind-boggling rates of interest, or APR. Banks have deserted this segment, citing limited demand. However, too many new lenders have sprung into play to support such statements, taking this sector as their own, with little regulatory oversight. It is hard to determine why banks have resisted small business lending. Some describe a regulatory culture that has grown over restrictive; something akin to the document morass that defines residential lending today. Others explain the dearth of banking activity in the small business space as being a result of the massive size of the post-2008 institutions, and their inability to economically service the business. Too time intensive they say, easier for an Internet start-up to utilize big data to quickly find the attractive borrower. Whatever the cause, the sector desperately needs access to capital to once again be a jobs engine for the US economy. Look for plodding economic results until this issue is resolved properly.
Our mega corporations, outside of banking, seem to have come to the conclusion that merging is the easiest route to squeezing out existing excess capacity. The Dow-DuPont linkup is a poster child for this, as is the airline industry. As the frequency of these mega mergers picks up steam watch for the pendulum to swing. Investment bankers will see the large fees awaiting the break up of these behemoths, causing a wave of new companies to form as the old names break up to become “efficient” once again. Memories of the 1980s and the ATT divestiture. The point to take away here, little contribution to GDP has come from the mega mergers, mainly cost cutting.
The technology sector has epitomized wongin’ the pog. Billion dollar valuations of still-private companies had become commonplace in a ZIRP world. We are seeing some of these numbers fall to earth, however, the technologies keep coming, changing the way we live our everyday lives. Look for this tech theme to dominate in 2016. Too many interesting developments in robotics, artificial intelligence, and materials innovation are taking place. Valuations will continue to be pressed to the upper bounds, but saner heads will prevail in a higher interest rate environment. This trend is evermore global, from Israel, to Germany, to Asian locales. New capabilities are springing up. It will make for a challenging stock pickers’ year, locating the far flung players in these spaces. The point to take away here, much contribution to economic development is taking place in the tech sector, but rarely resulting in large labor gains.
Unfortunately, the global picture also has a dark side. The Middle East, Ukraine, and European refugees all seem to become ever more irascible issues. There are no easy solutions and there will be no speedy end to these painful events. Count on 2016 having more of the same slog as leaders around the world flail along in their efforts for resolution. This is a slow march to the creation of a new trade block for the future. China – India – America will slowly evolve into a powerful trading alliance, mainly out of necessity, but certainly due to a myriad of pressures exerted on each country. This alliance will not resemble the Transatlantic links of the past, where culture and shared experiences fostered close ties. This will be a much colder, technologically driven affair, born from desperation to find trusted, well financed, functioning markets for goods and services. A destabilized neighborhood will force India to further liberate its markets to a lingering, confrontational China, and for the Chinese to yearn for the Indian structural fixes of contract law and large functioning internal markets. America, the most prolific economy the globe has ever seen, will be the only engine capable of sustaining these two massive developing economies.
The union will be slow, rarely warm and fuzzy, and fraught with disagreement and misunderstanding, but extremely lucrative. To envision the logical outcome here is quite exciting. China and India are starting from low levels of overall economic activity compared to the massive populations they serve. On the other end of the spectrum, the United States is plunging into demographic changes that will push her into partners arms. Aging work force issues and immigration are already changing American economic dynamics. Consider that some 60 million US inhabitants speak something besides English in their homes. A staggering figure, but one that bolsters the US position in global capabilities. Rand Corp. estimates the annual value of unpaid caregiving to the elderly, by friends and family, at $522 billion. The rolls of these elderly will only swell in the coming years forcing us to embrace new immigrant workers and innovative methodologies to compensate and finance this “greying” phenomenon. Overall our productivity will be sustained as the China – India – America trade block forms in earnest around this myriad of issues. The countries might resist the alliance at different stages, but their needs will far outweigh any of the perceived drawbacks.
So as we burst into 2016 let’s exhibit the bluster of the Rolling Stones, and embrace the changes occurring around us. Look at accumulating shares in badly beaten mining companies and energy stocks, awaiting their slow climb back to favor. Broaden technology holdings in portfolios and seek robotics, IT security, and broadband applications as additions. Payment systems will also see hefty growth as electronic payment accelerates among consumers. Indexes of European companies might also reflect value at this point in time. And most obviously, exposure to any aspect of the China – India – America axis would be favorable. In looking at China and India, broad index funds would reduce risk while providing needed exposure. Wongin’ the pog it isn’t, but the Rolling Stones’ “Paint it Black” would not be appropriate either.
E. B. “Chip” Beard
December 26, 2015