Navigating the New Navigating the New Normal: Portfolio Normal: Portfolio
Management in a Post-Management in a Post-Crisis WorldCrisis World
Portfolio Management InstitutePortfolio Management Institute
Atlanta, GeorgiaAtlanta, Georgia
April 22, 2010April 22, 2010
Portfolio Management Portfolio Management in a Hostile in a Hostile
EnvironmentEnvironment
Portfolio Management InstitutePortfolio Management Institute
Atlanta, GeorgiaAtlanta, Georgia
April 22, 2010April 22, 2010
OverviewOverview
Bottom line: From crisis to Bottom line: From crisis to crisiscrisis
ApproachApproach BaselineBaseline ThreatsThreats OpportunitiesOpportunities Mid-TermsMid-Terms
Baseline EconomicsBaseline Economics
Next 12 to 24 months – 2 to 4 % growthNext 12 to 24 months – 2 to 4 % growth Then – 4 to 5 % growth until mid 2 ought Then – 4 to 5 % growth until mid 2 ought
teensteens Then about 2.5 % annualThen about 2.5 % annual Inflation near 2 % through 2010Inflation near 2 % through 2010 Rising to 3 + % by late 2011/early 2012Rising to 3 + % by late 2011/early 2012 Returning to 2 % by 2013Returning to 2 % by 2013 Interest rates + 100 bp then tracking Interest rates + 100 bp then tracking
inflationinflation
Investors’ Threat # 1Investors’ Threat # 1InflationInflation
Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the FedStarts and ends with the Fed Can the Fed nix inflation?Can the Fed nix inflation?
Excess reservesExcess reserves
Investors’ Threat # 1Investors’ Threat # 1InflationInflation
Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the FedStarts and ends with the Fed Can the Fed contain inflation?Can the Fed contain inflation?
Excess reservesExcess reserves VelocityVelocity
Investors’ Threat # 1Investors’ Threat # 1InflationInflation
Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the FedStarts and ends with the Fed Can the Fed contain inflation?Can the Fed contain inflation? Will it? The beguiling role of excess Will it? The beguiling role of excess
capacitycapacity
Investors’ Threat # 1Investors’ Threat # 1InflationInflation
Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the FedStarts and ends with the Fed Can the Fed contain inflation?Can the Fed contain inflation? Will it? The beguiling role of excess Will it? The beguiling role of excess
capacitycapacity Response means slowdown 6 to 9 Response means slowdown 6 to 9
mos. latermos. later
Investors’ Threat # 2Investors’ Threat # 2Washington Anti-Investor Washington Anti-Investor
ClassClass Already extended 3.8% payroll tax to Already extended 3.8% payroll tax to
capital incomecapital income
Obama proposed 20% tax on cap gains and Obama proposed 20% tax on cap gains and dividendsdividends
Obama proposed $3.5 million/45% death Obama proposed $3.5 million/45% death taxtax
Cap’N TaxCap’N Tax
Investors’ Threat # 3 Investors’ Threat # 3 Sovereign DebtSovereign Debt
It could all begin in GreeceIt could all begin in Greece
European ContagionEuropean Contagion
Tidal waves flow in, and outTidal waves flow in, and out
States join in – deficits and unfunded retiree States join in – deficits and unfunded retiree benefitsbenefits
And then there’s WashingtonAnd then there’s Washington
Budget Deficits -- Unsustainable Budget Deficits -- Unsustainable
0
2
4
6
8
10
12
Deficits Average Deficit
CBO, 3/2010
% of GDP
Federal Receipts Return to Federal Receipts Return to NormalNormal
15
16
17
18
19
20
Receipts Modern Average
CBO, 3/2010
% of GDP
Problem is Washington Problem is Washington SpendingSpending
15
17
19
21
23
25
27
Federal Spending Historical Average
Source: CBO 3/2010
Average = 20.3
% of GDP
Unsustainable Federal DebtUnsustainable Federal Debt
102030405060708090
100
Publicly Held Debt Average Debt
CBO, 3/2010
CBO, 3/2010
% of GDP
Investors’ Threat # 3Investors’ Threat # 3WashingtonWashington
Taxes, Taxes, and a more TaxesTaxes, Taxes, and a more Taxes
VATVAT
Income TaxIncome Tax
Environmental TaxesEnvironmental Taxes
A Tale of Two StrategiesA Tale of Two Strategies
Reagan – Starve the BeastReagan – Starve the Beast Obama – Glut the BeastObama – Glut the Beast
A Tale of Two StrategiesA Tale of Two Strategies
Reagan – Starve the BeastReagan – Starve the Beast Obama – Glut the BeastObama – Glut the Beast
Massive spending increasesMassive spending increases
A Tale of Two StrategiesA Tale of Two Strategies
Reagan – Starve the BeastReagan – Starve the Beast Obama – Glut the BeastObama – Glut the Beast
Massive spending increasesMassive spending increases Spending as inevitableSpending as inevitable
A Tale of Two StrategiesA Tale of Two Strategies
Reagan – Starve the BeastReagan – Starve the Beast Obama – Glut the BeastObama – Glut the Beast
Massive spending increasesMassive spending increases Spending as inevitableSpending as inevitable As act of God or natureAs act of God or nature
A Tale of Two StrategiesA Tale of Two Strategies
Reagan – Starve the BeastReagan – Starve the Beast Obama – Glut the BeastObama – Glut the Beast
Massive spending increasesMassive spending increases Spending as inevitableSpending as inevitable As act of God or natureAs act of God or nature As long-term outcomeAs long-term outcome
A Tale of Two StrategiesA Tale of Two Strategies
Reagan – Starve the BeastReagan – Starve the Beast Obama – Glut the BeastObama – Glut the Beast
Massive spending increasesMassive spending increases Spending as inevitableSpending as inevitable As act of God or natureAs act of God or nature As long-term outcomeAs long-term outcome ANYTHING BUT A CONSCIOUS ANYTHING BUT A CONSCIOUS
POLICY DECISIONPOLICY DECISION
Implication of GluttonyImplication of Gluttony
IfIf much higher spending inevitable, much higher spending inevitable, then so are higher taxesthen so are higher taxes
Corporate rate already too highCorporate rate already too high Rangel, Wyden-GreggRangel, Wyden-Gregg
Implication of GluttonyImplication of Gluttony
IfIf much higher spending inevitable, much higher spending inevitable,
Then so are higher taxesThen so are higher taxes
Corporate rate already too highCorporate rate already too high Rangel, Wyden-GreggRangel, Wyden-Gregg
Current system nearly tapped outCurrent system nearly tapped out
Historical Perspective on Historical Perspective on the Fiscthe Fisc
Average federal tax about 18.2 % of Average federal tax about 18.2 % of GDPGDP
Average deficit = sustainable deficit Average deficit = sustainable deficit about 2.2 %about 2.2 %
Average spending about 20.4 % Average spending about 20.4 %
Taxes, Or NotTaxes, Or Not
Existing system to 20 % of GDPExisting system to 20 % of GDP
With 2 % deficit and 25 % spendingWith 2 % deficit and 25 % spending
Leaves gap of 3 % of GDPLeaves gap of 3 % of GDP
Absent fundamental entitlements Absent fundamental entitlements reforms, long-run shortfalls much reforms, long-run shortfalls much higherhigher
Implication of GluttonyImplication of Gluttony
IfIf much high spending inevitable, much high spending inevitable, Then so are higher taxesThen so are higher taxes Corporate rate already too highCorporate rate already too high
Rangel, Wyden-GreggRangel, Wyden-Gregg Current system nearly tapped outCurrent system nearly tapped out Must find another revenue sourceMust find another revenue source Answer – A VATAnswer – A VAT
The VAT WaveThe VAT Wave Volcker – AValue-Added Tax (VAT) “on the Volcker – AValue-Added Tax (VAT) “on the
table”table”
Brookings – 15 to 20 percent VATBrookings – 15 to 20 percent VAT
Congressional Budget Office – Studying VATCongressional Budget Office – Studying VAT
Tax Policy Center – A VAT to replace the Tax Policy Center – A VAT to replace the payroll tax and corporate income taxpayroll tax and corporate income tax
What’s A VAT?What’s A VAT?
An operational national retail sales An operational national retail sales taxtax
Intended as an add onIntended as an add on
VAT rates typically 15 to 20%VAT rates typically 15 to 20%
EU minimum standard rate of 15%EU minimum standard rate of 15%
Glut the Beast = VATGlut the Beast = VAT
Spending means fiscal policy Spending means fiscal policy unsustainableunsustainable
Massive source of new revenues Massive source of new revenues 1 percentage point = net $50 billion 1 percentage point = net $50 billion
in tax revenuein tax revenue 15 percent VAT = $750 billion in tax 15 percent VAT = $750 billion in tax
revenuerevenue 15 percent VAT -> 5 percent of GDP15 percent VAT -> 5 percent of GDP
Why a VAT?Why a VAT?
Massive source of new revenues Massive source of new revenues
VAT is among least damaging to VAT is among least damaging to economyeconomy
VAT is nearly invisible to taxpayersVAT is nearly invisible to taxpayers
Investors’ Threat # 3Investors’ Threat # 3
Glut the Beast – the Glut the Beast – the ConclusionConclusion
Sovereign debt crisis begins in GreeceSovereign debt crisis begins in Greece
Flows across Europe to U.S.Flows across Europe to U.S.
U.S. credit market crisis triggers a panic to actU.S. credit market crisis triggers a panic to act
VAT plus other tax hikes, especially on capitalVAT plus other tax hikes, especially on capital
Or reverse Obama’s spending?Or reverse Obama’s spending?
Opportunities, TooOpportunities, Too
Global economy more balanced Global economy more balanced (India, China, Brazil, etc.) (India, China, Brazil, etc.)
Output Gap over 10 percentOutput Gap over 10 percent Basic institutions remain soundBasic institutions remain sound Entrepreneurial spirit is aliveEntrepreneurial spirit is alive The nation woke upThe nation woke up Mid-Term ElectionsMid-Term Elections
Portfolio Management Portfolio Management in a Hostile in a Hostile
EnvironmentEnvironment
Portfolio Management InstitutePortfolio Management Institute
Atlanta, GeorgiaAtlanta, Georgia
April 22, 2010April 22, 2010
Portfolio Management Portfolio Management in a Hostile in a Hostile
EnvironmentEnvironment
Portfolio Management InstitutePortfolio Management Institute
Atlanta, GeorgiaAtlanta, Georgia
April 22, 2010April 22, 2010