The State of Federal Finances

The economy is one of the most popular topics among Americans. Both business and non-business individuals concentrate on the fed’s annual budget to help predict which direction the economy will move. The federal budget is garnering much interest now that the presidential election is coming closer, the next interest hike is being anticipated to take place in the near future and the many domestic and international issues are taking the spotlight at the moment.

So let us discuss some of the areas where the allocation of federal funds will be especially important. In order of % of the federal budget, the following are the main budget areas:

Medicare & Medicaid (27%)

• Medicaid and Children’s Health Insurance Program enrollees will total 68 million people in 2016
• Runoff costs over the next decade are estimated to be $146 billion
• 31 states participate in the Obamacare program

Social Security (23%)

• Has been running on a deficit since 2010
• Number of people receiving social security: 65.3M (Feb. 2016)
• Number of people in labor force who are employed: 151M
• Current social security tax rate is 6.2% for both employer and employee (12.4% total)

Non-Defense Discretionary (16%)

• Programs include education, scientific research, infrastructure, law enforcement, courts, national parks and forests,  and other national needs
• Bipartisan Budget Act of 2015 expires in 2018
• Projected to fall to historic lows; less than 8% of GDP beginning in 2018

Defense (15%)

• Consumed slightly over 21% of 2015 federal budget
•  Department of Defense projects a budget averaging $534 billion from 2016-2020
• Defense as a share of federal spending at all-time lows since 1950

Other (12%)

Net Interest (6%)

The federal budget deficit has been decreasing drastically since the millennium highs of 2009. However, the deficit is expected to increase steadily beginning in 2016 through 2026, though not as intensely as ’08-’12 levels. It is estimated that this will mean an increase in federal net debt, in the same period, of about 12%. If this materializes, this means federal net debt in 2026 will be equal to 85.6% of GDP.

The Congressional Budget Office predicts 10-year U.S. Treasury notes and 3-month U.S. T-bills interest rates to rise to 4.1% and 3.2%, respectively. These levels are thought to be reached and held, beginning 2021-2026. These rates will need to be tracked closely, T-bills especially, given that the interest rates have not changed much since 2009.

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PMI Index Signals Industrial Production Rise in 2H16

Purchasing Managers Index 1/12 rise signals industrial production rise in the 2nd half of 2016

The Purchasing Managers Index (PMI) 1/12 rate-of-change rose for the third straight month in February, confirming that a cyclical low occurred in November 2015. The upward movement in the 1/12 rate-of-change suggests that the current trend of decline in the US Industrial Production 12/12 is likely to transition to rise in the second half of 2016.

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Contributors to World GDP Growth, Years 1 to 2015

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The Chart Explaining Fed Rate Policy: Wages, The Real Reason why Fed Raises Rates

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Can Maturing CMBS Loans Wipe Out Your Equity and Wealth?

The large volume of maturing CMBS loans combined with new regulatory hurdles and widening spreads will have big impacts on the market in the coming year.

The wave of CMBS maturing loans that were created at the height of the real estate bubble will crest in 2016 and 2017. According to estimates by Trepp, nearly 20% of these maturing commercial mortgages will demand additional capital from current borrowers or new buyers when the loan is refinanced or the property is sold.

How Does the CMBS Market Work?

New risk retention rules coming into play in 2016 require that either the originating lender will have to hold a certain piece of the loan for at least 5 years and/or the B-piece buyer will have to hold the paper for that amount of time. As B-piece buyers aren't set up to comply with these regulations, they will be forced to create processes to handle, which will result in increased cost passed on to the borrower in the form of higher spreads.

Meanwhile, CMBS spreads are drifting wider with a recent 10-year AAA bond clearing at 140 basis points over swaps. This ongoing weakness has led some issuers scheduled to price this year to push off their deals until later in 2016.

CMBS Swap Spreads

What are the possible solutions for you?

Non-Bank Balance Sheet Lenders

Since 2008 a sizable contingent of non-bank balance sheet lenders have sprung up and they unencumbered by banking regulations, legal lending limits, or geographical footprint. They keep all loans in-house and rarely outsource underwriting or servicing to third parties. Permanent loans offered by non-bank lenders provide long-term financing for stabilized commercial real estate, with loan terms up to 20 years and without the hurdles of defeasance. Bridge loans by same lender are designed for un-stabilized properties or shorter term business plans and include leading-edge features such as additional future facilities for lease-up costs and loan terms up to 7 years. Most non-bank lenders make non-recourse loans 

Non-Real Estate Collateralized Lenders

Perhaps one of the oldest lending communities, non-real estate collateralized lenders offer flexible loans secured by a myriad of assets, including securities, business and real estate equity, etc. The closing processes are simplified and with lower costs. Financing may be used in combination with real estate backed loans.

To prepare for the coming wave please contact Redmount Capital Partners or learn more about our capabilities.

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Regularly Updated Estate Plans are Essential for Family Business Owners

The principal creators of wealth are family business owners. Family businesses contribute over 70 percent of global production. Estate planning plays a vital role in the perpetuation of a family business. Considering the rapid change in business dynamics, estate planning is essential these days.

The majority of family business owners don’t update their estate plan. Over 50 percent of family business owners don’t review their estate plan for over five years.

An estate plan becomes old or outdated after a few years. Adding to this, circumstances in families and relations among family members, business matters, net worth, etc., tend to change irregularly or over a period of time. This is when estate planning comes into the picture.

It doesn't matter how complex an estate plan is. It's better to get a customized estate plan as long as one's legally competent. It will also ensure safe passage of family business from one generation to another without any dispute that may further damage the prospects of growth.

When kept up-to-date, estate planning is also useful in offloading family business for a fair price. Understanding the business management philosophy is essential when preparing an estate plan, and more particularly, when the business transition is taking place.

Several academic institutions are offering courses on estate planning. For instance, American Law Institute is offering estate planning course CLE for those who represent family business owners. It provides right from estate administration, updates on transfer planning, current income tax, trust advisors, trust protectors, dealing with intra-family rivalries in succession planning, etc.

Academics and legal experts find that many family business owners lack awareness about even charitable planning and charitable gifts. Over 50 percent of family business owners are not exploring the options involved in tax benefits.

Some family business owners do not take advantage of several options available to avoid estate tax, gift tax and other taxes, legally. This happens out of ignorance or negligence. Hence, it's wise to review and refine existing estate plans.

Many family business owners realize that they're richer than when their estate plan was drawn up. Family business owners, depending upon their state and federal laws, can have updated estate planning not only enhance value, but add protection as well.

Estate planning is essential for inheritance. It helps heirs retain control of assets and minimizes tax imposed by the State and Federal government.

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US Consumers Never Looked So Good

Click to enlarge

Why US consumers have never looked so good?

1. Household debt service ratio as % of disposable income is lowest since 1980 
2. Household net worth is at its highest since 1990

What Effects The Fed's Expected Interest Rate Increase May Have on Small-Business Lending

With the Federal Reserve set to raise interest rates for the first time in seven years, there’s been lots of talk about its impact on investors and home-buyers. But any increase will also affect entrepreneurs who are trying to finance operations or expand to new areas.

What will an increase in rates mean for business owners? 

The obvious answer is that interest rates on small-business loans should go up. But the Fed’s move to increase rates after keeping borrowing near zero since the financial crisis is expected to be slow and easy, perhaps just 25 basis points this week, meaning that any impact on business borrowing costs should be minimal at first. Then, too, banks – which pulled back from small business lending during the financial crisis – might increase their lending to small businesses if the economy improves. That would be especially welcome as bank loans are cheaper than most other sources of capital.

The Bigger Question.

The bigger question over time – and one that hasn’t been tested in previous market cycles – is what will happen to the marketplace lenders that rely on algorithms and higher rates to fill the gap left by banks for small-business loans. These marketplace lenders have relied on money from hedge funds and private-equity firms who have been searching for yield in a low interest-rate environment. Whether that liquidity remains or not as rates rise depends what happens to the spread between marketplace loans and corporate debt over time – and how much risk investors are willing to take in a credit environment that’s become increasingly concerned about risk.

Fed policy is only one factor in small-business loan rates, as anyone who’s tried to get financing the past few years and been offered a loan at 40% or higher despite historically low interest rates knows. Whether banks truly return to small-business lending, how lenders are able to use technology to improve their underwriting, and whether the economy is on better footing will all be factors going forward. In the meantime, if you’re looking to start a business or get financing now, there are other things to worry about than the Fed’s decision.

To prepare for the coming change please contact Redmount Capital Partners or learn more about our capabilities.

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Clicking the Like button on various social media platforms, such as LinkedIn, Facebook, etc. does not constitute a testimonial for or endorsement of Redmount Capital Partners LLC or any Investment Advisor Representative. “Like” is not meant in the traditional sense. Posts must refrain from recommending investment advisory services or providing testimonials for our firm, since they are strictly prohibited. Please understand that we are required to delete such posts, since this is a regulatory requirement.

Emerging Markets: The Fundamental Divergence

While the US dollar appreciation and sharp drop in commodity prices since mid-2014 have been the reasons for our negative stance on emerging market producers throughout the past year, the second round of commodity price decline experienced during the past quarter, alongside Chinese cyclical weakness, has brought about a more generalized negative sentiment on all emerging economies, regardless of their fundamentals.

In a nutshell

• The fundamental divide between consumer and commodity producing countries is still in place – favor Asia.
• India looks particularly well positioned, both structurally and from a cyclical perspective.
• Brazil’s woes are not just oil-related, and point to a lengthy recession.

The recent contagion should not mask the wide divergences that remain between emerging countries. We hold to our view that caution and selectivity are warranted. Indeed, while Latin American countries and Russia continue to suffer from their dependence to commodity prices, as demonstrated by collapsing currencies and contracting industrial production growth, emerging Asia is faring much better, with industrial production still growing at a healthy pace. In other terms, despite the increased fragility of the emerging world at large, the divide between consumer and commodity producing countries remains. So long, of course, that we are correct in assuming a Chinese stabilisation – within its secular downtrend.

For now, many thus maintain our long-held preference for Asian countries. As a whole, the region still boasts solid fundamentals with an expected 2015 current account surplus of 2% (International Monetary Fund (IMF) data) and controlled inflation levels (except in Indonesia) allowing for pro-growth monetary policies. India’s long-term story also remains extremely positive, as long as supply-side reforms do not disappoint, with a fast growing and young middle class. Cyclically, as a net importer, India is a major beneficiary of the fall in commodity prices, which has also helped control historically high inflation levels, allowing the central bank to adopt an expansionary monetary policy.

On the other side of the spectrum, many remain negative on Russia, South Africa and most Latin American countries. Russia’s dependence on oil has brought about a vicious circle of falling currency, high inflation, tight monetary policy and contracting growth. Although, even though oil broke below $40, most expect oil prices to rebound to our long-held USD 50-70 range, this should not prove enough for Russia to break out of the vicious spiral anytime soon. With a large external deficit, high inflation and falling currency, South Africa remains vulnerable to capital outflows. Finally, within Latin America, indeed emerging economies as a whole, Brazil is our biggest concern. The issues there seem to have intensified rather than stabilized over the past few months. A broader collapse of Brazil, which represents some 3% of world GDP (roughly the size of France or Italy), would be particularly worrisome, not only for the region but also for already fragile global growth.

How concerned should we be about Brazil?

Like Russia, Brazil is trapped in a vicious spiral of collapsing currency, skyrocketing inflation, tight monetary policy and deepening recession. The oil price drop did exacerbate Brazil’s woes, but it is not their underlying cause. The country’s fundamentals had already been eroding for some 10 years, as evidenced by a deteriorating current account and lax fiscal policy – even as commodity prices were booming.

Most see three major risks for Brazil. The first is political: Dilma Rousseff’s growing unpopularity means that she has no capital to drive fiscal reforms. An impeachment could in theory allow for a more credible leader to take the reins, but it would also lead to a period of high uncertainty. The second risk stems from China: Brazil would be severely hurt by a hard landing of its main trading partner. The third risk is fiscal: while sovereign default is unlikely in our view given the low level of US dollar-denominated debt, private debt is also growing fast.

All told, many expect Brazil to remain in recession for some time and its currency to stay weak, which will eventually become a support. In terms of our global economic scenario, assuming that China, the US dollar and commodity prices do stabilize, Brazilian issues should not have a systemic impact.

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Monthly Economic Commentary

Economic and market highlights

Economics

The US Federal Reserve left the federal funds rate unchanged in October but adopted a more hawkish tone in its press release, removing references to global financial and economic risks. The implication being that the chances of a December rate rise have increased. The target band remains 0 to 25 basis points. We forecast that the first Federal Reserve interest rate rise for the new tightening cycle will occur in December 2015, which is in line with market consensus.

The Chinese Caixin Flash Purchasing Managers Index (PMI) shows manufacturing activity continues to slow, although the reading was fractionally stronger than anticipated at 48.3, up from 47.2 the previous month. In the eurozone, PMI readings have been relatively robust for most of the year, with October’s registering at 52.3 while after some strong data in the US over the past year, things are looking a little more subdued with the PMI at 50.1 with purchasing managers surveyed citing the strong dollar and energy markets as headwinds.

Source: MWM Research, Caixin, ISM, Markit, November 2015

Deflation in Europe remains a concern with Germany's Harmonised Index of Consumer Prices (HICP) registering a 0.2% fall year-on-year, while import prices fell 3.1%. The Euro area HICP is -0.1% year-on-year with core inflation running at 0.9%.

The latest real GDP figures from China show a 6.9% growth year-on-year, with the announcement after the 5th Plenum reiterating the goal to double China's GDP between 2010 and 2020, implying an average growth rate of 6.5% per year over the next five years.

Canada entered a technical recession in the first half of the year but is expected to return to growth in the third quarter. Australia was sailing close to the wind with a 0.2% quarter-on-quarter growth rate in the June quarter, although we expect a rebound for the third and fourth quarters of 2015 with a pickup in manufacturing output and strong retail trade.

Bonds

The downward trajectory of US 10-year note yields over the last few months looks to be reversing with the latest statements from the Federal Reserve conspicuously removing warnings about global financial and economic risks. Fixed income markets are pricing in a greater chance of a December rate hike after what was perceived to be relatively more hawkish statements. Yields in the United Kingdom, also close to a new rate hike cycle, followed suit. In Europe, while 10-year rates moved, there was very little response at the short end, which remain relatively stable near or below zero due to quantitative easing.

Equities

Equities were broadly stronger in October as they began to shrug off the volatility of August and September. In local currency terms, the strongest developed markets were Germany and Japan, up 11.8 and 10.9% respectively. The US gained 8.1% while Australia lagged, adding only 4.2%. Emerging market equities underperformed developed markets with China rallying 9.1% while the MSCI Emerging Market Index recovered 5.3 percent, dragged down by Brazil, India and Russia.

The S&P500 has staged a dramatic recovery, rallying 11.6% from its September lows and now rests just 1.4% away from new highs.

Currencies

The Canadian dollar and Swiss franc gained 2.4% while the British pound was up a fraction less at 2.0%. The Australian dollar has strengthened 1.6% over the course of October. The Quantitative Easing currencies euro and yen lost 1.0 and 0.8% respectively.

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Clicking the Like button on various social media platforms, such as LinkedIn, Facebook, etc. does not constitute a testimonial for or endorsement of Redmount Capital Partners LLC or any Investment Advisor Representative. “Like” is not meant in the traditional sense. Posts must refrain from recommending investment advisory services or providing testimonials for our firm, since they are strictly prohibited. Please understand that we are required to delete such posts, since this is a regulatory requirement.