More on the Capital Cycle

 More on the Capital Cycle

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Competition Neglect

Overinvestment is not a solitary activity; it comes about because several players in an industry have been increasing capacity at the same time. When market participants respond to perceived increases in demand by increasing capacity in an industry, they fail to consider the impact of increasing supply on future returns. “Competition neglect,” according to Harvard Business School professors Robin Greenwood and Samuel Hanson, is “particularly strong when firms receive delayed feedback about the consequences of their own decisions.” The authors of a paper in the American Economic Review sought to explain why so many new entrants into business frequently fail. They found that managers so overestimate their own skills they neglect competitive threats.

This failure to pay attention to the outward shift in the supply curve can be linked to another common behavioural trait, known as “base-rate neglect.” Namely, the tendency of people not to take into account all available information when making a decision. With regards to the workings of the capital cycle, investors focus on current (and projected) future profitability but ignore changes in the industry’s asset base from which returns are generated. At times, this tendency morphs into what psychologists call “cognitive dissonance” – a wilful refusal to consider disconfirming evidence once a course of action has been decided upon.

Skewed Incentives

Skewed incentives exacerbate these well-known behavioural weaknesses. CEO compensation is often linked to short-term performance measures, such as annual changes in earnings-per-share or shareholder returns. Stock prices often react positively to announcements of major capital spending. Companies which invest more often attract premium valuations. The stocks of high asset growth companies often exhibit positive momentum. Executive pay is also frequently linked to a company’s size, as measured by revenue or market capitalization. The incentives are thus skewed for managers to favour growth and to downplay any adverse long-term consequences. There is some evidence that managers with a large ownership stake are more likely to shrink capital employed – through buybacks – if they see few profitable alternatives.

Investors whose compensation is linked to short-term performance are also inclined to myopia. Investment bankers who drive the capital cycle – raising money to finance investment with debt and equity issuance and launching IPOs – are compensated according to their fee generation rather than the outcome their capital-raising activities may have for clients and shareholders. Investment bank analysts serve as cheerleaders; their pay is linked to brokerage commissions, generated by stock turnover. They too have little interest in long-term outcomes.

Fundamentals of Capital Cycle Analysis

Marathon’s approach is to look for investment opportunities among both value and growth stocks, as conventionally defined. They come about because the market frequently mistakes the pace at which profitability reverts to the mean. For a “value” stock, the bet is that profits will rebound more quickly than is expected and for a “growth stock,” that profits will remain elevated for longer than market expectations.

Focus on Supple rather than Demand

Given that the future is uncertain, why should Marathon’s approach fare any better? The answer is that most investors spend the bulk of their time trying to forecast future demand for the companies they follow. The aviation analyst will try to answer the question: How many long-haul flights will be taken globally in 2020? A global autos strategist will attempt to forecast China’s demand for passenger cars 15 years hence. No one knows the answers to these questions. Long-range demand projections are likely to result in large forecasting errors.

Capital cycle analysis, however, focuses on supply rather than demand. Supply prospects are far less uncertain than demand, and thus easier to forecast. In fact, increases in an industry’s aggregate supply are often well flagged and come with varying lags – depending on the industry in question – after changes in the industry’s aggregate capital spending. In certain industries, such as aircraft manufacturing and shipbuilding, the supply pipelines are well-known. Because most investors (and corporate managers) spend more of their time thinking about demand conditions in an industry than changing supply, stock prices often fail to anticipate negative supply shocks.

Analyze Competitive Conditions within an Industry

From the investment perspective, the key point is that returns are driven by changes on the supply side. A firm’s profitability comes under threat when the competitive conditions are deteriorating. The negative phase of the capital cycle is characterized by industry fragmentation and increasing supply. The aim of capital cycle analysis is to spot these developments in advance of the market. New entrants noisily trumpet their arrival in an industry. A rash of IPOs concentrated in a hot sector is a red flag; secondary share issuances another, as are increases in debt. Conversely, a focus on competitive conditions should alert investors to opportunities where supply conditions are benign and companies are able to maintain profitability for longer than the market expects. An understanding of competitive conditions and supply side dynamics also helps investors avoid value traps (such as US housing stocks in 2005–06).

Selecting the right Corporate Managers

Marathon is fond of repeating two comments of Warren Buffett. The first being to the effect that most chief executives have risen to the top of their companies because they “have excelled in an area such as marketing, production, engineering – or sometimes, institutional politics.” Yet they may not have the capital allocation skills required of managers. Such skills are essential, according to the Sage of Omaha, since, “after ten years on the job, a CEO whose company retains earnings equal to 10 per cent of net worth will have been responsible for the deployment of more than 60 per cent of all capital at work in the business.” Capital cycle analysis involves keeping a sharp eye on managers to assess their ability to allocate capital. Marathon spends a lot of time meeting and questioning managers to this effect.

Adopt a Long-Term Approach

Capital cycle analysis, like value investing, requires patience. It takes a long time for an industry’s capital cycle to play out. The Nasdaq started bubbling in 1995. Yet it wasn’t until the spring of 2000 that the dotcom bubble finally burst. New supply comes with varying lags in different industries. As we have seen, it can take nearly a decade for a new mine to start producing. Marathon warned of the dangers of rising mining investment back in May 2006 (see 1.3 “This time’s no different” – yet after rebounding in the wake of the financial crisis, the commodity super-cycle didn’t turn down for another five years. Marathon’s long-term investment discipline, with its very low portfolio turnover, is well suited to applying the capital cycle approach.

Capital Cycle Breakdowns

Capital cycle analysis requires patience, a certain doggedness (willingness to be wrong for a long period) and a contrarian mindset. Once the cycle has turned and overcapacity in an industry has been exposed, the progression of events appears inevitable. That’s hindsight bias. At the time, the outcome never seems so certain. Besides, on occasion the normal operation of the capital cycle breaks down. Over the last two decades, the Internet has destroyed many long-established business models – in advertising (Yellow Pages), media (newspapers), retailing (bookshops), and entertainment (music industry and video rental). Investors who underestimated the disruptive impact of new technology have lost money.35 The capital cycle also ceases to function properly when policymakers protect industries (see 5.4 “Broken banks” and 5.5 “Twilight zone”) and under conditions of state capitalism, as found in modern China (see Chapter 6, “China Syndrome”).

The Tenets of Capital Cycle Analysis

The essence of capital cycle analysis can thus be reduced to the following key tenets:

• Most investors devote more time to thinking about demand than supply. Yet demand is more difficult to forecast than supply.

• Changes in supply drive industry profitability. Stock prices often fail to anticipate shifts in the supply side.

• The value/growth dichotomy is false. Companies in industries with a supportive supply side can justify high valuations.

• Management’s capital allocation skills are paramount, and meetings with management often provide valuable insights.

• Investment bankers drive the capital cycle, largely to the detriment of investors.

• When policymakers interfere with the capital cycle, the market-clearing process may be arrested. New technologies can also disrupt the normal operation of the capital cycle.

• Generalists are better able to adopt the “outside view” necessary for capital cycle analysis.

• Long-term investors are better suited to applying the capital cycle approach.

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Edward Chancellor,

Excerpt from the Introduction of Capital Returns

Introduction to the Capital Cycle

Introduction to the Capital Cycle

Excerpt from the Introduction of Capital Returns

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This book contains a collection of reports written by investment professionals at Marathon Asset Management. What makes these reports stand out, in my opinion, is an analytical focus on the ebb and flow of capital. Typically, capital is attracted into high-return businesses and leaves when returns fall below the cost of capital. This process is not static, but cyclical – there is constant flux. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down returns. Conversely, when returns are low, capital exits and capacity is reduced; over time, then, profitability recovers. From the perspective of the wider economy, this cycle resembles Schumpeter’s process of “creative destruction” – as the function of the bust, which follows the boom, is to clear away the misallocation of capital that has occurred during the upswing.

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The key to the “capital cycle” approach – the term Marathon uses to describe its investment analysis – is to understand how changes in the amount of capital employed within an industry are likely to impact upon future returns. Or put another way, capital cycle analysis looks at how the competitive position of a company is affected by changes in the industry’s supply side. In his book, Competitive Advantage, Professor Michael Porter of the Harvard Business School writes that the “essence of formulating competitive strategy is relating a company to its environment.”1 Porter famously described the “five forces” which impact on a firm’s competitive advantage: the bargaining power of suppliers and of buyers, the threat of substitution, the degree of rivalry among existing firms and the threat of new entrants. Capital cycle analysis is really about how competitive advantage changes over time, viewed from an investor’s perspective.

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A Stylized Capital Cycle

Here’s how the capital cycle works. Imagine a widget manufacturer – let’s call it Macro Industries. The firm is doing well; so well, that its returns exceed Macro’s cost of capital. The firm’s CEO, William Blewist-Hard, has recently featured on the front cover of Fortune magazine. His stock options are in the money, and his wife no longer complains about being married to a boring industrialist. Of the nine investment bank analysts who cover Macro’s stock, seven have buy recommendations and two have holds. The shares are trading at a price-earnings multiple of 14 times, below the market average. Macro’s stock is held by several well-known value investors.

Macro’s strategy department anticipates strong demand growth for its products, especially in emerging markets where widget consumption per capita is less than one-tenth the level found in the advanced economies. After discussions with the board, Macro’s CEO announces his plans to increase manufacturing capacity by 50 per cent over the next three years in order to meet growing demand. A leading investment bank, Greedspin, arranges the secondary share offering to fund the capital expenditure. Stanley Churn of Greedspin, a close friend of Macro’s Blewist-Hard, is the lead banker on the deal. The expansion is warmly received in the FT’s Lex column. Macro’s shares rise on the announcement. Growth investors have lately been buying the stock, excited by the prospect of rising earnings.

Five years later, Bloomberg reports that Macro Industries’ chief executive has resigned after longstanding disagreements over corporate strategy with a group of activist shareholders. The activists, led by hedge fund Factastic Investment, want Macro to shutter under-performing operations. Macro’s profits have collapsed, and its share price is down 46 per cent over the last twelve months. Analysts say that Macro’s problems stem from over-expansion – in particular, its $2.5bn new plant in Durham, North Carolina, was delayed and over budget. The widget market is currently in the doldrums, suffering from excess supply. Macro’s long-established competitors have also increased capacity in recent years, while a number of new low-cost producers have also entered the industry, including Dynamic Widget, whose own shares have disappointed since its IPO last year.

The market for widgets is suffering from the recent slowdown in emerging markets. China, the world’s largest consumer of widgets, has vastly expanded domestic widget production over the last decade and has lately become a net exporter. Macro is reportedly considering a merger with its largest rival. Although its stock is trading below book, analysts say there’s little near-term visibility. Of the remaining three brokerages that still cover Macro, two have sell recommendations with one hold.

The ups and downs of this fictional widget manufacturer describes a typical capital cycle. High current profitability often leads to overconfidence among managers, who confuse benign industry conditions with their own skill – a mistake encouraged by the media, which is constantly looking for corporate heroes and villains. Both investors and managers are engaged in making demand projections. Such forecasts have a wide margin of error and are prone to systematic biases. In good times, the demand forecasts tend to be too optimistic and in bad times overly pessimistic.

High profitability loosens capital discipline in an industry. When returns are high, companies are inclined to boost capital spending. Competitors are likely to follow – perhaps they are equally hubristic, or maybe they just don’t want to lose market share. Besides, CEO pay is often set in relation to a company’s earnings or market capitalization, thus incentivizing managers to grow their firm’s assets. When a company announces with great fanfare a large increase in capacity, its share price often rises. Growth investors like growth! Momentum investors like momentum!

Investment bankers lubricate the wheels of the capital cycle, helping to grow capacity during the boom and consolidate industries in the bust. Their analysts are happiest covering fast-growing sexy sectors (higher stock turnover equals more commissions.) Bankers earn fees by arranging secondary issues and IPOs, which raise money to fund capital spending. Neither the M&A banker nor the brokerage analysts have much interest in long-term outcomes. As the investment bankers’ incentives are skewed to short-term payoffs (bonuses), it’s inevitable that their time horizon should also be myopic. It’s not just a question of incentives. Both analysts and investors are given to extrapolating current trends. In a cyclical world, they think linearly.

The Macro example also shows the lag between a rise in capital spending and its impact on supply, which is characteristic of the capital cycle. The delay between investment and new production means that supply changes are lumpy (i.e., the supply curve is not smooth, as portrayed in the economics textbooks) and prone to overshooting. In fact, the market instability created by lags between changes in supply and production has long been recognized by economists (it is known as the “cobweb effect”).

The capital cycle turns down as excess capacity becomes apparent and past demand forecasts are shown to have been overly optimistic. As profits collapse, management teams are changed, capital expenditure is slashed, and the industry starts to consolidate. The reduction in investment and contraction in industry supply paves the way for a recovery of profits. For an investor who understands the capital cycle this is the moment when a beaten down stock becomes potentially interesting. However, brokerage analysts and many investors operating with short time horizons generally fail to spot the turn in the cycle but obsess instead about near-term uncertainty.

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Edward Chancellor,

Excerpt from the Introduction of Capital Returns

The Myth of Efficient Government Service

The Myth of Efficient Government Service

[This excerpt from Man, Economy, and State, with Power and Market is an explanation and elaboration of points first made in Ludwig von Mises's Bureaucracy—and provides an excellent example of how Murray Rothbard's treatise built on Mises's to employ and extend the core analytical framework. The footnotes have been shortened. The excerpt is from pages 1260–72.]

The well-known inefficiencies of government operation are not empirical accidents, resulting perhaps from the lack of a civil-service tradition. They are inherent in all government enterprise, and the excessive demand fomented by free and other underpriced services is just one of the many reasons for this condition.

Thus, free supply not only subsidizes the users at the expense of nonusing taxpayers; it also misallocates resources by failing to supply the service where it is most needed. The same is true, to a lesser extent, wherever the price is under the free-market price. On the free market, consumers can dictate the pricing and thereby assure the best allocation of productive resources to supply their wants. In a government enterprise, this cannot be done. Let us take again the case of the free service. Since there is no pricing, and therefore no exclusion of submarginal uses, there is no way that government, even if it wanted to, could allocate its services to the most important uses and to the most eager buyers. All buyers, all uses, are artificially kept on the same plane. As a result, the most important uses will be slighted, and the government is faced with insuperable allocation problems, which it cannot solve even to its own satisfaction. Thus, the government will be confronted with the problem: Should we build a road in place A or place B? There is no rational way by which it can make this decision. It cannot aid the private consumers of the road in the best way. It can decide only according to the whim of the ruling government official, i.e., only if the government official, not the public, does the "consuming." If the government wishes to do what is best for the public, it is faced with an impossible task.

Government can either deliberately subsidize by giving a service away free, or it may genuinely try to find the true market price, i.e., to "operate on a business basis." This is often the cry raised by conservatives—that government enterprise be placed on a "business footing," that deficits be ended, etc. Almost always this means raising the price. Is this a solution, however? It is often stated that a single government enterprise, operating within the sphere of a private market, buying from it, etc., can price its services and allocate its resources efficiently. This, however, is incorrect. There is a fatal flaw that permeates every conceivable scheme of government enterprise and ineluctably prevents it from rational pricing and efficient allocation of resources. Because of this flaw, government enterprise can never be operated on a "business" basis, no matter what the government's intentions.

What is this fatal flaw? It is the fact that government can obtain virtually unlimited resources by means of its coercive tax power. Private businesses must obtain their funds from investors. It is this allocation of funds by investors on the basis of time preference and foresight that rations funds and resources to the most profitable and therefore the most serviceable uses. Private firms can get funds only from consumers and investors; they can get funds, in other words, only from people who value and buy their services and from investors who are willing to risk investment of their saved funds in anticipation of profit. In short, payment and service are, once again, indissolubly linked on the market. Government, on the other hand, can get as much money as it likes. The free market provides a "mechanism" for allocating funds for future and present consumption, for directing resources to their most value-productive uses for all the people. It thereby provides a means for businessmen to allocate resources and to price services to insure such optimum use. Government, however, has no checkrein on itself, i.e., no requirement for meeting a profit-and-loss test of valued service to consumers, to enable it to obtain funds. Private enterprise can get funds only from satisfied, valuing customers and from investors guided by profits and losses. Government can get funds literally at its own whim.

With the checkrein gone, gone also is any opportunity for government to allocate resources rationally. How can it know whether to build road A or road B, whether to "invest" in a road or a school—in fact, how much to spend for all its activities? There is no rational way that it can allocate funds or even decide how much to have. When there is a shortage of teachers or schoolrooms or police or streets, the government and its supporters have only one answer: more money. The people must relinquish more of their money to the government. Why is this answer never offered on the free market? The reason is that money must be withdrawn from some other use in consumption or investment—and this withdrawal must be justified. This justification is provided by the test of profit and loss: the indication that the most urgent wants of the consumers are being satisfied. If an enterprise or product is earning high profits for its owners, and these profits are expected to continue, more money will be forthcoming; if not, and losses are being incurred, money will flow out of the industry. The profit-and-loss test serves as the critical guide for directing the flow of productive resources. No such guide exists for the government, which has no rational way to decide how much money to spend, either in total, or in each specific line. The more money it spends, the more service it can supply—but where to stop?1

Proponents of government enterprise may retort that the government could simply tell its bureau to act as if it were a profit-making enterprise and to establish itself in the same way as a private business. There are two flaws in this theory. First, it is impossible to play enterprise. Enterprise means risking one's own money in investment. Bureaucratic managers and politicians have no real incentive to develop entrepreneurial skill, to really adjust to consumer demands. They do not risk loss of their money in the enterprise. Secondly, aside from the question of incentives, even the most eager managers could not function as a business. Regardless of the treatment accorded the operation after it is established, the initial launching of the firm is made with government money, and therefore by coercive levy. An arbitrary element has been "built into" the very vitals of the enterprise. Further, any future expenditures may be made out of tax funds, and therefore the decisions of the managers will be subject to the same flaw. The ease of obtaining money will inherently distort the operations of the government enterprise. Moreover, suppose the government "invests" in an enterprise, E. Either the free market, left alone, would also have invested the same amount in the selfsame enterprise, or it would not. If it would have, then the economy suffers at least from the "take" going to the intermediary bureaucracy. If not, and this is almost certain, then it follows immediately that the expenditure on E is a distortion of private utility on the market—that some other expenditure would have greater monetary returns. It follows once again that a government enterprise cannot duplicate the conditions of private business.

In addition, the establishment of government enterprise creates an inherent competitive advantage over private firms, for at least part of its capital was gained by coercion rather than service. It is clear that government, with its subsidization, if it wishes can drive private business out of the field. Private investment in the same industry will be greatly restricted, since future investors will anticipate losses at the hands of the privileged governmental competitors. Moreover, since all services compete for the consumer's dollar, all private firms and all private investment will to some degree be affected and hampered. And when a government enterprise opens, it generates fears in other industries that they will be next, and that they will be either confiscated or forced to compete with government-subsidized enterprises. This fear tends to repress productive investment further and thus lower the general standard of living still more.

The clinching argument, and one that is used quite correctly by opponents of government ownership, is: If business operation is so desirable, why take such a tortuous route? Why not scrap government ownership and turn the operation over to private enterprise? Why go to such lengths to try to imitate the apparent ideal (private ownership) when the ideal may be pursued directly? The plea for business principles in government, therefore, makes little sense, even if it could be successful.

The inefficiencies of government operation are compounded by several other factors. As we have seen, a government enterprise competing in an industry can usually drive out private owners, since the government can subsidize itself in many ways and supply itself with unlimited funds when desired. Thus, it has little incentive to be efficient. In cases where it cannot compete even under these conditions, it can arrogate to itself a compulsory monopoly, driving out competitors by force. This was done in the United States in the case of the post office.When the government thus grants itself a monopoly, it may go to the other extreme from free service: it may charge a monopoly price. Charging a monopoly price—identifiably different from a free-market price—distorts resources again and creates an artificial scarcity of the particular good. It also permits an enormously lowered quality of service. A governmental monopoly need not worry that customers may go elsewhere or that inefficiency may mean its demise.

A further reason for governmental inefficiency has been touched on already: that the personnel have no incentive to be efficient. In fact, the skills they will develop will not be the economic skills of production, but political skills—how to fawn on political superiors, how demagogically to attract the electorate, how to wield force most effectively. These skills are very different from the productive ones, and therefore different people will rise to the top in the government from those who succeed in the market.

It is particularly absurd to call for "business principles" where a government enterprise functions as a monopoly. Periodically, there are demands that the post office be put on a "business basis" and end its deficit, which must be paid by the taxpayers. But ending the deficit of an inherently and necessarily inefficient government operation does not mean going on a business basis. In order to do so, the price must be raised high enough to achieve a monopoly price and thus cover the costs of the government's inefficiencies. A monopoly price will levy an excessive burden on the users of the postal service, especially since the monopoly is compulsory. On the other hand, we have seen that even monopolists must abide by the consumers' demand schedule. If this demand schedule is elastic enough, it may well happen that a monopoly price will reduce revenue so much or cut down so much on its increase that a higher price will increase deficits rather than decrease them. An outstanding example has been the New York subway system in recent years, which has been raising its fares in a vain attempt to end its deficit, only to see passenger volume fall so drastically that the deficit increased even further after a time.

Many "criteria" have been offered by writers as guides for the pricing of government services. One criterion supports pricing according to "marginal cost." However, this is hardly a criterion at all and rests on classical economic fallacies of price determination by costs. For one thing, "marginal" varies according to the period of time surveyed. Furthermore, costs are not static, but flexible; they change according to selling prices and hence cannot be used as a guide to those prices. Moreover, prices equal average costs—or rather, average costs equal prices—only in final equilibrium, and equilibrium cannot be regarded as an ideal for the real world. The market only tends toward this goal. Finally, costs of government operation will be higher than for a similar operation on the free market.

Government enterprise will not only hamper and repress private investment and entrepreneurship in the same industry and in industries throughout the economy; it will also disrupt the entire labor market. For (a) the government will decrease production and living standards in the society by siphoning off potentially productive labor to the bureaucracy; (b) in using confiscated funds, the government will be able to pay more than the market rate for labor, and hence set up a clamor by government job seekers for an expansion of the unproductive bureaucratic machine; and (c) through high, tax-supported wages the government may well mislead workers and unions into believing that this reflects the market wage in private industry, thereby causing unwanted unemployment.

Moreover, government enterprise, basing itself on coercion over the consumer, can hardly fail to substitute its own values for those of its customers. Hence, artificially standardized services of poorer quality—fashioned to governmental taste and convenience—will hold sway, in contrast to those of the free market, where diversified services of high quality are supplied to fit the varied tastes of a multitude of individuals.

One cartel or one firm could not own all the means of production in the economy, because it could not calculate prices and allocate factors in a rational manner. This is the reason why State socialism could not plan or allocate rationally either. In fact, even two or more stages could not be completely integrated vertically on the market, for total integration would eliminate a whole segment of the market and establish an island of calculational and allocational chaos, an island that would preclude optimal planning for profits and maximum satisfaction for the consumers.

In the case of simple government ownership, still another extension of this thesis unfolds. For each governmental firm introduces its own island of chaos into the economy; there is no need to wait for socialism for chaos to begin its work. No government enterprise can ever determine prices or costs or allocate factors or funds in a rational, welfare-maximizing manner. No government enterprise can be established on a "business basis" even if the desire were present. Thus, any government operation injects a point of chaos into the economy; and since all markets are interconnected in the economy, every governmental activity disrupts and distorts pricing, the allocation of factors, consumption/ investment ratios, etc. Every government enterprise not only lowers the social utilities of the consumers by forcing the allocation of funds to ends other than those desired by the public; it also lowers the utility of everyone (including, perhaps, the utilities of government officials) by distorting the market and spreading calculational chaos. The greater the extent of government ownership, of course, the more pronounced will this impact become.

Aside from its purely economic consequences, government ownership has another kind of impact on society: it necessarily substitutes conflict for the harmony of the free market. Since government service means service by one set of decision-makers, it comes to mean uniform service. The desires of all those forced, directly or indirectly, to pay for the government service cannot be satisfied. Only some forms of the service can or will be produced by the government agency. As a result, government enterprise creates enormous caste conflicts among the citizens, each of whom has a different idea on the best form of service.

In recent years, government schools in America have furnished a striking example of such conflicts. Some parents prefer racially segregated schools; others prefer integrated education. Some parents want their children taught socialism; others want antisocialist teaching in the schools. There is no way that government can resolve these conflicts. It can only impose the will of the majority (or a bureaucratic "interpretation" of it) by coercion and leave an often large minority dissatisfied and unhappy. Whichever type of school is chosen, some groups of parents will suffer. On the other hand, there is no such conflict on the free market, which provides any type of service demanded. On the market, those who want segregated or integrated, socialist or individualist schools can have their wants satisfied. It is obvious, therefore, that governmental, as opposed to private, provision of services, lowers the standard of living of much of the population.

The degrees of government ownership in the economy vary from one country to another, but in all countries the State has made sure that it owns the vital nerve centers, the command posts of the society. It has acquired compulsory monopoly ownership over these command posts, and it has always tried to convince the populace that private ownership and enterprise in these fields is simply and a priori impossible. We have seen, on the contrary, that every service can be supplied on the free market.

The vital command posts invariably owned monopolistically by the State are: (1) police and military protection; (2) judicial protection; (3) monopoly of the mint (and monopoly of defining money); (4) rivers and coastal seas; (5) urban streets and highways, and land generally (unused land, in addition to the power of eminent domain); and (6) the post office. The defense function is the one reserved most jealously by the State. It is vital to the State's existence, for on its monopoly of force depends its ability to exact taxes from the citizens. If citizens were permitted privately owned courts and armies, then they would possess the means to defend themselves against invasive acts by the government as well as by private individuals. Control of the basic land resources—particularly transportation—is, of course, an excellent method of ensuring overall control. The post office has always been a very convenient tool for the inspection and prohibition of messages by heretics or enemies of the State. In recent years, the State has constantly sought to expand these outposts. Monopoly of the mint and of the definition of money (legal tender laws) has been used to achieve full control of the nation's monetary system. This was one of the State's most difficult tasks, since for centuries paper money was thoroughly distrusted by the people. Monopoly over the mint and the definition of monetary standards has led to the debasement of the coinage, a shift of monetary names from units of weight to meaningless terms, and the replacement of gold and silver by bank or government paper. At present, the State in nearly every country has achieved its major monetary goal: the ability to expand its revenue by inflating the currency at will. In the other areas—land and natural resources, transportation and communication—the State is more and more in control. Finally, another critical command post held, though not wholly monopolized by the State, is education. For government schooling permits influencing the youthful mind to accept the virtues of the government and of government intervention. In many countries, the government does not have a compulsory monopoly of schooling, but it approaches this ideal by compelling attendance of all children at either a government school or a private school approved or accredited by government. Compulsory attendance herds into the schools those who do not desire schooling and thus drives too many children into education. Too few youngsters remain in such competing fields as leisure, home study, and business employment.

One very curious governmental activity has grown enormously in the present century. Its great popularity is a notable indication of widespread popular ignorance of praxeological law. We are referring to what is called "social security" legislation. This system confiscates the income of the poorer wage earners and then presumes to invest the money more wisely than they could themselves, later paying out the money to them or their beneficiaries in their old age. Considered as "social insurance," this is a typical example of government enterprise: there is no relation between premiums and benefits, both changing yearly under the impact of political pressures. On the free market, anyone who wishes to invest in an insurance annuity or in stocks or real estate may do so. Compelling everyone to transfer his funds to the government forces him to lose utility.

Thus, even on its face, it is difficult to understand the great popularity of the social security system. But the true nature of the operation differs greatly from its official image. For the government does not invest the funds it takes in taxes; it simply spends them, giving itself bonds, which must be later cashed when the benefits fall due. How will the cash then be obtained? Only from further taxes or inflation. Thus, the public must pay twice for "social security." The social security program taxes twice for one payment; it is a device to permit palatable taxation of the lower-income groups by the government. And, as is true of all taxes, the proceeds go into governmental consumption.

In weighing the question of private or governmental ownership of any enterprise, then, one should keep in mind the following conclusions of our analysis:

1. every service can be supplied privately on the market;

2. private ownership will be more efficient in providing better quality of service at lower cost;

3. allocation of resources in a private enterprise will better satisfy consumer demands, while government enterprise will distort allocations and introduce islands of calculational chaos;

4. government ownership will repress private activity in noncompeting as well as competing firms;

5. private ownership insures the harmonious and co-operative satisfaction of desires, while government ownership creates caste conflict.

• 1. Cf. Ludwig von Mises, Bureaucracy (New Haven: Yale University Press, 1944), pp. 50–53.
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• Murray N. Rothbard, Feb 3, 2022
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• Murray N. Rothbard made major contributions to economics, history, political philosophy, and legal theory. He combined Austrian economics with a fervent commitment to individual liberty.
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• Source
• 
  
• https://mises.org/library/myth-efficient-government-service

The Canadian Revolution

The Canadian Revolution

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As a salute to the Truck Drivers now protesting in Ottawa...I offer an oldie but a goodie...from Keith Richard who runs the ValueTrend investing blog...If you like Justin Trudeau and I don't, please be forewarned and don't read on...This one is for you guys and thank you for delivering the food on our shelves over the past two years...I know its been a trying time for you...

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Todays’ blog is my yearly off-topic rant. I’d like to present a revolutionary idea for a new type of tax system in Canada. A few points to start:

• It’s political.
• Its my opinion, not necessarily that of my staff.
• I won’t take the time to argue my points in the comments section of this blog. Write your own blog if you feel differently.
• As someone once said: “Just because you are offended, doesn’t mean its wrong!”.
• Trolls – don’t bother. I won’t post your comments.
• The financial figures noted were obtained from sources that I believe to be reliable however, I cannot guarantee they are accurate or complete.
• I’ve provided links within the text for greater detail on many of my points

That said….Sit back and enjoy the ride as I first cover WHY we should examine changing our tax system, and then HOW I propose to change it. A little tongue in cheek may apply as we examine the “HOW” part of this strategy. Enjoy!

PART 1: THE PROBLEM

What’s wrong with this picture?

Canada sports the second highest income taxes in the world. Bad enough, that…But then there’s the 13% HST on top of our after-tax dollars! There’s property taxes (vs. tax deductible in the USA!), investment taxes (gains, dividends, interest), drivers licenses, and plate stickers. There’s custom/import taxes, luxury taxes, parking fees (for roads our taxes supposedly already pay for), land transfer taxes (shockingly high), and other excise taxes.  Lets not forget our lovely carbon taxes (now scheduled to rise again!) on top of existing gasoline taxes. How about probate fees, and estate taxes. These, after a lifetime of paying all those other taxes. Incredible, really.

Is it only “the rich” who are paying these tax levels? Not according to Pierre Poilievre: “Right now, low-income people face marginal effective tax rates of up to 80 per cent when you count both the clawbacks and taxes.”

The taxes noted above vastly exceed income taxes, and most of them affect lower/ middle class income earners.

Despite the incredibly high and pervasive taxes in Canada, don’t you dare criticize high tax levels in the presence of some people. You’ll get this response:

“Don’t you like your streets, hospitals, police, sewers, schools, etc.?”

My answer: Yes, I agree that paying taxes for universal access to Medicare, roads, education etc. is desirable.

My beef is not about paying taxes:  I would prefer that our tax dollars  actually be used for schools, hospitals, streets, etc.

“Improving the condition of only one group has to come at the expense of another group” Lester Thurow

Tax dollars were meant to pay for these things?

All animals are equal, but some animals are more equal than others

This proclamation was made by the pigs who control the government in the novel Animal Farm , by George Orwell . The sentence is a comment on the hypocrisy of socialist governments who propagate equality of their citizens but in reality, give power and privileges to a small elite.

Take the $8.6MM cottage upgrades to allow Trudeau greater comfort while he hid from parliamentary enquiry over COVID spending and the WE scandal.  His bedroom conversion alone was $378,711. You and paid for a bedroom reno that cost as much as some peoples entire houses! We paid for a helipad at that cottage because he prefers to be helicoptered to that cottage rather than drive. He also built at our expense a tree house with a zip line, a $9,000 bee farm complete with bee farmers, a $6,000 organic garden, then spent $13,500 to protect the garden. He bought several canoes and boats, and $2,000 to improve the ice on his private skating rink.

How about the latest in a growing list of scandals, like the WE charity contributions by taxpayers that ended up back in his family pockets? Lets not forget about his first two costly ethics scandal’s.  Not to mention his narrow escaping another charge via the Norman fiasco. Then there’s the raise he attempted to give himself and MP’s (then shamed into not accepting it) right at the time of COVIDs breakout – when jobs were being lost, and businesses were closing across the nation.

How about the endless vacations, and the chef’s and costume makers he travels with. How about the 2 nanny’s he tried sneaking past the taxpayer, or the money to Aga Khan’s charity followed by the return gift of a personal vacation? On and on….

Double standard

Trudeau calls business people tax cheats if they write off ineligible items – like a personal expense as a business expense. Well, what does he call spending our tax dollars on his personal pleasures?

 Deja vu’ 1981!

Justin learned from the best – his father!

“Don’t you like your streets, hospitals, sewers, schools, etc?”

Forget improving Medicare wait times or improving infrastructure that would benefit Canadians. Instead, Trudeau directed $761MM sent to other countries to enhance their education and family planning. Or how about the $2.6B (that’s with a B!!) sent to the Commonwealth climate change program, the $300MM Rohingya refugee program, the $125MM Caribbean reconstruction program, the $650MM sexual health program in Haiti, the $50MM to Palestine flood relief, the $840MM to Syria, the $4.6B on his botched pipeline negotiations, the $750MM given to to India.

Just this week, the Liberals announced yet another $485MM being given to the WHO for foreign aid outside of our own country. Meanwhile, countless small businesses across the nation close their doors. I’m (almost) speechless!!!!

How about the $600MM gifted to the media who’s union vowed to destroy the Liberal’s competition? Not to mention the continued yearly $1BB donation to the state-media organization, the CBC. Or the private gifts of our tax dollars of $200MM to Loblaws (associated with Weston), or the $370MM to Bombardier “to save jobs”. Bombardier promptly laid thousands of workers off after that little bonus, courtesy of you and I. Not surprising – both Weston and Bombardier, along with SNC (the subject of Trudeaus second Ethics charge) have disproportionately contributed to the Liberal party. A coincidence, of course.

All of this, yet when asked about helping our Canadian war veterans – the claim is that the government cannot afford to help???

Gambling pays

There’s no new money for medical system improvement (longest wait periods in the developed world, becoming longer). But we have the money for select private corporations. Recently, the Fed gave $200MM to Gateway Casino.

Elections B.C. political contribution disclosures show that Gateway Casinos & Entertainment donated $218,902 to the BC Liberal Party between 2015 and 2017, and that the Great Canadian Gaming Corp. had donated $127,413 during that period. Another coincidence, of course.

You just bought a car 

Not long ago, Trudeau, along with Ontario’s Premier Doug Ford, gifted nearly $600MM of your tax dollars so Ford Motor Co. could build electric cars, then sell them for $5000 less than their sticker price. Gee, that’s nice. This is using your share of the tax bill to pay for a car that you’ve not authorized, and may not purchase. Its a cost born by you and I – benefitting only those who actually buy the car. Oh, and the corporation, of course.

Question: What right does a government have to spend our money so indiscriminately?

To paraphrase Dr. Brian Lee Crowley (Managing Director of the Macdonald-Laurier Institute):

There is an incorrect assumption by citizens in Canada that the government “knows best” as to how to spend our money. This assumption fails to recognize that the knowledge of one small group of politicians cannot possibly match the knowledge of millions of citizens. Citizens from all walks of life form a collective skillset and intelligence that exceeds a small group of elitists.

A politician cannot, and should not, be free to act outside of basic society needs without some type of consultative process.

PART 2: THE SOLUTION

Here’s the tax returns we are used to:

The new tax return – for kicks and giggles

What if your total tax bill this year was (for example) $30,000. Wouldn’t it be great if it was itemized? For fun – lets make an imaginary breakdown that might be reported on your income tax return.  I truly believe I am massively understating the discretionary figures in this example.  Of your imaginary $30,000 tax bill, you receive the following financial statement:

Questions

Here’s a question for you: Were we to pay our taxes after an itemized report like the above, how much more attention would you pay to Justin Trudeaus spending decisions?

Let me ask you another question. If you received this tax bill, and knew that a good portion of  your money was being used for expenses that you did not endorse or agree with, how would you react?

Make governments report just like a corporation

What if  our personal net costs of government expenses were presented to us every year in a fully disclosed manner for scrutiny? What if an independent audit disallowed expenses that didn’t fall into ‘allowable expenses”. You know, like personal benefits to an MP? Those expenses would be paid back by the bad guys who tried sneaking them through…like any tax cheat has to.

What if  taxes were used only for what they are meant to cover – expenses like roads, education, police, fire, Medicare, etc? In this way, Justin would be held to the same standards as a business is.  He’d have to pay for his personal pleasures just like we do…with his OWN money! BTW – this would go for all politicians.

The political donor card

Perhaps you like the idea of helping an MP upgrade his cottage. Here’s how you could do it without infringing on the rights of your fellow Canadians! Picture a new twist on the donor portion of your drivers license. Here’s what we have now:

The new tax donor card 

The Canadian Revolution

The truth behind the American revolution was not that the “rebels” rejected taxes. They rejected  taxes that would  go to a king with no benefit to themselves. They rejected having their money taken and spent without direct and fair representation of how that money would be distributed. Sound familiar?

I reject the concept that Justin Trudeau and his government have the “right” to use our tax dollars for anything that extends beyond law and order, military, health, education and multi-use infrastructure. Further: Charitable contributions to foreign entities, private corporations, special interest groups, etc. should be  by choice of the individual. Like my proposed donor card.

I believe that even the most die-hard Justin fan would reconsider the expenses this government has placed upon them if it were itemized on their tax returns. Moreover, I believe that even his most loyal voters might not be so willing to write that optional cheque (per my proposed donor card) for personal chefs and bee farms. Nor for foreign nations, and corporate donations. But…. if they did wish to gift Justin some of their money to help buy that new zipline at the cottage, or to buy Loblaws some refrigerators, then what the heck. Its their decision!

We must reject Justin Trudeau and his “right” to use our tax dollars beyond their original purpose.

Justin Trudeau has crowned himself king, and then stole from the people. It is time for a Canadian revolution.

Liar, liar, pants on fire!

“I believe in fiscal responsibility, and I, quite frankly, I think Liberals who believe that the government should be doing things well and should be doing some certain things are more motivated to therefore do them well, do them responsibly, not going to massive deficits the way certain other governments who have been less motivated to deliver good government have” – Justin Trudeau on CNN’s Foreign Affairs show in 2014 when campaigning on a $10 billion deficit.

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Keith Richard, Dec 18, 2020

Source

https://www.valuetrend.ca/the-canadian-revolution/

Is it Hot in Here, or Is It Just Me?

Is it Hot in Here, or Is It Just Me?

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Normally when you think of January you think cold temperatures or winter. But as of late, the markets have been heating us up and not in a good way. Maybe we can compare it to when you’re wearing a thick turtleneck that you thought would keep you warm but it ended up being more of a thermal blanket that left you nervous that people would start to notice the beads of sweat gathering on your forehead or upper lip. Those nerves or surging fear is what keeps people from wanting to invest in the market, intimidates investors that should remain invested, and seeing red causes panic to rise and initiate the fight or flight instinct. And all of these feelings of uncertainty are blurring judgment as people act without taking the time to understand why things are happening the way they are.  

With that said, I wanted to follow up my rather long diatribe from Wednesday’s Newsletter (01/25) with some digestible nuggets about the lackluster Fed meeting that also took place that same that the newsletter when you. I will also paint a more vivid picture of how oversold we currently are by showing some informative charts that I find to be extremely helpful.

The Fed Meeting Commentary:

1. No surprises: he told us he was going to rein in the bond-buying and probably do an interest rate hike in March and Wednesday, he said it again. 
2. Inflation well above the target 2% and strong labor, thus soon appropriate to raise Fed Funds rate.
3. Powell confirmed that he would use the Fed Funds Rate (the cost of funds charged to member banks of the Federal Reserve) as his primary tool. 
4. The economy is continuing to strengthen. Thus far earnings for Q4 2021 are dramatically better than forecast and forward projections are stronger than initially thought.
5. Supply / Demand imbalances related to the pandemic are the cause of inflation. Since the supply chain issues are far from easing, this is expected to continue.
6. Will remain sensitive to economic changes and adjust accordingly. Didn't go on to mention a bunch more hikes.

What happened? The market was very strong at the open Wednesday due to Tuesday night earnings from the biggest software company on the planet far greater than expected. The difference that we have seen over the last three days was that there were fewer lows on Tuesday and Wednesday than there were on Monday. This implies that possibly this is the end of the decline and the beginning of a new basing process from which the markets could recover.

This brings me to my final point: where we are on the "downside momentum" spectrum. The Debbie Downers are out in force. Jeremy Grantham calling for an additional 50% downside, Ralph Acampora's call for another 20% down (he is affectionately called Ralph (I Can Make Ya Poorer). On top of this, the UN is mobilizing troops to the Russia / Ukraine border, not to speak of China's cancerous continuous creep into Taiwan and the continuously declining support for the Biden Administration. Corrections can be sharp and deep, as we have experienced since the beginning of this year, but this does not necessarily begin a bear market. The market's current technical status is akin to a giant coiled spring fully compressed and ready for a violent snapback. Remember the adage of the sage of Wall Street, Warren Buffet, "Be fearful when others are greedy and greedy when others are fearful."

I am going to insert a few charts for comparative understanding. For starters, the markets are almost as sold off as they were at the COVID lows of March 2020.  Some indicators are showing the most oversold readings on record! When these lows have been registered in the past, the next place the market traveled was upward. Here are five charts that I believe are worth at least considering.

Oversold readings are seen at or near market bottoms. Currently, NAUD is registering the most oversold reading on record. 

 

Similarly, the NAHL also registered the most oversold reading on record. 

This chart also registered the most oversold reading on record

 

On Monday morning, January 24th, this indicator slid to a record low

 

Readings below -1000 are oversold. At this writing, the NYUD is registering the most oversold reading on record. 

These are five charts that provide perspective. What they don't provide is an exact answer. Every time is a little different. What we do know is there is no major calamity (like COVID) in the offing. What Powell is doing is because our economy is good, not because it is bad. I am not about to tell you that the market decline is definitely over, but rather that it is much closer to an end than a beginning. We are paying attention to what we own, why we own it, and what is going on in the world to provide runways for their respective futures. 

We are here to answer any questions you may have, address your individual concerns, and make any changes you would like us to make to assist you in achieving your individual goals and objectives. I realize that the information I have provided above is really quite technical in nature, but I am hoping that the pictures make the technical nature understandable. If you would like a greater explanation, please call us and we will answer your questions. 

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Important Disclosures: 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. 

Investing involves risks including possible loss of principal.

The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The Nasdaq-100 is a large-cap growth index. It includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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Source

https://www.tower68.com/blog/is-it-hot-in-here-or-is-it-just-me