Willingdon Views

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Tuesday, 18 October 2016 15:25

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The Great Tug of War

I have very fond memories of middle school. The best of those memories involved Field Day, one of the last days of the year when the entire school gathered at the track to compete in all sorts of contests including relay races, backward runs, and softball games. The grand finale of this exciting day was the great tug of war between the classes. Tug of war is an exhausting test of strength, requiring teamwork and leadership. Beyond that, it demands commitment from each member of the team. To excel, participants must embody a will not to give up when shoulders ache and hands become blistered and painful. Proudly, when our team won, it produced a year of bragging rights, joyful memories, and invaluable life lessons.

In our country, the great tug of war between the increasing power of the state and the free enterprise system is about to intensify to a whole new level. Let me be crystal clear about one thing – We can grow the size and influence of government, or we can grow the private economy, but we cannot sustainably grow the former while growing the latter at a rate that will provide for a higher standard of living and widespread prosperity. We have to make a choice, or perhaps more accurately, if we don’t make a choice, a choice will be made for us.

Lessons from Wells Fargo... In the wake of the sales and marketing scandal at Wells Fargo, the Chairman and CEO, John Stumpf, lost his job as did thousands of employees over the past several years as the company sought to remedy the situation. Stumpf was also forced to forego about $40 million in compensation. Beyond that, the company paid a fine of $185 million. Was everything handled well at all levels during this process? Probably not, but the company was held accountable and rightly so. Meanwhile, at the Consumer Finance Protection Board, as well as at the other six or seven federal agencies responsible for overseeing banking activities, not a single person was held accountable in any way. No jobs were lost, no pay recouped, nothing. In this instance, and arguably more broadly, government isn’t being held accountable. I think this needs to change. If we don’t hold all parties accountable, how do we evaluate whether they are doing a good job?

Which brings me back to the great tug of war... If business is held accountable, and I would argue that it is, either by rules and regulations, or by the marketplace itself, while the government bureaucracy isn’t, which do you think will grow faster? It is no wonder that government is winning the current tug of war, by a wide margin.

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And the loser gets... The U.S economy continues to be the loser in this epic battle. The proverbial aching muscles, sore hands, and the angst of losing are replaced by struggling economic growth, higher taxes, massive underemployment, and ever-growing dependency by a larger segment of the population. But, if we can find a way to hold the government accountable, then perhaps this can change.

Moving forward, our economy is likely to face higher taxes and higher interest rates in 2017. Moreover, crony capitalism will reign supreme, meaning the state will play a leading role in picking winners and losers at industry and company levels. Strategists are already producing forecasts for potential winners and losers depending on the outcome of the election. These forecasts assume that the winning candidates will follow through on their campaign promises. In my view, serious investors should not be willing to make that bet.

Hope in gridlock... Should the branches of government remain divided, then the separation of powers may provide some insulation from the continued onslaught of the federal bureaucracy. Unfortunately, this is far from a certain outcome.

Given this macro-economic outlook, prudent asset allocation and a conservative bias within portfolios, makes a lot of sense to us from a risk management perspective. Meanwhile, market volatility will present opportunities to exploit, which we intend to take advantage of in a disciplined way.

Our economy and markets are resilient. The next four years will be a test of that resiliency. I remain hopeful that inspirational leaders will emerge who can unite us and lead our country in a better direction. I am convinced they are out there, waiting to be discovered. I’ll leave the last word of this newsletter to coaching legend, Vince Lombardi -

“Most important of all, to be successful in life demands that a man make a personal commitment to excellence and to victory, even though the ultimate victory can never be completely won. Yet that victory might be pursued and wooed with every fiber of our body, with every bit of our might and all our effort. And each week, there is a new encounter; each day, there is a new challenge.”

Michael Kayes, CFA

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