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1Q19 Investment Outlook - Tax Reform Worked

By: Dennis S. Fulmer
Tuesday, May 7, 2019

The results are in and the dramatic reduction in the corporate income tax has increased investment as expected, at least as expected by its supporters. The recently released GDP numbers for 2018 showed 7.0% growth in Gross Private Domestic Nonresidential Investment. This is on top of 5.3% growth in 2017 and only a 0.5% increase in 2016.  This came as a welcomed confirmation in our belief that businesses would respond to a more favorable tax climate.  Economic laws of human behavior are almost as predictable as scientific laws, such as Newton’s laws of motion.  Humans respond to incentives.  Also noteworthy is that tax revenues have been running close to last year’s revenues, and the latest month’s exceeded last years. In conclusion, the increase in the deficits are primarily due to increased government spending, and not due to the tax cuts.

Who holds the Government accountable?  

Frequently, we read of seemingly endless investigations of big business by various government agencies, but seldom do we see similar efforts holding government programs accountable.   When Grant’s Interest Rate Observer published a mock prospectus for an offering of United States Treasury Debt, we read it with interest.  A prospectus is a document a bond or stock issuer files with the SEC to disclose financial information and list risk factors for potential investors to read before buying the securities.  The Federal government is exempt from filing such documents, but this effort was a disturbingly thorough effort to summarize the financial picture of our country. 

Grants pointed out that 24 federal agencies had what were considered to be “material weaknesses” in their financial statements, which prevented them from issuing audited financial statements for 2016 and 2017.  These 24 agencies control 38% of our government’s assets. Grants went on to estimate $141 billion in fraudulent payments in 2017.    The General Accounting Office was unable to express an opinion on the government’s financial statements. 

The section titled “Ratings agencies may downgrade the Government’s securities” offered further clarity by reviewing the 2011 downgrade by Standard & Poor’s, which was met with criticism from several politicians. The CEO of S&P resigned just a few weeks later.  It was concluded that such coercion “might cause investors to lose confidence in credit ratings, and in the government’s creditworthiness….”  No kidding!   Perhaps our Chinese friends are more objective, as their leading credit agency downgraded our government to BBB+ from A- in January of 2018.  They concisely summed up our Government’s situation as “increased reliance on the debt-driven mode of economic development will continue to erode the solvency of the United States.” 

We are not anti-government, but are pragmatists who want policies that work and are cost effective.  Since we are in the finance industry, the lack of accurate financial statements is maddening, considering the way the government scrutinizes banks and other industries.  The question for investors now is how long can the major “Western Democracies” keep selling debt to the public?  Not an easy question to answer, but some countries, i.e. Italy and Greece, can no longer sell debt unless someone else (the Germans) guarantees it.  As investors, we agree with Jim Grant, that bonds are not offering enough yield to lock in for more than a few years.   

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