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JCP Investment Partners - United States Tour 2012
US Tour Insights
Small Steps Towards The Rebuild
In July 2012, Michael Fitzsimmons [Chief Investment Officer]
and Craig Shepherd [Senior Economist] travelled to the United
States: specifically New York, Washington and Orange County,
to meet with a number of economists, academics, politicians,
government bodies, journalists and local company representatives across a range of industries. We saw this process as
fundamental to gaining a better understanding of the shifting
landscape in the US. This report provides a summary of our
impressions from these meetings. Importantly, we also consider
how best to capture these impressions in our portfolios going
forward.
Our primary aim from our 30 meetings was to uncover whether
the US has lost its ‘entrepreneurial mojo’ [which has historically
delivered strong productivity growth], and whether the US could
still be relied upon to be a key driving force for global growth and
innovation.
Additionally, we were keen to assess whether the US will be able
to resolve its current political deadlock, lack of fiscal discipline,
and infrastructure deficiencies.
August 2012
Americans like to talk about their short-term economic and political
challenges. For example, the fiscal cliff and many partisan issues
were often raised in meetings. But when discussions turned to
the long term, it became clear that, as Winston Churchill once
famously said, “Americans can always be counted on to do the
right thing... after they have exhausted all other possibilities.”
Future Sources of Productivity
Unlike economies in ‘catch-up’ mode, or small countries highly
reliant on external demand, the US needs to find new ways of
generating productivity growth. We believe economic growth
in the US will be stronger over the next decade as the US has
many options at their disposal, including important reforms and
opportunities such as:
• Broadening the tax base to improve incomes for the lower
and middle classes.
• Dealing with the current infrastructure shortfall with increased
private sector involvement.
• Leveraging the past decades’ advances in information and
networking technology to improve public sector productivity.
From a portfolio perspective, we were specifically interested
in whether or not the US can continue to deliver real GDP per
capita growth of 2%+ [as it has done for the past hundred years],
how they will domestically exploit their emerging energy [shale
gas] opportunities, and will this new energy source be a future
threat to Australian LNG exports.
• Reforming the health care system which is currently ‘bloated’
by excessive delivery costs.
Answers to these questions are important for Australian equities
portfolios because at this stage North America remains the
world’s largest market for China and the Australian economy is
inextricably linked to the fortunes of China [see JCP Investing
in Practice China Tour 2012]. The US dollar is also currently
the global reserve currency and as such, the benchmark for
Australian interest rates which are an important component of
our equity valuation models.
Infrastructure
Our meetings provided the following valuable insights:
1. Underneath the political malaise and grandstanding,
important legislative progress is being made in areas which
will ensure core infrastructure in the US is being built which
should underpin future productivity improvements.
2. The US housing market is showing definite signs of life.
3. The large and unsustainable budget imbalances can be
resolved in the medium term through a combination of tax
and expenditure reform, mixed with a certain amount of
financial repression.
4. Information technology and the use of the internet network
are a core part of the reform and innovation process.
5. Energy policy [and shale gas in particular] offers genuine
economic opportunities from lower future energy prices,
as well as the necessary industry retooling and investment
required to exploit this new energy source.
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• Exploiting the ‘energy dividend’ from shale gas and oils, as
the North American continent moves toward energy independence over the next 10 years.
America appears to be rebuilding itself from the ground up, as
evident in recent bipartisan support for the Federal Transportation
Bill, as well as the promotion of the National Infrastructure Bank
and various state-based initiatives. The Federal Government is
demonstrating its willingness to direct infrastructure investment,
with high speed rail and Public Private Partnerships [PPP’s] now
appearing as priorities.
President Obama and the Tea Party are emerging as bedfellows
in the area of local infrastructure. The former understands the
importance of promoting employment, whilst the latter agrees
with more local control of taxes and spending.
Progress on the ground so far has mainly focused on industrial
and commercial floor space, exploiting good locations and an
underutilised labour market. For example, there has been a lot
of activity in places like Alabama, Mississippi, Texas and Florida.
This is often partly funded by foreign direct investment, and
makes the most of the current low interest rate environment. One
expert commented to us that good progress had been made in
freight and retail [evident, for example, in Australian consumers’
experience with Amazon].
The ongoing development of technological infrastructure in the
form of data networking is also very important. For example,
the Department of Homeland Security is building the base for
public sector consolidation by driving productivity through better
information sharing amongst government departments. It is
JCP Investment Partners - United States Tour 2012
US Tour Insights
hoped that when the different government agencies speak the
same ‘data language’, duplication will be removed, thereby
generating a new wave of productivity gains in the government
sector.
Many people we met with recognised the transformative potential
of shale gas and were confident the infrastructure necessary to
exploit this new energy source will be forthcoming. One informed
contact suggested exports will be allowed, but only as a means
to control pricing internally so as to continue to encourage
investment in the sector. Existing LNG import facilities are in
the process of being converted into export facilities to aid the
export process. However, the establishment of new facilities will
be limited to encourage the use of this new source of energy
domestically. It was also made clear to us that the destination of
exports may have a political dimension.
Housing Market
The housing market in the US is clearly improving. Demand
for housing is now at a more sustainable level as job security
prospects have improved, prices are cheaper, and affordability
is high. Inventory levels have declined more than expected in
some cities and there has been a greater shift toward short sales
as a means for banks to liquidate their delinquent loans.
The institutional and private investor rental market has been
important to the improvement in the number of transactions,
and this will probably continue to support prices going forward.
In some markets that we observed, there is over five years of
demand build versus supply creating an imbalance, with supply
of development land appearing to be the main problem. As a
consequence, a short squeeze in land is now evident in some
cities.
Increasing activity in construction provides increasing
employment opportunities. A more stable price environment also
helps labour mobility, which has historically been an important
factor for the US economy. Experts cited a 40 per cent chance
that home prices will rise by 8 per cent CAGR, or higher, over the
next four years. If this scenario eventuates the wealth effect on
consumption and investment could be considerable.
After six years of crisis we wondered if the appeal of housing
would be lost to an entire generation. If so, this could impair the
recovery for an extended period of time. A number of people,
including Meg Burns [Senior Adviser, FHFA], made the point
that home ownership remains a social and political priority in the
US.
From a portfolio perspective, we have addressed the potential
for increasing growth in the US housing market in our James
Hardie [JHX] model. We now assume housing starts increase
from 765,000 in 2013 to 1,767,000 in 2017. Despite this bullish
outlook, we still think the stock is relatively expensive.
August 2012
The Budget
We had a number of meetings with US budget experts, including
former staff of the Office of Management and Budget, and the
Congressional Budget Office. We were encouraged by the short
and long-term reforms planned to ensure the US achieves a
more sustainable budget deficit.
Broadening the tax base and reducing tax expenditures [tax
deductions] are at the core of a large body of work currently
being conducted behind the political facade. Reducing the US
tax system’s inherent complexity is also likely to encourage
further productive investment. We have already seen examples
of this such as the Simpson-Bowles Commission in 2010, but
other reforms continue to emerge. However, the political hurdles
are high, not least because of the pledge [promoted by Grover
Norquist and supported by most Republicans] to “never raise
taxes”.
Importantly, small steps have the potential to lead to huge gains.
Limiting the deductibility of mortgage payments, or means
testing healthcare [Medicare and Medicaid] alone would save
huge amounts of money in the future.
Obama: A Failed President?
The founding fathers of the US implicitly designed the federal
government system for inaction and conflict to ensure it
largely stayed out of the economy. For example, in designing
the state-based senate system there was an explicit goal to
reduce federal effectiveness, as Constitutional Convention
delegate Edmund Randolph put it, “to restrain, if possible, the
fury of democracy” that could arise from the House. Having the
Executive sit outside of the parliament added further difficulty for
government action.
In such an environment only great politicians can garner
widespread support, promote reformist legislation and build
national consensus. This institutional framework requires an
effective working relationship between Capitol Hill and the White
House. This has not been the case over the past four years.
For example, arguably good legislation in ‘ObamaCare’, and the
‘Dodd-Frank’ financial reforms, remain unfinished in many key
details therefore rendering these important reforms somewhat
ineffective.
This is important because in an environment where business
investment is uncertain, a bad political landscape drags on
confidence and delays investment. Republicans and Democrats
who otherwise would be forced to the table for debate and
compromise have been inflexible, with ‘behind the scenes’
political institutions unable to achieve resolutions to difficult
problems. As a 40 year Washington veteran told us, an “18th
century constitution has given power to crazy people to blow
things up”.
The next election is an opportunity to move past this political
gridlock and we suspect a framework for compromise will be
much easier to achieve.
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JCP Investment Partners - United States Tour 2012
US Tour Insights
August 2012
A ‘Heartland’ Viewpoint
Jobs Growth: A Nagging Concern
On the final day of our trip we gathered together five interesting
people in Orange County [not exactly US ‘heartland’, but as
close as we got to it] for a roundtable discussion. One guest built
retirement villages; another was a CEO of a national retail chain.
Also at the table was an economics academic who is an advisor
to Paulson & Co; a representative from the local Orange County
Chamber of Commerce; and a professional political advisor.
Despite the general optimism of our meetings, we found that on
the critically important issue of jobs growth, the vibe was a bit
more downbeat. The US is a private-consumption led economy,
so there is a strong need for private income growth to stimulate
aggregate demand, with jobs growth being a crucial component
of this equation. Part of the solution is to focus the economy on
employment generated by investment and exports, which still
remains an important challenge for the US.
Each individual forthrightly defended the continued existence of
America’s ‘entrepreneurial mojo’. Despite these people having
different backgrounds and agendas, all agreed that American
values including strong adaptability mixed with relatively
favourable demographics, created a positive economic impetus
for the future. Together they also identified a list of reforms and
priorities expected to be implemented in the future to improve
productivity. Important issues discussed included: tort reform,
reforming campaign financing, and regulations around political
advertising.
Client Portfolio Implications
Based on the insights above, we believe the US economy
provides a good medium-term growth framework that underpins
much of the revenue growth in our valuations, either directly
for those companies with US based earnings [such as News
Corporation, Brambles, CSL and QBE], or indirectly through
Chinese exports.
On the following page is a list of the contacts we met with on our
US tour.
For further information please contact:
Michael Fitzsimmons
Chief Investment Officer
[email protected]
Craig Shepherd
Economist
[email protected]
THIS MATERIAL IS INTENDED FOR USE SOLELY BY INSTITUTIONAL INVESTORS. STRICTLY NOT FOR PUBLIC DISTRIBUTION.
The information contained in this brochure is general information only. It has been prepared without taking into account specific
investor objectives. You should assess whether this investment us suitable for your specific investment objectives and seek
professional advice before deciding to invest in the product. JCP Investment Partners cannot guarantee the success
of our return of capital of any investment in this product. Information contained herein is accurate at the date of issue.
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JCP Investment Partners - United States Tour 2012
US Tour Insights
August 2012
Meeting List:
New York
Michael Likosky, Center on Law and Public Finance
Geert Bekaert, Professor of Finance and Economics at Columbia Business School
Nick Danaher, Blue Ridge Capital
Bill Featherstone, Analyst (UBS)
Linda Lord, Senior Political Advisor (UBS)
Steve Freedman, Wealth Management Senior Investment Strategist (UBS)
Mark Steinhert, Global Head of Product Development & Management (UBS)
Pippa Malmgren, Senior Advisor President & Founder (Principalis Asset Management)
Dennis McGill, Zelman Associates
Dan Oppenheimer, Credit Suisse, Housing Analyst
James Kahn, Professor of Economics (Yeshiva University)
Washington
Frank Kelly, Head of Government Affairs, (Deutsche Bank)
Ed Ettin, Deputy Director (Division of Research, Federal Reserve Washington)
Charles Konigsberg, President (Federal Budget Group LLC)
Meg Burns, Senior Associate Director for Housing and Regulatory Policy (Federal Housing Finance Agency)
Bob Ryan, Senior Advisor to the Secretary (HUD)
Barry Anderson, Independent Consultant on US & International Budget
Jarod Burnstein, Senior Fellow (Center on Budget and Policy Priorities)
Teresa Minassian, Independent Economic Consultant
Orange County
Tom Reimers, President (Land Advisors Organisation)
Christopher Lynch, VP (Irvine Chamber of Commerce)
Neil Watanabe, Executive VP & CFO (Anna’s Linens)
Christopher Thornberg, Economist/Real Estate
Richard Cisakowski, President (Distinguished Homes)
Frank Haffner, CEO, American Senior Living
John Withers, Principal, Californian Strategies