Westshore Wealth

Thematic trading ideas based on the election outcome have become extremely popular of late.?One such idea with broad consensus support is to avoid emerging markets.?The thinking is that tariffs will extinguish incentives for American companies to import goods from these nations.?Experts point to the fact that since the onset of Trump’s tariffs in 2016, China’s share of U.S. imports have fallen from 21% to 15%.?What will happen when tariffs go up by 60%??Doomsday, right? It's important to understand that tariffs create distortions in economic incentives.?While it is true that the U.S. share of Chinese imports fell, how do we reconcile the fact that China’s share of global exports rose by over 1.5 percentage points since the tariff introduction??Was the rest of the world growing faster than the United States??No.?Did China find other countries to buy their goods??Perhaps.?However, the magnitude of China’s growth suggests that American importers and Chinese exporters simply found a way to circumvent the rules.?Vietnamese solar panels, constructed with Chinese solar wafers, still managed to get to the U.S.?iPhones made of Chinese circuit boards and displays saw final assembly in India, and in turn were imported into the U.S. as Indian goods.?Meanwhile, Mexico’s exports to the U.S. grew 55% from 2016 to present.?Could some of those imports have been Chinese goods that were simply reimported into the U.S. as Mexican goods??Likely. Our point here is simple.?The United States doesn’t have infinite resources, nor a cost and competitive advantage in every industry.?There are plenty of commodities and parts that can be produced more cheaply and efficiently outside of America.?Tariffs do a lot to distort incentives, but enterprising people always find remedies to problems that aren’t immediately contemplated.?Our sense is that emerging markets embed extraordinarily low expectations and are likely to be just fine.

As Winston Churchill famously remarked, “those who do not study history are doomed to repeat it.”?The S&P 500 Health Care Sector ETF (XLV) has fallen roughly 10% in the past two months, punctuated by an accelerated drop post the President-Elect’s announcement that he intends to nominate Robert F. Kennedy Jr as Secretary of Health and Human Services.?Trump’s quote encouraging RFK Jr to “go wild” on healthcare has investors on edge that it could imperil fundamentals, unleash price controls, and restrict sales of vaccinations.?We remind investors that this pattern of selling off healthcare stocks in past election cycles is not new.?We saw this during the lead up to Bill Clinton’s presidency (Hillarycare), the election of Obama (Obamacare), and in both Trump terms (the first related to CMS being allowed to negotiate drug pricing for Medicare, and now the second with RFK Jr fears).?Our message to investors is that very little of consequence changes.?In the end, the catch-up trade is very powerful.?Don’t fall prey to this trap. If historical context doesn’t put your mind at ease, we urge investors to ask themselves the following questions.?Do you really think that we will roll back over 120 years of historical usage of vaccinations??These are the very scientific discoveries that allowed us to functionally eradicate smallpox, polio, tetanus, measles, mumps, and rubella.?Could we have tougher, longer trials, with larger control sizes??Perhaps, but we aren’t going to radically alter the administration of vaccinations.?Second, do you truly believe that Donald Trump or the Republican party wants to cede dominance in leadership industries like pharmaceutical discovery, biotechnology, or medical technology to foreign entities??Strangling these domestic companies with regulation, preventing them from selling lifesaving medications, or restricting them from pursuing trials or discovery would absolutely cause that outcome.?The odds seem exceeding low to our team.?Finally, do we think that the Republican party will usher in price controls and extinguish the economic incentive for the industry to spend on research and development??History tells us the opposite position has been a hallmark of the Party’s political stance for years.?Bottom line don’t let fear drive your investment function.?Common sense, and plenty of historical context, tells us the healthcare sector will be just fine.

The clear investment winner from the Trump victory in our opinion will be U.S. small capitalization equities (represented by the Russell 2000 index). Four quick points help explain why. 1.)???Small cap companies derive the bulk of their revenue domestically, and thus are less impacted by the President-elect’s campaign promise to raise tariffs. ? 2.)???Small caps are extremely leveraged to changes in interest rates.?Unlike large capitalization equities found in the S&P 500 index, most small caps don’t have the cash flow consistency to access the long-term, fixed-rate debt markets.?They are confined to short-term bank loans where interest rates float.?BlackRock estimates that the average S&P 500 company is financed for the next 10 years at a rate of less than 3.5%.?By contrast, most small cap equities are financed for the next 2-3 years at rates between 6% -11%. ?Here is the good news.?The Federal Reserve is amidst a campaign to lower interest rates, having reduced Fed Funds by 0.75% in the past three months.?As loans reset for small caps, their interest expense will fall and that delta will bolster profitability. 3.)???Small caps are extremely sensitive to tax rates.?While the House of Representatives election outcome is still being tabulated, most media outlets believe that Republicans will retain legislative control.?If that is the case, it opens the door for Trump to enact one of his campaign promises, namely lowering the U.S. corporate tax rate further from 21% to 15%.?While large capitalization names generate revenue all over the world, and thus are subject to different tax regimes, small capitalization names are largely domestic in nature.?Thus, they tend to feel the full extent of the tax reduction.?This will drive faster earnings growth within the small cap universe relative to large caps. 4.)???Finally, while past performance is no guarantee of future results, small capitalization equities have dramatically outperformed large cap equities over the long-term, better than double the performance since 1926. That said, the opposite has been true over the past 10 years.?According to JP Morgan Asset Management, the 10-year annualized return of large cap growth (indicative of the S&P 500) has outpaced small caps by over 7.5% annually.?That delta is unprecedented and has been driven by a concentrated group of equities.?To illustrate, the top 10 names within the S&P 500 account for nearly 36% of the index weight and have accounted for over 50% of performance.?Their collective Price/Earnings ratio is a whopping 31x.?That is 150% of average since 1996.?To say that has left large cap companies quite rich relative to historical standards is an understatement.?We believe the aforementioned points above will prove to be the catalyst to drive mean reversion.

Cohen & Steers, a venerable asset manager specializing in real estate, recently shared the following illustration with its clients.?It depicts monthly changes in U.S. commercial real estate (CRE) valuations.?There are three different indices, MSCI, Costar, and Green Street that all independently suggest that valuations rose month-over-month in August 2024.?Why is this important??This represents the first time all three have risen in unison since March 2022.?It underscores our view that the CRE market is bottoming.? The timing of this recovery seems to be playing out on schedule relative to historical precedent.?Typically, public real estate securities (REITs) tend to bottom first.?They did so this cycle in October 2023.?Valuations of private CRE tend to bottom out approximately 12 months later (according to these indices, it would be 11 months post the REIT bottom).?CRE debt distress, the final, lagging indicator, tends to work itself out 12-plus months after the CRE valuations bottom.? How are we playing these trends at Westshore??As you may recall, we recommended investors shift from private real estate to public mid-year 2024.?The resulting outperformance has been substantial, with the Cohen & Steers Institutional Realty Shares fund (CSRIX) that we selected, up over 12.5% since June 1.?Meanwhile the largest private real estate vehicle, Blackstone BREIT, is up fractionally.?As we surveil the landscape, we believe distressed real estate debt restructuring offers the next big opportunity.?While the headlines are apt to get worse before they get better, the time to evaluate that asset class is now.?We intend to diligence and recommend a strategy in the coming months.?

The inconvenient truth about AI, and the data centers that power it, is that they consume huge quantities of power to perform their computationally intense “learning.”?According to Business Insider, ChatGPT, one of the most well-known AI models, is using approximately 500,000 kilowatt-hours of electricity to respond to its roughly 200 million daily requests.?To put that in context, the average US household uses 30 kilowatt-hours/day according to the Unites States Energy Information Association.?Said differently, ChatGPT uses enough energy to power nearly 17,000 homes.?At what point do data centers start to drive up electricity prices, cause power shortages, and seed a retail consumer revolt? The 10/8/24 Wall Street Journal article, entitled Arizona Voters at Breaking Point Over Cost of Electricity, illustrates that this problem isn’t simply esoteric.?Data centers consume 7% of total power in AZ, shy of some of the other states in the Union, but at the higher end of the continuum.?The issue becomes increasingly tricky as we move forward.?If estimates prove accurate, Nvidia is on pace to sell enough AI chips to power the equivalent of 1,000 ChatGPT models by the end of 2026 (source Empirical Research, JP Morgan).?Not all of these will be based in the United States of course, but if they were, that would equate to enough energy demand to power nearly 12% of all homes in America. Our point here is simple.?In the not-too-distant future, the location of data centers likely becomes a NIMBY (not in my backyard) issue.?This represents an exogenous risk that needs to be considered when investing in many of the most popular technology companies. Data centers’ share of total power consumption. Source:?Electric Power Research Institute, Apollo Chief Economist. Note..States in Grey lack reliable data.

We have started to receive some nervous calls over the potential impact of the East and Gulf Coast dockworkers strike.?To be sure, this is meaningful for the US economy.?The 14 largest ports affected by the strike collectively handle 25% of US goods imports and 27% of goods exports.?That equates to 2.8% of US GDP on the import side and 1.9% of US GDP on the export side of the equation.?Could this cause a dip in payrolls, decrease the availability of goods, put further pressure on the manufacturing sector, and cause inflationary pressures??The answer is yes, however, let us put it in context.?As you can see in the following Goldman Sachs chart, most of these strikes last a week or less.? Goldman estimates a 10-day strike would cost the US economy 0.2%.?A strike lasting twice as long would add a similar proportional impact and would cause a payroll dip of approximately 45k workers.?That would be easily identified in the dataset, and thus we believe investors would treat it as a one-time item.?We believe there is intense pressure on the current political administration to avoid a protracted strike which would imperil growth or stimulate inflation.?That alone should be a catalyst to resolve this situation quickly.?Our bottom line is this.?Strikes are transitory and the stock market treats them as such.?Don’t panic.

One of the more interesting observations that we have witnessed lately is the continued disdain for Emerging Markets (EM) equities and debt.?According to Lazard Asset Management, Emerging Markets remain an under-owned asset class.?Their work concludes that a mean reversion to the 20-year average asset allocation weighting would represent inflows of $910 billion into the asset class.?For context, that equates to roughly 58% of current EM assets under management. Why the disconnect from historical asset allocation patters??Investors often suffer from a cognitive bias that favors recent events over historic ones.?We call that Recency Bias.?In this situation, EM has underperformed for years in a row, there has been significant geopolitical risk, and finally, the largest emerging market in the world, China, has been embroiled in a property bust akin to what the United States experienced in 2007-08.?However, there are reasons for optimism. What will be the catalyst to propel outperformance and nudge investors to devote more capital to the asset class??First, EM economic growth in 2024, as measured by GDP is up 4.2% YTD while developed markets have seen growth slow to 1.5%.?Earnings are following suit.?Consensus forecasts have EM growing 17% in 2024 and 15% in 2025, as compared to the United States at 11% and 14%, respectively.?Meanwhile, valuations of EM equities reside at 12.6x compared to 18.7x for developed markets, and 21.7x for the United States.?Additionally, we are finally entering into a period of Federal Reserve interest rate easing.?Historically, this provides cover for emerging markets to follow suit, and incidentally, we are already seeing it.?Finally, China is starting to recover.?The charts below, courtesy of Carlyle, show that Chinese real estate sales appear to bouncing off the lows, coincident with housing pricing finding its bottom.?And by the way, that was observed before China’s central bank unveiled a major package of measures aimed at reinvigorating the country’s economy on Tuesday.?The list is lengthy, but it included reductions to mortgage rates, lower minimum down payments for real estate purchases, and loans by the central bank to fund local governments’ purchase of unsold real estate. Our bottom line is that the catalysts are lining up and yet investors are strangely indifferent.?We think this will be a powerful revaluation story and we intend to capture it for our clients.

Election Outcomes Matter Less Than You Think--With the Presidential Election coming into focus, we are entertaining many questions of how that may shape forward returns. It may surprise some, but copious amounts of data suggest that the market is remarkable agnostic about which political party holds office. So, while one candidate or another may not support your belief set, don't use that as a reason to shift your asset allocation. Time in the market matters above all else. For more detail, please visit https://lnkd.in/gwmDPgvc.

Estate Tax Exemption Sunset--As part of the Tax Cuts and Jobs Act (TCJA) of 2017, the lifetime gifting exemption per individual was lifted from approximately $5.6 million to $11.8 million. That figure is indexed to inflation and presently stands at roughly $13.6 million per person. What does that mean? For a married couple with an estate size of less than $27.2 million, the transference of wealth to heirs can occur tax free. However, the TCJA was not set up in perpetuity. If the Act is not extended or changed by Congress, it will expire on December 31st, 2025. That means the gifting exemption will return to inflation adjusted levels that existed prior to 2017. Said differently, estates of married couples in excess of roughly $14 million will now be taxable to heirs. Westshore can help clients and their estate planning attorneys employ strategies to preserve these higher gifting exemptions. To see a comprehensive list of strategies that we are employing today, please visit our insight page, https://lnkd.in/geM8xaNv or contact our team at 949-825-7518.