GLOBAL MARKET COMMENTARY

August 25, 2016

GLOBAL MARKET COMMENTARY EXECUTIVE SUMMARY

2. The world’s governments need to take the baton from central banks and make pro-growth reforms. Continued economic progress will depend more and more on structural reform (less bureaucratic red tape, so new business can be formed and hire new workers) and constructive fiscal policy (lowering U.S. taxes so that they are on par with foreign taxes). The power of central banks to spark growth will continue to erode, and prolonged ultra-low rates will begin to have more and more unexpected and negative consequences. Watch prospects for such structural and fiscal reforms as bellwethers of economic growth in coming months and years. 3. New vocational tech initiative shows hope for jobs, productivity. The long-term health of the U.S. economy, and the productivity of its workforce, depend on training workers effectively with skills that are actually in demand in the workplace. The Department of Education has a new initiative to leverage Federal assistance for coding academies

and other high-tech vocational training programs. Such initiatives will be far more beneficial than the across-the-board expansion of access to four-year programs that some politicians have suggested. 4. The Greek endgame? The Greek government is preparing to collect data on the privately held assets of 8.5 million Greeks -- everything from real estate to cash in their wallets to antiques and jewelry -- and they will have to keep their records current within a month of any changes. Clearly, the Greek government is preparing to levy a wealth tax in an effort to square the circle of its impossible financial situation. Investors should note well that while such events only occur in extreme circumstances, they are not unthinkable -- and at some point, could be implemented even in the United States. For this reason, it’s wise for investors to hold a portion of their assets in physical gold -- which would rise if a policy of confiscatory taxation were implemented in any country. 5. Security concerns? Try a token. We follow up our recent rundown of good cyber-security practices for investors by noting a piece of technology that can enhance the security of your online accounts: an electronic token. 6. Market summary. Although many pundits created fear of negative Brexit fallout, there has been no psychological impact and very little manifest fear of a collapse of trade between the U.K. and Europe. Businesses and consumers obviously do not agree with the pundits that Brexit will substantially damage economic growth in Europe in the short run. Before and after the Brexit vote, Europe’s growth rate has been slow and steady, which will create an ongoing opportunity in Europe for investment. We would use market corrections to buy British and European stocks. With ultra-low rates now pushing below zero in

© Guild Investment Management Inc.

1. Brazil reforms are coming into view. We continue to be bullish on Brazil. The Brazilian senate has voted to begin President Dilma Rousseff’s impeachment trial. When that is completed, probably within a month, and Michel Temer is confirmed as President, he will embark on his most ambitious reform effort: a constitutional amendment to freeze Brazil’s budget at current levels in real terms for up to 20 years. After that, he intends to tackle entitlement reform by raising and standardizing Brazil’s retirement age, and move on to labor market, tax, and political reforms -- aiming to get as much done as possible before he has to face re-election in late 2018. Any reform successes -- particularly the fiscal freeze and social security reforms -- could be catalysts for the Brazilian market, even though their positive economic effects could be a year or more away.

August 25, 2016

EDITORS

MONTY GUILD Chief Investment Officer

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Executive Summary, cont’d many countries, the options open to many central banks are currencydepreciating tactics to allow their governments to repay debt in depreciated currency. This will be a boon for commodity investments: gold, real estate, commodity-producing companies, and those which hold large amounts of commodity assets and which borrow in depreciating dollars. Both Hillary Clinton’s wealth redistribution and Donald Trump’s tax cuts and the

likely continued embrace of low interest rates should be inflationary. Whoever is elected, a trend toward higher inflation may be the wave of the future. We continue to be bullish on several markets, and because we are now nearing the often volatile September/October timeframe, we are waiting to buy some quality companies in the U.S., India, Brazil and other countries on a mild market correction.

Brazil Reforms: Getting Closer suggested that a bottom could be in for the Brazilian market and the Brazilian currency, even if the final impeachment of Brazil’s President was months off and the economy had not yet turned the corner. Since our October 2015 note, Brazil’s Ibovespa stock market index, the Brazilian real, and Brazilian bonds have all risen substantially in U.S. dollar terms.

RUDI VON ABELE Senior Research Anaylist

CONTACT INFO 1-310-826-8600 [email protected]

Mon-Fri 6:30-4:30

Source: Bloomberg


One of our favorite themes in 2016 has been reversion to the mean, and one of our favorite reversion-to-the-mean themes has been Brazil. We began to turn positive on Brazil in October of last year, when we noted that “The news [in Brazil] is so bad it beckons the seasoned speculator.” In March we noted that ANTHONY DANAHER Brazil’s perfect storm of economic crash and political crisis bore a strong resemPresident blance to the Watergate scandal in the U.S. in the early 1970s. The comparison

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Brazil Reforms, cont’d

Now Dilma Rousseff’s fate is finally in view. Brazil’s senate has voted to move forward with the trial, which is expected to happen within the next several weeks, and which is expected to result in Rousseff’s impeachment. Temer will serve out the remainder of her term and face re-election in 2018. There has been little doubt about the outcome of the impeachment vote. Nevertheless, as long as Temer is merely the acting president, his status has made it difficult to ensure he has the political capital to push through difficult reforms. In the meantime, Temer has moved carefully. The speaker of Brazil’s lower chamber resigned last month facing corruption charges, and was replaced by a Temer ally who will help push through planned reforms. It has been a careful balancing act for Temer to build support and work to ensure his confirmation as President after Rousseff’s impeachment. So Temer’s reform drive is soon set to begin in earnest, and he’ll want to act quickly once Rousseff’s impeachment goes through -- so that he will have time to weather any popular reaction before the 2018 elections get underway. What are his key reforms, and when could they be implemented? First, and most critical, is a constitutional amendment that would freeze Brazil’s budget in real terms for up to 20 years -- only permitting budget increases at the pace of inflation. This would be one of the deepest fiscal reforms in Brazilian history, and would offer strong reassurance to investors that Brazil would reverse the trend towards unsustainable debt levels. (On current trends, Brazil’s debt would exceed 80% of GDP next year -- a developed-world debt level for a developing economy -- and further dim international investors’ view of the country’s prospects.) Temer’s administration is confident that it will be able to muster the three-fifths majority it will need

to push the measure through. However, this reform requires another one. Without a reform of pension and social security entitlements, those entitlements will eat up a larger and larger part of government spending once the new fiscal freeze is in place. These reforms will include raising the retirement age (currently just 55 for men) and gradually eliminating retirement discrepancies between men and women and among various special occupational groups. If the fiscal freeze goes through as expected in October, social security reforms would be on track to follow in the first half of 2017. These are Mr. Temer’s two front-burner issues and will go far to stabilize Brazil’s financial foundations. He also wants to push for reforms to make the labor market more flexible; firing workers in Brazil is expensive, and wage negotiations highly regulated and cumbersome. All of this will make employment recovery from the current recession slower and more painful. He would like to revamp Brazil’s complex and bureaucratic tax system, which falls heavily on consumption and therefore has seen revenues decline drastically during the recession. And finally, he would like to see political reforms -- particularly a “barrier clause” which would help restrict the presence and influence of Brazil’s swarm of small parties. (As we’ve noted in the past, since they receive government funding, many small parties are just a form of rent-seeking, and actively hamper the functioning of Brazilian democracy rather than enhancing it.) Temer’s ambitions are bold, and, we do not doubt, would be very beneficial for the Brazilian economy if they are enacted. For now, he is concentrating on securing his power and seeing off his predecessor; then he will move to the big fiscal reform and try to push it through before election worries begin to rise. Shortly thereafter, he’ll tackle pension reforms. Markets may respond positively to catalysts along the way: when the Rousseff impeachment vote goes through; when the fiscal freeze amendment is made to the constitution; when pension reforms occur. It will take a long time before the positive effects of these reforms make themselves strongly felt in the Brazilian economy -- but the market will anticipate those benefits months before they are actually seen. We continue to be bullish on Brazil.


Brazil’s President, Dilma Rousseff, was suspended in May pending an impeachment trial, and Vice President Michel Temer took the country’s helm as acting President. He immediately moved to reassure global markets by selecting a business-friendly cabinet and proposing reforms that would help turn around an economy hard-hit by the global commodity downturn and the spendthrift policies of his predecessors.

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Brazil Reforms, cont’d Investment implications: We continue to be bullish on Brazil. The Brazilian senate has voted to begin President Dilma Rousseff’s impeachment trial. When that is completed, probably within a month, and Michel Temer is confirmed as President, he will embark on his most ambitious reform effort: a constitutional amendment to freeze Brazil’s budget at current levels in real terms for up to 20 years. After that, he intends to tackle enti-

tlement reform by raising and standardizing Brazil’s retirement age, and move on to labor market, tax, and political reforms -- aiming to get as much done as possible before he has to face re-election in late 2018. Any reform successes -- particularly the fiscal freeze and social security reforms -- could be catalysts for the Brazilian market, even though their positive economic effects could be a year or more away.

Bank of England Brexit Response Shows the Need For Governments to Step Up

While holders of long-dated government bonds in the U.S., the U.K., and Japan may be celebrating now, it is becoming increasingly obvious that central banks are reaching the limits of what monetary policy can achieve to spur growth. As Mohamed El Erian noted recently in the Financial Times: “These investment gains come at a cost to the system as a whole; and it is a cost that could turn out to be considerable if the government does not follow through with policies that promote high inclusive growth. These include structural reforms [and] a more balanced fiscal stance…” Reinforcing a point we have made in this letter, he observes that in the absence of pro-growth structural reforms and fiscal policy, a prolonged ultra-low interest rate regime can have many negative and

counter-intuitive effects -- and that we may already be seeing some of those effects. For one, participants in the financial system whose health is essential for growth -- including banks and insurance companies -- are hurt by prolonged ultra-low rates. Rather than encouraging spending, ultra-low rates can on the contrary encourage more saving, as economic actors try to ensure that they can meet their future needs for income. Ultra-low rates could eventually push market participants to engage in speculative unregulated financial products, leading to heightened risk and volatility. Investment implications: Continued economic progress will depend more and more on structural reform (the curtailing of bureaucracy) and constructive fiscal policy from governments (such as lower taxes). The power of central banks to spark growth will continue to erode, and prolonged ultra-low rates will begin to have more and more unexpected and negative consequences. Watch prospects for such reforms as bellwethers of economic growth in coming months and years.


Investors in gilts, U.K. government bonds, saw strong gains over the past month as the Bank of England implemented measures to counter potential Brexit-related woes: cutting interest rates, renewing asset purchases, and easing leverage rules for U.K. banks.

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In the U.S., Long Overdue and Finally Appearing: Loans for Vocational Training and Other Alternatives to Four-Year College Relentless statistics show that the past decade’s huge growth in U.S. college enrollment is leading to a buildup of onerous debt, but no corresponding buildup of graduates with relevant and lucrative skills. Nearly half of recent graduates are “underemployed” -- that is, employed in positions that do not require their degree. At a typical four-year public college, less than half of students beginning their studies will finish in six years. This means that a lot of money is being spent to no effect -- debt that will hamper students’ financial futures and that may eventually fall on the public to repay.

but will still be comprised almost entirely of hightech vocational training.

We saw a hopeful development recently in an Education Department initiative called EQUIP, which is spending $17 million to help 1,500 low-income students get educated -- but not at traditional institutions. Instead they’re attending programs run by for-profit companies such as the Flatiron School and Epicodus -- both boot camps which offer intensive education in computer coding. Other participating programs include one run by General Electric [NYSE: GE] to train students in the operation of manufacturing software. Some programs offer the prospect of a degree through an umbrella institution,

Investment implications: The long-term health of the U.S. economy, and the productivity of its workforce, depends on training workers effectively with skills that are actually in demand in the workplace. The Department of Education has a new initiative to leverage Federal assistance for coding academies and other high-tech vocational training programs. Such initiatives will be far more beneficial than the across-the-board expansion of access to four-year programs that some politicians have suggested.


This is obviously a direction far more likely to lead to positive economic outcomes for students and for the country than a brute expansion of enrollment in four-year college programs, and we hope to see the initiative expand and prosper. As we have observed frequently, U.S. economic prospects depend on productivity growth, and a workforce with needed skills is a critical component.

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Greek Government Begins Registering All Privately Held Assets In February, more than 8.5 million Greek taxpayers will be required to itemize all their wealth and register it with the government -- detailing not just their income and cash holdings, but all their “movable and immovable assets.” Real estate, vehicles, paintings, antiques, jewelry… all included. They’ll have to register changes as they occur and not just annually. (Outraged Greeks in public internet forums are wondering aloud if they have to re-register their cash after buying a pack of cigarettes.) The program is absurd on the face of it, since, first, the Ministry of Finance has not specified who will appraise the assets or how. Second, as many wags have observed, tax avoidance is a national pastime for Greeks, so they are unlikely to report data on their wealth accurately to the institution that is preparing to tax it. That, of course, is the endgame here, protestations of the Greek government notwithstanding. A 30% wealth tax on Greeks would “solve” their problems of over-indebtedness, keep them in the Eurozone, and assuage Europe’s financial powers… while a prolonged deflation, as even the International Monetary Fund has painfully demonstrated, presents instead the prospect of interminable economic suffering

for the Greek people with no resolution to be seen. So a “one time” reset wealth tax begins to come into view. Once again, we are left wondering whether Greece is the test-case for a program that could eventually find its way even to the shores of the United States. We don’t think it’s imminent, but we also don’t think it’s impossible. Investment implications: The Greek government is preparing to collect data on the privately held assets of 8.5 million Greeks -- everything from real estate to cash in their wallets to antiques and jewelry -- and they will have to keep their records current within a month of any changes. Clearly, the Greek government is preparing to levy a wealth tax in an effort to square the circle of its impossible financial situation. Investors should note well that while such events only occur in extreme circumstances, they are not unthinkable -- and at some point, could be implemented even in the United States. For this reason, we always recommend that investors hold a portion of their assets in physical gold -which would rise if a policy of confiscatory taxation were implemented in any country.

The only real security that a man can have in this world is a reserve of knowledge, experience, and ability. (Henry Ford)

they often are, so it’s always good practice to lean on the side of caution when creating security preferences for your personal financial accounts.

On July 15, 2016 we wrote a piece on identity protection and cybersecurity. One of our last suggestions was to request an electronic cyber-token from your bank, broker, or financial institution, if they are available.

Here are some potential signs of trouble that could alert you to fraudulent activity:

The hacks and breaches that make it into the news are institutional-scale, so individuals might not think that they could be similarly targeted. But of course,

1. You see trades or account other activity you don’t recognize. 2. When you visit your financial service provider’s website, you see a message that it is “Down for maintenance.” This could be a sign that a hacker is attempting to intercept your communications.


Two-Step Authentication Offers Security Advantages

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Two-Step Authentication, cont’d 3. Your financial data have been compromised in the past; this puts you at risk for future trouble, and should prompt you to a higher state of alert. 4. You suddenly begin getting an unusual number of investment-related junk-mail solicitations. Any of these events might suggest the benefit of another layer of security, such as a “secu-

rity token.” A security token is a small electronic device that generates an asynchronous passcode -- a one-time, randomly-generated series of numbers to be entered after your usual log-in and password. Your institution recognizes passcodes generated by its tokens -- but even hackers with supercomputers couldn’t create a fake passcode, or reverse engineer the algorithm.

Market Summary Prior to the Brexit vote, many pundits were pushing the narrative that Brexit fears would create a big decline in business’ expansion plans. They believed that the fear of future economic decline would make businesses want to retrench. It was expected that many U.K. operations domiciled abroad would start selling their British office headquarters and begin laying off employees, and that business confidence would be badly damaged -- causing a liquidation of inventories and a desire to move out of the U.K. This pessimism, they thought, would be visible in economic statistics and early warning indicators of economic activity such as the Purchasing Manager Indices (PMIs). This has not happened -- in fact, if anything, PMIs have been stable and slightly higher in Europe as a whole. In fact, both the euro and the British pound have risen versus world currencies since the first few days of panic that followed the vote. So far since the victory of the Brexit vote, there has been no psychological impact and very little manifest fear of a collapse of trade between the U.K. and Europe. Businesses and consumers obviously do not agree with the pundits that Brexit will substantially damage economic growth in Europe in the short run. Before and after the Brexit vote, Europe’s growth rate has been slow and steady, with growth at the pre-Brexit rate expected to continue. This will create an ongoing opportunity in Europe for invest-

ment. We would use market corrections to buy British and European stocks. Here at GIM, we are looking for undervalued European companies to add to client portfolios. This is another clear case of panic and overreaction to expert fear-mongering. First the pundits called the vote wrong, and in order to support their call for no Brexit, they promoted a story that Brexit would be disastrous for the European economy. So far, they have been wrong and the business community -- whose job is to grow and create more opportunities -- has been correct in their more optimistic outlook. Low Interest Rates Create Pressures For Fiscal Policies To Stimulate Economic Growth Central banks in the developed world have lowered rates to such an extent that the negative bound has been breached (i.e., interest rates are below zero) and they have very little they can do on the monetary front short of actually giving cash payments to many citizens of their countries. Most of the options open to these major central banks are currency-depreciating tactics to allow their governments to repay debt in depreciated currency which gradually declines in buying power over a number of years. By depreciating their currency, which is a tactic used after both the First and Second World Wars, debts are repaid with higher tax receipts as citizens are pushed into higher tax brackets. This will be a boon for commodity investments: gold, real estate, commodity-producing companies, and those which hold large amounts of commodity


Pundits Are Wrong Again: Europe Continues to Grow post-Brexit

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Market Summary, cont’d The Two U.S. Presidential Candidates Are Both Presenting Inflationary Messages: Are the Seeds Being Sown For a Return to a More Inflationary Environment? Donald Trump, because he is a sounding a populist note which will include low interest rates and lower tax rates; and Hillary Clinton, who is plumping for higher taxes and more redistribution of wealth. More wealth redistribution will mean a continuation of the current budget deficits, which would be inflationary -- while a low-interest-rate regime under Donald Trump, along with the tax cuts he proposes,

would also be inflationary. Investors should realize that whoever is elected, a trend toward higher inflation may be the wave of the future. Markets We continue to be bullish on several markets, and because we are now nearing the often volatile September/October timeframe, we are waiting to buy some quality companies in the U.S., India, Brazil and other countries on a mild market correction. Thanks for listening; we welcome your calls and questions.


assets and which borrow in depreciating dollars.

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