Tax Policy And Competitiveness Of US Based Corporations

Listening to the Presidential debates and reading the platforms of the 2 candidates, there is a lot of noise, truths and half truths related to what should be policy to ensure that the US corporations remain competitive in a global economy.  In my usual reading of corporate proxy material and other filings, I came across this in the S-4 filing related to the Eaton Corp acquisition of Cooper Industries.  It states that to grow in todays economy, Eaton Corp has to move their incorporation offshore to both grow faster.

".....Eaton’s proposal assumed that the transaction will be structured such that the surviving parent entity would be incorporated outside the United States. The decision that the parent company would have a non-United States location was made because the transaction was not economically feasible without incorporation outside the United States due to material competitive advantages currently enjoyed by Cooper as a result of its non-United States incorporation. Amongst those advantages are greater flexibility and lower cost of cash management, an enhanced ability to grow faster through organic growth and acquisitions, as well as a lower worldwide effective tax rate. Loss of these existing Cooper competitive advantages would have caused a large dis-synergy that would have prevented the acquisition from occurring."

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Don't Fight The Fed

Speculation regarding the US Federal Reserve Board's Open Market Committee (The Fed) quantitative easing program was the dominant theme impacting financial market over last three months. The Fed ultimately signaled that until the unemployment rate was reduced to more reasonable levels they would continue to be accommodative. This accommodative policy combined with the belief in the old adage of "Don't fight the Fed" fueled stock market gains. In a similar vein, the European Central Bank (ECB) President also provided soothing commentary to the markets by stating that he would do everything within his power to prevent further deterioration in Europe. The probability of any of the member countries exiting the Euro decreases with this reassurance. In a bid to reignite a sluggish economy, The Bank of China also began a new round of accommodative monetary policies. With the availability of “easy money”, a number of investors were caught chasing a rising stock market. In light of the current round of global synchronized easing, perhaps the new mantra for investors should be "Don't fight the Feds".

With mediocre economic growth, bond yields remain near historic lows. The slow pedantic rate of economic growth suggests that bond yields will remain relatively stable, with low rates of return.

The official US government data continues to show lackluster US GDP growth, even though there are pockets of strength. Both US auto sales and retail sales data came in better than expected. In our April quarterly commentary, we discussed our belief that housing was close to a bottom. We have increased confidence that not only has housing seen the bottom, but we are now starting to see resurgence in housing and remodeling activity. While we still do not want to make any sort of call on a significant increase in housing prices, rising housing activity is positive for both future employment growth and US GDP growth. The US Consumer Confidence Index surpassed expectations in September producing the best data point since the beginning of the recession.

A wise market pundit once told me that the better we can define the problem, the closer we are to the bottom. There is a high level of awareness of these fiscal problems across all segments of the population. Issues such as the Euro crisis, the slowing Chinese economy, the US political gridlock and the potential fiscal cliff in the US are discussed over dinner in many homes. With everyone able to accurately describe in exacting detail these potential risks, one must conclude that these concerns are largely reflected in current stock valuations and prices.

Investors are tired of the never ending discussions of an impending recession, the financial crisis, and housing troubles. They would like to move on. Europe has not blown up, and investors are beginning to believe that it is unlikely to happen. The big question plaguing investors has morphed from “how will we handle the crash” to “what would market valuations be if there is no European crisis ?“ If we believe that the crisis can be contained, and the three most important central banks in the world continue to ease, then we can make a case for valuations (and stocks) being higher than their current position.

We meet a lot of Canadian investors who want to avoid US based investments. These investors feel more secure allocating their entire stock portfolio to Canadian equities. Their assumption is that as long as the Canadian economy continues to chug along, they are insulated from what is occurring outside our borders. We believe that this could not be further from the truth.

Canadian Commodity producers (metals, energy and agriculture related companies) sell the majority of their products to other global companies. Sales prices (typically denominated in US dollars) are determined by global forces that are largely influenced by the American, European and Chinese economies. Owning primarily Canadian stocks will not insulate investors from events outside our borders. Furthermore, they are at increased risk due to a lack diversification within their portfolios. Most Canadian companies in the same sector are typically correlated to the same macro factors. An example of this is the energy and gold producers' fortunes are tied to the price for oil, natural gas or gold.

The advantage of investing in US stocks is the ability for true diversification. The Canadian market is based primarily on financials and resource stocks whereas the US market has a both a depth and breadth both within and between the various sectors. The Canadian market has a relative paucity of choices, thus narrowing the possible candidates that could be considered for an individual’s stock portfolio.

Concerns in regards to a weak US dollar negatively impacting US stocks may in fact represent an advantage. US companies that are international players may benefit competitively from a devalued US dollar due to their US dollar based costs falling lower than their foreign competitors. To complete this cycle, the foreign income may translate back into US dollars at a higher rate thus providing a further lift to earnings.

We continue to recommend a balanced portfolio, with a bias towards conservative stocks. Equities are likely to be the primary financial beneficiary of the current global synchronized easing. We do own bonds, but due to their low yields, we are relatively underweight this sector. In the fixed income sector, our preference is for high grade corporate bonds. On the stock side, we are investing in high quality, dividend paying companies that have the continued ability to grow both earnings and dividends in the current sluggish economic environment.