Submitted by Thad Beversdorf – The First Rebuttal Blog
A couple months back I wrote a fairly fiery rebuttal to comments made by BMO CIO Brian Belski. Brian was touting a 20 year bull run and claiming that the outstanding performance of the past 6 years in the markets was driven by strong consumer demand. That really hit a nerve with me. I asked Brian, in the event he read the rebuttal, to reach out to me as I wanted to understand his incredibly positive view.
And well, to his credit, Brian recently did reach out to me. His initial e-mail to me not only explained that my rebuttal was based on poor analysis but that I was using scare tactics, and by doing so I am the one hurting this nation. He also expressed that we need to believe and unite in order to improve things here in America. In my head that sounded like someone who didn’t want to discuss the issues and I replied as such. It was then that we began to walk through the issues, and again it’s to Belski’s credit for taking this head on. In his second email Brian’s team provided various in-house analyses to substantiate his view point. His third email to me is his answer to a question I posed in my response to his second email to me.
The following is Brian’s last email to me (maroon font below) and my responses to that email (in black font below) which Brian will receive via this article. I asked him to specifically help me understand BMO’s call for a capex revival which, in his team’s opinion, is to be a main driver of 14 more years of all time market highs. Additionally, I queried why there is no mention of the words ‘revenue’ or ‘sales’ even once anywhere in their economic and financial forecasts.
And so on to the discussion between Brian Belski and myself. I leave it to you, the reader, to decide for yourselves which view point you can get behind.
That being said, answers to your specific question are as follows:
Cap ex –
We believe the rebound will be driven by further consternation/weakness in EM. Think of it this way = the last 20 years has been about price/quantity (shipping as much capacity overseas and making things as cheaply as possible); while the next 10-15 years will be about time and quality
Why the change from quantity and cheap to time and quality? Weakness in emerging markets should lead to declining wages and thus costs overall in emerging markets, making it a difficult choice for CEO’s to move production back to much higher production costs in the US.
Think about it…
Example – A company is unable to receive parts from China due to supply channel issues, increasing wages, etc. Yet their customer needs the end product (that the parts are necessary for) tomorrow. To achieve the SALE (revenue event), they would rather pay 5 cents more per widget to a company in Racine, WI to be able to complete the sale of the end product.
These logistics problems have always been part of the equation yet did nothing to slow the outsourcing. Increasing Chinese wages may mean finding a new, lower cost labour pool but the move will be to new lower not higher (i.e. America) labour pools, if wage is the concern.
The fact is, the terrible drag on US capex is due to poor fiscal policy (e.g. 39% corp tax, difficulty repatriating profits), poor monetary policy (e.g. an alternative gtee’d investment), many cost disadvantages and declining incomes (thus demand) for 80% of Americans. Capex is always a function of ROI. The best NPV projects win. I find it very difficult to accept the US is the environment to produce the best NPV projects given the factors I just mentioned. I really found this part of your analysis to be particularly weak.
5 cents? – Yes, because we do not need to the quantity of goods relative to the past given our increased efficiency (less people, less cost).
The operating efficiencies in your analysis are based on operating contraction which would go in the face of your capex revival. As does your point that we do not need as much quantity (thus don’t need as much capacity meaning less capex).
This is what will drive the resurgence in revenue. In fact it is already occurring in AL, MS, LA, ND (not all about shale), SD, TX, NY, MI and even MN.
Well shale and cannibalizing revenues from other states based on tax arbitrage.
So to summarize your capex resurgence; weak emerging markets will result in surging(?) labour costs in China, which in addition to ‘new’ just in time and quality requirements will result in firms moving operations to the US where higher costs will be offset by lower output. Despite the higher costs and lower output we will see a surge in domestic capex boosting economic growth and revenue growth. Hmm.
Primary sources of revenue growth the next 5-10 years:
1) Tech – replacement cycle
Very diluted growth impact these days due to continuous maintenance.
2) Financials – see our private wealth/asset mgmt theme
This is basically a circular argument. If we have another 14 year bull then perhaps financials do well, however, if we don’t they don’t. If the bull dies so too do financials.
3) Industrials – age of equip is at all-time highs
Again this only happens if consumer demand strengthens significantly, which requires widening income distribution (I’ve shown mathematically in some of my past articles that economic growth is impossible below a certain point of income distribution). Consumer demand driven revenue is required to generate growth in capex which is the reason for the past 15 year plunge in capex expenditures. Age of equipment has been at all time highs for years. We’ve not had a large replacement cycle because most industrials are very skeptical of forward demand. Again the proof is in the pudding. If we had, in fact, been in a demand driven economy for the past 6 years not only would that record old equipment have been replaced but we would have seen capacity expansion. However, today not only is capacity declining but capacity utilisation has been on a downward trend over the past 45 years.
4) Health Care – innovation This seems very reasonable. Agreed.
AMERICA remains the number one country in terms of patents issued and in the pipeline. As US corporate cash grows, so too will innovation. China, India and other EM will continue to suffer given their growth prospects – period.
Patents are issued in the US because of the strength of contract law here. But I fail to see how that results in economic prosperity. Again fixed capital investments are decided on the best ROI parametres (location being a major factor). So while patents may be registered in the US, that has no bearing on who will benefit from the economic investment tied back to the innovation. US corporate cash held domestically is being used to financially engineer earnings, which we’ve agreed on. US corporate cash held offshore is growing and will continue to drive capex offshore from innovations protected by US law.
YES – this will take a behavioral change…
Behaviour doesn’t change.
…YES – this is early days
BUT
In investing – you have to pass the ball where the player is GOING – not where they are or have been (which academics and econometric analysis focus on).
Agreed, but a forecast as to where the player is going should be based on something more than hoping for a change in behaviour.
The Cap ex trade will only become stronger over the next few years as our country attains new leadership that will help accentuate the move toward:
a) Energy independence
Energy sector will remain contracted in the US for at least the next couple years.
b) Corporate tax reform
This is very important I absolutely agree but the point is about whether it will happen. We have a serious deficit epidemic and a suffering working class making it very difficult politically to back lower corp tax rates.
c) Retraining of the work force – less workers, better wages, more efficiency
Efficiency through less workers is positive for short term micro level profits but not long term micro or short/long term macro level prosperity.
d) Cash repatriation
Again I agree this is important but will it happen?? Unlikely but possible.
Despite the naysayers, North America is positioned for the next great 100 years – we just need to work together to make it happen.
I agree we could be but we have no chance for prosperity if the policies in place now i.e. foreign, domestic, fiscal and monetary continue to drive our nation. The fact is the nation is in decline because of our policies. That is not a scare tactic but stark reality backed with very hard empirical data. It is simply the truth, which may be scary. Simply suggesting we need to work together doesn’t make the ideal so.
Earnings – yes I would agree that EPS have been propped up by buybacks but growth has not been entirely driven by this. The BEA corporate profit data confirms this as it is (I think) a net income and not per share measure. Agree earnings have been all about engineering and contraction. Neither of which are positive on a macro scale.
And by the way – revenue growth has been INCREASING and is expected to continue. (see aforementioned comment on sectors)
Actually S&P real revenues remain materially below where they were pre ’08 crash 6 years ago. They are flat to negative when adjusting for outstanding shares decline. Not to mention if you adjusted for population growth and unsustainable consumer debt. Again demand driven revenue growth leads to capex which leads to economic growth.
Economy – GDP growth has been improving to more normal levels and we’ve added a huge amount of jobs over the past 2 years. Confidence is an uptrend, business conditions remain in highly expansive territory and despite all the warnings and doom and gloom, housing has hung in there. The only point that can be made is wage growth remains to low but even that appears to be changing.
GDP growth is no longer a measure of economic prosperity. Including debt consumption in our measure of prosperity makes absolutely no sense, which is why we don’t do it on the individual level. I don’t say I made $250K this year if $200K of that was new debt. Yet that’s exactly what we do in GDP. How does GDP grow while real incomes decline?? Government spending and debt. How do real incomes decline if the job market is so strong?? The answer is in the U6 figure. Not sustainable growth factors. Remember GDP growth is not meaningful in and of itself.
And housing is simply a red herring these days. The old ‘wealth effect’ that we look to stir up consumption is dead due to the stupidity of government policy enacted by the Clinton Administration. It may well be 100 years before a real estate wealth effect plays materially into consumption again. You can see this empirically looking at Jumbo mortgages being offered at lower rates than standard mortgages. If you understand why that can happen you will understand why the ‘wealth effect’ is dead.
There’s some “facts” not based on ideology.
But you have not provided any facts. This perhaps is the problem. Do we actually no longer understand what empirical data means? You provided a good amount of conjecture but almost nothing still in the way of facts. I don’t want to sound harsh but if I were grading this as a paper you would not have passed with the answers you provided. I know you will point to your bio to prove that you are skilled, and it is an impressive bio Brian, but it does not seem to have been by way of your understanding of fundamentals, at least as presented above.
And again I fully expect one no longer requires, and in fact does better not to understand fundamentals to perform well in equities. The market is completely dislocated from all fundamentals. That is a fact. The point I was looking to make through this exercise is that you cannot spin or falsify economic prosperity the way you spin financial markets. While I very much appreciate your attempt to tie market all time highs and a 20 year bull run to economic fundamentals, attempting to do so looks a bit foolish regardless of one’s bio.
I have a fiduciary responsibility to my clients from a research and portfolio management perspective (we manage real live $$$ for the BMO private client channel and global asset management arm).
I understand what you do and it is the reason I expect it matters not, to you and likely your investors, why the market goes up so long as it does,. That, I feel is ok if you are being honest about it or at the very least humble about it. However, touting a call for a 20 year bull market on CNBC based on anything other than the Fed, and certainly on a very weak argument for a capex revival, I feel is recklessly disingenuous.
As such, we base our existence on analysis and experience – a backdrop that has served us and our clients well over the past 25 years.
What about the bad years?
Just google search our name when we were at Merrill – especially during the downturn in 2008-2009 – enough said.
Again anyone not calling for rough times ahead by 2008 was simply drunk. However, if you were calling for it in early 2007 before the market peaked I would absolutely give you credit along with folks like Peter Schiff, Bill Fleckenstein, Ron Paul, John Paulsen and others.
Fear-based analysis does nothing but cause chaos and turmoil – thus is not constructive and not useful to anyone.
Brian, I believe people have a right to understand the truth behind the storyline. Things like the capex revival would be great but the facts go completely against such a revival taking place over the next year or two. The most alarming issue I found in your team’s analysis is that you completely exclude the working class consumer as a significant parameter. The one and only thing that all businesses must have is revenue and essentially all revenue (outside of healthcare and defense) is driven by the individual consumer.
I have to believe you understand, as anyone with a bit of business acumen does, that generally, CEO’s are not looking at America (or any major western economies) as a prime environment for operational expansion with the exception of perhaps the healthcare and defense sectors being those are driven by government spending. Most other sectors rely too heavily on the declining real median household incomes and climaxing consumer debt levels for the bulk of their revenues.
Note debt consumption is a net negative on GDP not a growth factor, that is simple mathematics. All that consumption we’ve enjoyed on debt must be subtracted plus the real rate of interest from future GDP. I’m not sure how a CEO could responsibly ignore that fact. I don’t mean that to be scary but I can understand how one might confuse such facts with scare tactics.
Let’s agree to disagree…but let’s agree that our country and party needs to unite to ensure victory and end the weakness in DC.
I expect we will have to agree to disagree. I’m sorry Brian I really wanted to walk away from this feeling much better about things. And while I am no longer certain that you are intentionally or maliciously perpetuating poor policies, I am more certain now that your forecast is based on very weak arguments. That said, I’m skeptical that you honestly buy in to those arguments but rather simply must stand behind them.
Remember we are not debating whether the market is going up or down but based on what. I expect that is the real conflict we face. In my mind you are a sharp enough man to know that markets are at all time highs only because of direct central banking intervention. I know given your role it is very difficult to lead the call for a market collapse despite jumping on board when a collapse becomes imminent. Nor is it easy for one in your role to disclose to a national audience that markets are where they are due only to the Fed and financial engineering.
I sense you know the arguments you provide are weak. That is why I held you to account and pressed for you to substantiate your message delivered on CNBC. The truth is hard to overcome when directly confronted. If you had come out on CNBC and suggested another 14 years of a bull market because the Fed wants it to be, well Brian, we would have never met. And I am grateful for your inclination to work through this matter. BMO and your team should be impressed with your tenacity, sincerely.
I hope you can appreciate (even if we must agree to disagree on the fundamentals) that there is a group of concerned citizens, well versed in these matters, that is working to unite this country around truth and remind ourselves it is we the people that are the power and wealth of this nation. And that we the people also have the obligation to defend this nation against a political class that our founding fathers assured us would eventually enslave us. The defense of our nation begins with an awakening to the truth in all things touched by the political class. Truth is a function of respect and it is time that we earn back the respect of those that control the ‘truth’.
Thank you Brian, sincerely, and all the best in 2015.
Thad.
StealthFlation 