In intellectually preparing for a meeting with a prospective new client today, I was silently rehearsing my discussion points. I noted that clients must understand our “investment process” in order to support our efforts on their behalf. In that regard, I determined that it is best to reverse engineer the algorithm for our process and then describe it.
What makes for a good investment – stock, bond or real estate? Well, it is the free cash flow that the investment generates and the opportunity to successfully reinvest those cash flows. How do those cash flows and reinvestment opportunities arise? Part of it is through superior execution by the management of the entity, and part is the environment that they operate in.
What defines that environment? General economic conditions.
What Impacts economic conditions? A willingness to take some risk with savings and the political environment. Actually, that willingness to risk capital is also somewhat dependent upon the political environment.
Why is the political environment important? First, the political system incorporates the rules of engagement. If an investor is of the mindset that the capital that is being risked will be rewarded, and not punished, then the willingness to risk that capital is enhanced. More tangibly, the “rule of law” or, enforcement of contracts, is critically important too. Similarly, protection of intellectual property is a major concern. That leads us back to a starting point of monitoring the political and geo-political environment (since we invest internationally too).
The current political dynamic is somewhat perplexing. We note from the recent national elections that there was a shift towards the ideology of the democratic party with President Obama winning reelection and democrats gaining seats in the legislature. But, in state races, Republicans gained in numbers. What does this imply?
One reading is that national elections are seen with a focus more on social issues (gay marriage, immigration reform, women’s rights, etc.) than fiscal ones. In contrast, states seem to be the election laboratory where more influence comes from fiscal matters. As our colleague Walter Kirchberger points out, not all voters pay federal income taxes, but all state voters pay some type of tax in their state – either income, sales, property, or some combination. If this assessment is correct, then it may become increasingly evident that Bill Clinton’s tagline, “It’s the economy, stupid” will once again reassert itself and a restoration of economic growth may await the US.
We welcome all comments or questions.
Bob Bilkie, CFA