Perverse Incentives

According to Republican Representative Jim Gerlach of Pennsylvania, Ernst & Young has a report out that says raising tax rates on the rich could cut 700,000 jobs over the next ten years. The Republicans want to use this as an argument against raising rates. But President Obama was re-elected despite an abysmal jobs performance, and his administration is poised to issue new regulations, held up until the elections were over, that will undoubtedly cause more job losses. Clearly his agenda of a better quality of life regardless of economics is based on his practical experience with "voter-nomics" that shows him the unemployed will vote for the party of entitlements, not the party of jobs. The worry is the Republicans are using arguments that are meaningless to the President, and overestimating their leverage. The White House is now insisting on a more permanent resolution of the debt ceiling, one of the few leverage points the Republicans have. This implies the cliff negotiations may drag into the new year, creating more volatility in the market in the meantime, and more layoffs, which will be used by the White House to blame Republicans.

Why I’m Voting for Romney

It’s a tough choice between two candidates who sincerely want a better America, and whose campaign rhetoric has been tainted by the need for each of them to appeal to their own party bases--representing very polarized groups. I’ve come down to a few simple ideas to make this decision. My biggest concern is the structural budget deficit the US is facing. The US President answers to the people, of course, but he tends to decide what the people are saying to him--usually leaning to the view of a mandate. We haven’t seen it in our day, but the President may soon come to answer to the bond market. Ask the governments of Greece and Spain how this works. Obama’s agenda--or maybe it’s his party base’s agenda, has driven up baseline federal spending to 24-25% of GDP, from about 20-21%. We’ve never been able to raise more than 18% or so of GDP in taxes, except during WW II. Currently taxes are only raising 15% or so of GDP. Taxes are based on activity and incomes, and the incomes portion is really falling short. If we become a higher cost economy, that part may not improve. I don’t mind a 3% budget deficit. If the economy grows that fast, we won’t increase our debt-to-GDP ratio, and the bond vigilantes won’t be dictating terms to us. If we continue on our current path, however, we are likely to keep running deficits in the 6-10% area, increasing our debt-to-GDP ratio and bringing the bond market into play. Remember that even now the Federal Reserve is buying a big portion of the new debt we’re issuing. We can avoid a debt default in this manner, but only at the cost of a dollar that will buy alarmingly fewer goods and services. The government in this scenario would have little choice but to keep printing money because if it paid high bond rates, government spending could be driven up to 27-28% of GDP, leading to catastrophic deficits. I don’t believe much of either candidate’s published plans, but I think Romney will be more serious about fiscal discipline than Obama. The polarization of America is a big concern to me. It bothers me that so many reasonable Americans can’t engage in civil discourse on politics. On a pure track record basis, Romney was able to reach across the aisle as a Republican governor in a a state where the legislature was 85% Democrats. I don’t think this was solely due to his sparkling personality, but I do believe his experience has taught him that you need to solve problems, not hope they’ll go away. I also think it’s important that Massachusetts has a flat tax. I believe that the progressivity of the tax code is the most corruptive influence on politics today. In Massachusetts, the people have had chances to vote on a progressive tax code, and always turned it down. And this is a very liberal state! If politicians have an expensive dream, they have to get a broad spectrum of people to pay the bill. They can’t sell it to some folks on the basis that others will pay for it. It keeps them honest, well, at least for politicians. But most of all, it creates space for political dialog on real issues. Because once you have a progressive tax code, the central issue is always one of what is the fair share of taxes to be paid by different groups. And it is a question that can never be answered. So instead of talking about how we build wealth as a society and opportunity for all, we argue about who pays. If we didn’t have that argument, we’d have more opportunity to reach across the aisle as Romney did. All of us. Of the two candidates, Romney stands for less progressivity in the tax code. The third decision point for me is track record. Romney has been very successful at most things he’s done. People love to attack him for moving jobs to China, but as a businessman I know that making those decisions has taught him what the reasons are that lead to those decisions. And he knows how government can fix the environment that leads businesspeople to make those decisions so more Americans can keep their jobs. I don’t see any background that would let President Obama understand this at a gut level. He didn’t have much of a track record in the Senate, not introducing any bills, and as President, he let the most divisive elements of his party write key legislation instead of taking on a leadership role in the design of it. I’ve hired lots of people in my career. I attribute most of the success I’ve had to identifying talent and motivation in others--since I didn’t have much talent myself! When I think of myself as interviewing Romney and Obama for the job of President, and think about which one is more likely to solve the complex problems he’ll face, I just think Romney has the track record that tells me he’ll be able to accomplish that.

The Windows 8 Ecosystem

My biggest theme this year has been Windows 8. Things looked good earlyin the year, but as the launch approached, the lack of hype, coupled with the slow sales of PCs, and the thought that the PC was dead, drove the stocks in the ecosystem down: Dell, Hewlett, Microsoft, Nokia. Nokia bottomed on July 18, and is up 70% since then. Microsoft made it’s low on October 23 and has been up over 5% in a market which has been essentially flat. The timing of Microsoft’s move is interesting, as it is essentially coincident with the Window 8 launch, and with a great deal of weakness in Apple’s stock. Microsoft isn’t “cool” and its stock has suffered from the perception that it’s products don’t measure up to those of Apple. Over time, though, Microsoft has been adept at becoming a mass market leader in businesses invented by others. It overcame a lead by CPM to become the PC OS leader. Lotus was once the leader in spreadsheets, and Word Perfect in word processors, while Excel and Word are now the staples of Microsoft Office, one of the three big revenue producers at Microsoft. Let’s not forget how Microsoft has performed in the gamebox business. It doesn’t always work, but Microsoft has a lot of patience. On the “cool” front, word is that Oprah sees the Surface tablet as one of her “Favorite Things” of the year. There are a at least two important innovations in Window 8. First is the use of essentially the same operating system and user interface among PCs, tablets, and cell phones.Second is the idea of a touch interface on PCs. The latter may not be perfected yet, but it’s a big change to see Microsoft leading the way, instead of following. As a user, I like the idea of using the same apps on my PC as I do on my tablet and cellphone, with a similar user interface. On my investment axis, I see Microsoft as offering a solid economic value proposition, but it’s brand image is not “cool.” This may slow consumer acceptance of the new system. However, I believe businesses will look at this and see reduced training time, increased help desk efficienncy, and easier integration with corporate systems and security regimes. Many corporations are still running XP. haven’t skipped the Vista and Windows 7 upgrade cycles. XP support runs out in 2014. I think this will be a very attractive upgrade. This upgrade plays right into moving Office to the Cloud and Microsoft’s dominance of the corporate infrastructure software market. It looks to me that market expectations are low, and the company is entering a powerful upgrade cycle. That’s why Microsoft is my largest position. There are some hardware opportunities in the space, but they seem less certain to me. Given the OS integration, we will see convertible devices such as laptops that have detachable tablets. But right now, the speed and simplicity of Windows 8 has given my old laptop new life. I may actually delay purchase of a new laptop. Hewlett and Dell make printers, and the printer business is endangered. Network printers mean we don’t have to have a printer for every PC, tablets are easy to read on, and cell phones allow me to carry electronic travel intineraries instead of printing them, as well as eliminate the need for printing out those Google maps directions. Printing seems to be in secular decline. New products are aimed at enticing users to remotely print stuff from mobile devices for later viewing. We’ll see. Because of all this and it’s other issues, I don’t own any Hewlett, and I wish I didn’t own any Dell. The opportunity for these two is that the market seemed to reprice them since their latest earnings report for a secular PC decline. If that quarter reflected the typical decline in demand before a new OS launch there is plenty of upside. And if the last quarter’s decline was exacerbated because corporate customers wanted to wait for a new generation of machines to run the new OS, there’s even more upside. Dell has $11 billion in cash on a $16 billion market cap, and now has a 3.5% yield. The company has a reputation for finding ways to get cash to shareholders, although there’s a risk that DELL makes more acquisitions to bolster the IT services business and reduces the flow back to shareholders. I’ll probably swallow hard and average down in this one. It’s likely I’ll buy some mbefore the earnings cll and some after. It may be too soon yet for positive guidance to emerge from the call. Even if Windows 8 phones capture market share, the question for Nokia is whether they will make them or somebody else will. If Windows 8 is successful, then Intel also looks cheap. The new iPad mini is selling well, and over the next few years I see a lot of creativity in devices. I see a convergence of tablets and phones, especially among women, who seem to be willing to use devices with larger screens--possibly because they carry purses to put them in! There are signs that some PC makers are thinking about building phones, maybe with Intel chips. It’s clear that the PC hardware makers want to follow the customers into their new devices. If innovation slows down at Apple, their lower cost structures could begin to gain share in the non-PC device market. It would appear even now that Samsung may be making phones that can go toe-to-toe with the iPhone, and how much change will we see from iPhone 5 to iPhone 7? It may be more about forms than function. In a rapidly changing world, the Steve Jobs vision may not last forever. I still think there are lots of things to happen in the future that can keep the PC alive. The touchscreen is here, and it is likely that effective voice recognition is getting closer. Siri is wonderful, but faster chips, which are usually found on PCs rather than mobile devices, are more suited to really practical voice recognition. I believe the market grows as functionality improves.