Demographics are Destiny...

Well not exactly, but there is truth in this.  It takes a fertility rate of 2.1 children per woman to hold a country’s population steady. The U.S. had been at this number but recently has fallen back (see chart below). The number of children American women hope to have and what they achieve is drifting apart. Marriage is getting postponed and unmarried births are falling (which incidentally is a great thing!). If immigration does not increase we may be facing economic problems. Like government revenues falling and Social Security getting more difficult to pay for.

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This is nothing new for countries like Korea and Japan. Births in Korea, for instance, are running at about one child per woman. And many Asian countries are resistant to immigration which compounds the problem. China is also facing issues. The one child policy has been scrapped but urban families are reluctant to have a second child due to child rearing costs.

The National Bureau of Economic Research looks at birth rates and economic growth, and since 1990 a slowdown in the birth rate has always preceded a slowdown in the economy. Will we see a recession now? We might, but there have also been false positives where a decline in the birth rate did not lead to a drop in the economy. Nothing is simple!

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And the fertility rate can turn around. Earlier this decade Russia was expected to see a sharp fall in its population due to alcohol deaths and a low birth rate. But birth rates have rebounded recently.

We will definitely be rooting for an uptick in birth rates in the U.S. now. Time to change the mantra from, “Make America Great Again” to, “Make Sex Great Again!”

All That Is In Peril Is Not Lost…

Well maybe, but you might not want to be too complacent. China is the world leader in many areas today (manufacturing, exports, solar panels, etc.) and catching up fast in others, like technology. Chinese startups have come to Silicon Valley for years to see how things are done. Now they are wondering if there is anything to learn here. 

As one Chinese said in The Wall Street Journal recently, “China is like a startup. The U.S. is like a big corporation. China runs very fast, tweaking along the way. The U.S. runs at a steady pace…”

According to a February article in The Economist, America’s attitude towards Chinese technology has progressed from first, the country is irrelevant to second, Chinese firms are just copycats to, more recently, China is a separate insulated market and won’t translate beyond its borders to finally, wow China is very close to closing the gap.

The general consensus according to The Economist is that Chinese technology is still only about 45% our equal but this number is increasing rapidly. In 2012, China was assumed to be only 15% our equal. Within 10 or 15 years China may be neck and neck with us. 

Apple (American) and Geely (Chinese) are good examples of what is happening. Early on the iPhone could command a high price due to its innovative technology. The phone still commands a premium price. But the Chinese competition is getting tougher, their technology better and their price lower. The chart below shows Apple’s diminished market share in a number of growing Asian economies. In China, Apple has only an 8% market share although profits are still strong. It won’t be long before we see Huawei, Xiaomi, and other Chinese phones here. In cars the Chinese are far behind us in combustion engine technology. So what are they doing? Doubling down on electric cars where they may very well be the winners and buying foreign technology, like Geely’s acquisition of Volvo and their recent big investment in Mercedes.

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Anyone who has been to China will vouch for the work ethic there. Americans are not lazy. We are notorious for taking very little vacation, but the Chinese have not yet heard of work-life balance. Long hours and the quest for market dominance seem to be everything in China. Chinese companies, aided by Chinese government policy, will continue to be the big force to worry about.

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How Money Makes Us Feel...

Financial writer Morgan Housel once contrasted the financial lives of two very different people: One was Grace Groner, who was born in rural Illinois in 1909, started working as a secretary during the Great Depression, bought used clothing and never owned a car. The other was Richard Fuscone, who attended Dartmouth, got an MBA from the University of Chicago and became a top executive at Merrill Lynch.

The twist to the story is that, to the shock of her friends, Grace Groner died in 2010 with $7 million of wealth. She had lived a frugal homespun life and had bought $180 worth of stocks in the 1930s that she never sold. In contrast, also in 2010, Richard Fuscone was forced to file for bankruptcy while facing foreclosure on his Palm Beach home and his 18,000 square foot New York mansion with a seven-car garage.

Go figure how a secretary beat out a financial executive with a Chicago MBA -- and take whatever you wish from the story: the power of saving, the failure of even fancy finance experts to regulate their own behavior, or perhaps a little schadenfreude. But the story surely reveals what a funny thing money is.

I was reminded of Grace Groner because I’ve been reading a book called Your Money or Your Life by Vicki Robin and Joe Dominguez, a bestseller from 1992, since updated in 2008 and 2018. The book certainly extols saving and frugality. But really, the point of the book is that we need to get a grip on our relationship with money. If we do become fully conscious of how much effort it takes to earn money and what we’re really getting out of the money we spend – both literally and psychically -- we almost certainly will start saving more and spending less.

In addition, we will be free to spend our time on the things that really matter. That is what the authors call “Financial Independence.” And by that, they don’t mean the conventional idea of having so much money you can do whatever you want. They mean being free to live your life without letting money control you.

The book offers a nine-step program for getting to what they call Financial Independence – regardless of your income or your values. Not everyone who reads the book will follow through, and actually, the book can be pretty hokey. The self-help language doesn’t help (sometimes, it made me wince a little). But still, I couldn’t stop reading it. There is some compelling, thought-provoking stuff in here.

The authors will get you to think about those strange “watery” feelings you get whenever you receive a bill, tip generously, or get an unexpected bonus or check. They will get you to think about how unconscious your spending is as you march through life: You know, as the authors tell it, you work hard all week. Then you make brunch for the family on Saturday, and when you realize you don’t have flour, you run to the nearby store, but also end up with gourmet strawberries and Sumatran coffee. Then you drive the family to the lake. It’s great, but you can’t resist the cute country restaurant, and the bill goes on the credit card.

It’s not that there’s anything wrong with spending money on these things. The authors emphasize that there are no value judgments to be made about your choices. The philosophy is “No shame, no blame.”

It’s just that you should be fully conscious of how money is flowing through your life. When you spend, you should be sure you’re getting your full enjoyment out of your expenditure and that it aligns with your values. Otherwise, spending can become just like mindless eating, when you plop yourself in front of the TV and overeat without realizing it instead of savoring each bite.

There is a lot in this book about how to save more. The authors have you do things like take an inventory of all your possessions and record every cent you spend ugh, you’ll see the excess for sure! They also will urge you to stop using money to show off, impress others and make yourself feel less empty.

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But even if you don’t follow the program here, the book will make you think about what is “enough.” For every individual, there is a point where you have enough, and beyond which more will mean declining fulfilment (see the diagram). Our job is to find our point of “enough” and then to exercise frugality. But remember, frugality here is not about deprivation, being a tightwad, or making do. It’s about having a high joy-to-stuff ratio.

What To Do With All That Cash...

The Tax Reform Act passed last December was good news for Corporate America. Tax rates on profits earned at home dropped from 35% to 21% and levies on lower taxed foreign earnings were significantly reduced. But the biggest near-term positive impact may come from the provision that reduced taxes on cash balances held abroad to a low 15.5% rate. This “repatriation” tax could be imposed on as much as $2 trillion in accumulated overseas earnings.

Architects of the latest tax reforms had at least two objectives in mind when crafting policy. First, they wanted to bring U.S. corporate tax rates more in line with those of our international competitors. Second, they hoped to give the economy a boost by stimulating productivity enhancing investments. Lowering the cost of bringing funds back home, it was hoped, would do just that.

Unfortunately, as of today it remains unclear how much cash will end up back on our shores and how the money that does return will be spent. In a recent survey of S&P 500 executives, BofA Merrill Lynch found that only 35% of total repatriated cash is likely to be spent on capital spending. Almost 75% is expected to be returned to shareholders in the form of dividends and share buybacks (see chart below.) Over the past month alone, American companies have announced more than $178 billion in share buybacks, the largest amount ever in a single quarter.

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This current buyback binge is drawing criticism from many quarters. One complaint is that buybacks are nothing more than a ploy by management to boost compensation. Buying back shares reduces the share count which can, in turn, boost earnings per share. While compensation structures can impart bias, benefit consulting firm Equilar reports that only one-third of corporate boards use earnings per share to determine executive pay. Further, many companies such as Apple, repurchase shares simply as a way to offset the dilutive impact that results from employees exercising stock options.

Critics also claim that buybacks have historically drawn funds away from other productivity enhancing investments. The research supporting this claim, however, is not compelling. Harvard professors Jesse Fried and CV Wang recently examined the amount of funds returned to shareholders in the form of buybacks and dividends over the 2007-2016 period. After adjusting for additional share issuance and taking into consideration R&D spending, they found that shareholder payouts amounted to just 33% of adjusted net income.

The rush to buy back shares today, however, should be viewed critically for two other reasons. First, management should repurchase shares when they have available cash and when they perceive them to be undervalued. Unfortunately, the historical record here is not great. As the chart below shows, the volume of share buybacks tends to peak at market highs and decline precipitously when share prices fall.

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Second, over the last decade companies have loaded up on low cost debt – in many cases borrowing funds for the sole purpose of repurchasing shares. This approach makes sense as along as conditions remain as they are today. But if rates rise or the economy softens, two very possible outcomes, elevated debt levels could swiftly become a problem. Deleveraging in a soft economy when cash flows weaken or in a rising rate environment will not be an easy task.