Navigating the New Normal: Portfolio Management in a Post-Crisis World

1. Navigating the New Normal: Portfolio Management in a Post-Crisis World Portfolio Management Institute Atlanta, Georgia April 22, 2010

2. Portfolio Management in a Hostile Environment Portfolio Management Institute Atlanta, Georgia April 22, 2010

3. Overview • Bottom line: From crisis to crisis • Approach • Baseline • Threats • Opportunities • Mid-Terms

4. Baseline Economics • Next 12 to 24 months – 2 to 4 % growth • Then – 4 to 5 % growth until mid 2 ought teens • Then about 2.5 % annual • Inflation near 2 % through 2010 • Rising to 3 + % by late 2011/early 2012 • Returning to 2 % by 2013 • Interest rates + 100 bp then tracking inflation

5. Investors’ Threat # 1Inflation • Timeframe: late 2011 • Starts and ends with the Fed • Can the Fed nix inflation? • Excess reserves

6. Investors’ Threat # 1Inflation • Timeframe: late 2011 • Starts and ends with the Fed • Can the Fed contain inflation? • Excess reserves • Velocity

7. Investors’ Threat # 1Inflation • Timeframe: late 2011 • Starts and ends with the Fed • Can the Fed contain inflation? • Will it? The beguiling role of excess capacity

8. Investors’ Threat # 1Inflation • Timeframe: late 2011 • Starts and ends with the Fed • Can the Fed contain inflation? • Will it? The beguiling role of excess capacity • Response means slowdown 6 to 9 mos. later

9. Investors’ Threat # 2Washington Anti-Investor Class • Already extended 3.8% payroll tax to capital income • Obama proposed 20% tax on cap gains and dividends • Obama proposed $3.5 million/45% death tax • Cap’N Tax

10. Investors’ Threat # 3 Sovereign Debt • It could all begin in Greece • European Contagion • Tidal waves flow in, and out • States join in – deficits and unfunded retiree benefits • And then there’s Washington

11. Budget Deficits -- Unsustainable % of GDP CBO, 3/2010

12. Federal Receipts Return to Normal % of GDP CBO, 3/2010

13. Problem is Washington Spending % of GDP Average = 20.3 Source: CBO 3/2010

15. Unsustainable Federal Debt % of GDP CBO, 3/2010 CBO, 3/2010

19. Investors’ Threat # 3Washington Taxes, Taxes, and a more Taxes • VAT • Income Tax • Environmental Taxes

20. A Tale of Two Strategies • Reagan – Starve the Beast • Obama – Glut the Beast

21. A Tale of Two Strategies • Reagan – Starve the Beast • Obama – Glut the Beast • Massive spending increases

22. A Tale of Two Strategies • Reagan – Starve the Beast • Obama – Glut the Beast • Massive spending increases • Spending as inevitable

23. A Tale of Two Strategies • Reagan – Starve the Beast • Obama – Glut the Beast • Massive spending increases • Spending as inevitable • As act of God or nature

24. A Tale of Two Strategies • Reagan – Starve the Beast • Obama – Glut the Beast • Massive spending increases • Spending as inevitable • As act of God or nature • As long-term outcome

25. A Tale of Two Strategies • Reagan – Starve the Beast • Obama – Glut the Beast • Massive spending increases • Spending as inevitable • As act of God or nature • As long-term outcome • ANYTHING BUT A CONSCIOUS POLICY DECISION

27. Implication of Gluttony • If much higher spending inevitable, then so are higher taxes • Corporate rate already too high • Rangel, Wyden-Gregg

29. Implication of Gluttony • If much higher spending inevitable, • Then so are higher taxes • Corporate rate already too high • Rangel, Wyden-Gregg • Current system nearly tapped out

30. Historical Perspective on the Fisc • Average federal tax about 18.2 % of GDP • Average deficit = sustainable deficit about 2.2 % • Average spending about 20.4 %

31. Taxes, Or Not • Existing system to 20 % of GDP • With 2 % deficit and 25 % spending • Leaves gap of 3 % of GDP • Absent fundamental entitlements reforms, long-run shortfalls much higher

33. Implication of Gluttony • If much high spending inevitable, • Then so are higher taxes • Corporate rate already too high • Rangel, Wyden-Gregg • Current system nearly tapped out • Must find another revenue source • Answer – A VAT

34. The VAT Wave • Volcker – AValue-Added Tax (VAT) “on the table” • Brookings – 15 to 20 percent VAT • Congressional Budget Office – Studying VAT • Tax Policy Center – A VAT to replace the payroll tax and corporate income tax

35. What’s A VAT? • An operational national retail sales tax • Intended as an add on • VAT rates typically 15 to 20% • EU minimum standard rate of 15%

36. Glut the Beast = VAT • Spending means fiscal policy unsustainable • Massive source of new revenues • 1 percentage point = net $50 billion in tax revenue • 15 percent VAT = $750 billion in tax revenue • 15 percent VAT -> 5 percent of GDP

37. Why a VAT? • Massive source of new revenues • VAT is among least damaging to economy • VAT is nearly invisible to taxpayers

38. Investors’ Threat # 3Glut the Beast – the Conclusion • Sovereign debt crisis begins in Greece • Flows across Europe to U.S. • U.S. credit market crisis triggers a panic to act • VAT plus other tax hikes, especially on capital • Or reverse Obama’s spending?

39. Opportunities, Too • Global economy more balanced (India, China, Brazil, etc.) • Output Gap over 10 percent • Basic institutions remain sound • Entrepreneurial spirit is alive • The nation woke up • Mid-Term Elections

40. Portfolio Management in a Hostile Environment Portfolio Management Institute Atlanta, Georgia April 22, 2010

43. Portfolio Management in a Hostile Environment Portfolio Management Institute Atlanta, Georgia April 22, 2010