On The Political Season and Tax Proposals

Bloomberg just put out a piece (Clinton Tax Plan Seen Costing 697,000 Jobs) wherein we get these two juicy paragraphs:

“The Democratic presidential nominee’s tax plan, which includes proposals to raise taxes on multimillionaires and impose a “financial risk fee” on banks, would change economic behavior enough to reduce U.S. gross domestic product by 2.6 percent over the long run, according to a study prepared by the Washington-based Tax Foundation. In that slightly smaller economy, wages would be 2.1 percent lower, the report said.

The Clinton campaign disagreed with the analysis and said the Tax Foundation’s methodology was flawed. Clinton’s plan will “result in stronger growth and more jobs, not the opposite,” said Julie Wood, a campaign spokeswoman.”

These polar opposite quotes capture everything that is wrong about politics these days. Nobody cares about the truth. It’s a race to the most eyeballs, no matter the casualty, which more often than not is the truth. The truth is usually somewhere in between. The truth rarely hangs out at the extremes. It is gray, not white or black. It’s messy.

As far as I can see, what we ultimately have here in terms of choices are two approaches to our tax code. One is a known quantity. It proposes raising taxes on those who can “afford” it, in the spirit of “fariness” and moral obligation. It is also an approach that lumps billionaires and people making $150,000/yr together in one big happy caviar-filled mega yacht – as if they share lot lines in South Hampton and spend the afternoon test driving each others’ Lambos. The meme that we’re only going to raise taxes on the super rich is perhaps the greatest political fraud of the last hundred years. They never only raise taxes on the super wealthy because the numbers don’t add up. It’s just math.

The other proposal is the disruptor. This proposition would broaden the tax base and lower revenue, at first. It means the Federal government would have fewer resources, the States would have a wealthier tax base and the private sector would experience an increase in aggregate demand. We are so far removed emotionally from the fundamental fact that this country was founded on the principal of limited government (the currency of which is a combination of legal rights reserved for the States and limitations on the purse we afford the Federal government) that we can’t process the basic fact that money is fungible and the economy is a reflection of who controls the decisions made around allocation of financial resources. Government is an irrational actor, paying almost no attention to the inefficiencies caused by malinvestment. If you grant government a larger role in the allocation of financial resources, you stifle competition, reduce the multiplier effect and slow growth. It’s just logic.

So here we are: an obscene, rude New Yorker who wants to revamp the existing tax code and a career, consummate DC insider who wants it all to stay the same (and who has made hundreds of millions of dollars milking the system). Are we smart enough to process the fact that we have all the evidence we need to conclude that the way things are is not working? Have we become so intellectually warped that we buy into the idea that lowering taxes doesn’t grow the economy more than raising taxes? The war isn’t on the middle class but on the upwardly mobile; the middle class is a casualty of limited growth and a convenient talking point for the political class that seeks first to preserve their power and then to govern, if it doesn’t conflict with their tee-time….



No, Trump’s Poll Numbers Aren’t A Proxy For The Mexican Peso

Much fanfare is made about the impact on Mexico every time a new poll shows resilience for a Trump Presidency, and then the Mexican peso goes the other direction (and just because Bloomberg has a chart suggesting otherwise, doesn’t mean it’s real). It’s a classic case of media hype when the narrative suits but when the nanosecond correlation breaks down, we get silence. So, here it is: there is zero meaningful correlation between Trump and the Mexican peso (ok, fine, maybe not zero but de minmis). We are not saying there haven’t been and won’t be knee-jerk reactions. What we are saying is that the best way to understand long term impacts on the Mexican peso appears to be the JPYUSD. We look at a 5yr daily correlation (using a 252 period) and it’s pretty clear that when the JPY rallies against the USD, the peso gets a boost. Conversely, when JPYUSD destabilizes, the peso suffers. That’s it in a nutshell. The reasons why can be debated for sure but our view increasingly sees the rise of peso liquidity as the main causal factor than anything else. Free market capitalism cuts both ways and Mexico’s increased reliance on internal consumption, in large part, means that the central bank can manage periods of FX stress through smart monetary measures. Note: Mexico’s central bank in a surprise move this month, bumped the overnight rate 50bps. Second note: That Mexico can raise rates seems to have gotten little or no press.



Mexico’s Rise as a Global Power

Since the global recession, Mexico has been making its voice heard at the global level. And it should be since Mexico is now the 15th largest economy in the world, 2nd largest trading partner with the United States, 12th largest global exporter and a poster child for how other commodity export-dependent peers can transition to an internally-fueled economy through structural reform aimed at bolstering sustainable consumer demand. Recall Mexico of the early 1990s, going through the same privatization fury we saw in the former Soviet Union, Eastern Europe and China – and yet Mexico’s story stands out for several reasons.

First, in the 1980s, oil exports were approximately 80% of USD income; today, oil represents only 20% of USD income with export manufacturing representing the largest source of USD income, just ahead of foreign remittances. What this means is the government budget no longer lives and dies by the price of oil but by Mexico’s strategic position as a value-add exporter of manufactured goods. This evolution, made more robust by the rise of the middle class consumer, makes Mexico one of the most important global trade partners and a major beneficiary of foreign direct investment.

Second, over the last 25 years, Mexico has successfully transitioned away from the single party political system, marked by graft, back room deal-making and a heavy-handed regulatory environment. That said, while it’s certainly easier to do business today in Mexico, they still have a lot to do to make business investment easier. Note: avoid getting dragged into court if doing business in Mexico. Its Napoleonic legal system is not fun and unless your claim is physically documented, notarized and witnessed by the Ave Maria, you may find yourself sucking wind on the short end of a contractual good faith agreement. Intent matters little; paper rules. So no, an email isn’t going to make your case in court.

Third – and this is the theme we’ve really watched over the last few years – Mexico is becoming a bona fide global player in both foreign affairs and trade. Many don’t realize that Mexico is an extremely key member of OAS, the 10th largest country measured by contributions to the UN’s annual operating budget and under Claudia Ruiz Massieu, Mexico’s visibility on the global stage has only increased (Fact: Mexico has 80 embassies and almost 200 consulates around the world). So, this from Dow Jones this morning, reminds us that Mexico’s growing role on the global stage should be seen from two perspectives: First, Mexico, like all countries, seeks to promote its own interests. That is a given, but, second, Mexico appears more and more to be carrying water for US foreign policy when it makes sense. Dragging what remains of OPEC into the 21st century strikes us as one of those policy objectives that suits Mexico’s unique position well.

“Dow Jones: Mexico Energy Min Says “Just Coming for Informal Conversations” with OPEC, Non-OPEC Representatives in Istanbul

Wed Oct 12 06:37:23 2016 EDT”

No, it’s not the first time that Mexico has attended an OPEC meeting but given all that has transpired, it surprises us little that Mexico pops up for “informal conversations” with OPEC members as world focus on crude supply remains – let’s say – intense.


LatAm Real Estate Zigs Higher As US REITs Zag Lower

ON the heels of real estate being reclassified into a standalone sector in August, it would appear that many investors elected to dump US REIT holdings (What Happens to Real Estate When the Fed Raises Rates?) – but Latin America real estate, especially REITs, have gone in the other direction. The reasons are both macro and specific to the asset class. Attractive valuations and yield plus favorable demographics, suggest that LatAm real estate could be on the verge of another mini-boom – but one that will take place not in the hallowed chambers of global private equity board rooms, but in the local secondary markets. The convergence of private and public returns shows no signs of slowing which means we’re likely to see more M&A, PIPEs and other PE-financed investing in the public space versus the traditional direct investment in real property.  The LARE Index has rallied over 14% since the start of June versus XLRE and VNQ which are down almost 3% and 2%, respectively. US REITs remain an attractive source of income but the resetting of interest rate expectations appears to be taking a toll.


LARE Index versus XLRE and VNQ trailing 2 months as of 10/11/2016

Expectations for Rate Cuts in Brazil Pick Up Steam

Let’s recall that only a few months ago most viewed prospects for a Brazil rebound as somewhere between dead cat bounce and hopium. Most institutional investors missed the late Fall 2015 signs of a bottom being put in; then in February 2016 they sat waiting for the “floor” to drop out; finally, in June, they said that it wouldn’t last, that Brazil is doomed. We literally had pension investors telling us in July that Brazil was going to sell off hard, again. And this was well after the massive political upheaval and decided improvement in forward-looking macro data – especially trade, FDI and inflation. Well, how things change.

Our view towards Brazil shifted materially last Fall when it became apparent the correlation between EM FX and the USD started to break down. Following the January swoon, the time to buy was clearly staring right into our eyes. Fast forward, it’s pretty clear that when forward looking macro indicators started showing material improvement in Q2, combined with Dilma’s ouster, the inflection point had arrived.

Over the last several months, expectations for rate cuts have gained momentum and with YoY CPI now trending decidedly lower, most believe the central bank will cut as early as the end of October.

“DJ Brazil’s Central Bank Might Cut Aggressively — Dow Jones – Tue Oct 11 09:06:25 2016 EDT

The initial approval by Brazil’s lower house of a proposed constitutional amendment on taming government
spending paves the way for fast and aggressive interest-rate cuts, says Cristiano Oliveira, chief economist at Banco
Fibra. He expects the Selic to be slashed some 5 percentage points the next year from the current 14.25%. Central-bank
officials next meet next week.

While we don’t expect 500bps of cuts in 2017, it is certainly possible, but Brazil does have an inflation issue and it will be a while before we can really measure its progress in the post-commodity global paradigm. Our view is we’ll get a 25bps to 50bps cut either at the next meeting in a couple of weeks or next month and then it will be wait-and-see for inflation. The Fed’s lower for longer policy removes some of the Brazil central bank’s urgency to see growth rebound at the expense of moving too fast, too soon. For 2017, we continue to think a reasonable expectation would be for 200bps to 300bps in rate cuts.

What Happens to Real Estate When the Fed Raises Rates?

What Happens to Real Estate When the Fed Raises Rates?

What Happens to Real Estate When the Fed Raises Rates?

 The Federal Reserve seems likely to raise interest rates in December, barring a collapse in the economy. How will that affect real estate?

Despite its reluctance to raise the federal funds rate in September, the Federal Reserve seems likely to raise interest rates in December, barring a collapse in the economy. In the past, when interest rates have risen, real estate as a whole has tended to underperform, but that may not be the case this time around.

“U.S. real estate will probably trade off a bit [when the Fed raises rates], but Latin America will probably be relatively cushioned against any policy move,” said Jamie Anderson, managing principal of Tierra Funds.

Part of the reason the Federal Reserve, led by Janet Yellen, has been so reluctant to raise interest rates is the effect it would have on global markets, particularly in light of the economic volatility seen in Europe, following Brexit. “The Committee continues to closely monitor inflation indicators and global economic and financial developments,” the Federal Open Market Committee stated in its September 21 release.

 However, not all real estate is likely to be negatively affected, with Mexican REITs, for instance, already trading at a discount due to the weakness seen in the peso.
Latin America real estate over the past 60 days has gained 4% compared to the Real Estate Select Sector SPDR Fund State Street Global ETF (XLRE) , a huge spread that is rarely seen. As such, Anderson has been recommending the Tierra Funds Latin American Real Estate ETF (LARE) to his clients, thinking it can go up between 10% and 15% plus the yield over the next twelve months. Anderson helped create the fund as part of his role at Tierra Funds.

Looking further out, Anderson thinks U.S. real estate, in particular real estate investment trusts, will have more time to adapt and adjust, since the Fed is likely going to take a longer time frame to adjust to normal policy — in this case two to three years — easing the pressure on real estate. “The risk for U.S. REITs is investors may not get the appreciation they’ve seen over the past one to two years — dividend growth will be there and you can get a decent coupon, but there may not be a lot of upside,” Anderson said.

Real estate finally has its own sector in the S&P 500, which gives the $2 trillion asset class a clearer and more transparent way to benchmark. It’s not a one-size fits-all category, and some parts are likely to be less sensitive to a rate hike, chief among them, multi-family real estate.

“Multi-family real estate is going to be a little less reactive to interest rate changes because it’ll provide a better bump in rents as the economy gets better,” Anderson explained. The Vanguard REIT ETF (VNQ) holds residential REITs in its portfolio as well as commercial and specialized REITs. VNQ may also continue to outperform because of its exposure to the industrial economy, which because of the nature of the business, is more closely tied to the global economy and can surpass some of the interest rate-tied headwinds seen in other portions of real estate.

Conversely, areas that are more sensitive to interest rate rises, such as malls, are likely to underperform, Anderson explained, because of “an increase in the cost of capital which will be another headwind for an already struggling sector.”

Other areas around the globe, including the Middle East and specifically Turkey, are quite interesting to Anderson because of young demographics. “Any country that has favorable medium or long term demographics is going to be very good for real estate,” Anderson said.