A Demographic Ephiphany

It all started last weekend when my wife texted me a picture of months-old babies lined up on a couch at a friend’s house. While the photo included five tiny tots, actually, there were a total of 10 babies on display!  The very next night we had a group of friends to our house for dinner and there were no fewer than four young couples that will likely celebrate their nuptials within 18-24 months, and we all know what happens then. The fact that I received news this morning that a young man in our office was now the proud father of a healthy 8 pound 7 ounce baby boy only adds to the anecdotal evidence of some larger demographic happening. However, a closer look at the facts informs us that a new demographic trend is developing and it offers meaningful economic hope.

Demographers generally define those people currently between the ages of 18 and 37 as Generation Y or Millennials, most having entered adulthood after the turn of the century.  Interestingly, these Millennials snuck up on us, not only in terms of their numbers, but their spending power as well.  Generation Y is now 86 million strong and currently represents 27% of the population – outnumbering the baby boom generation, which has just over 80 million members and represents 25% of the U.S. population. When factoring in immigration, the Millennials could grow to over 88 million by 2020. As for spending power, the Millennials represent huge potential.  Consider for a moment that the baby boomers reached their peak spending years in the 1990s and were largely responsible for an average 3.4% GDP growth during those years.  If a similar pattern occurs with Generation Y, GDP growth could be boosted a full percentage point or more from current levels.  To be sure, 3.5% growth is the elusive economic elixir necessary to combat mounting debt levels.

Millennials got off to a very slow start as the first decade of their adult lives was plagued by two recessions, one classified as the Great Recession in recognition of its magnitude and its historical significance.  Moreover, the stock market was flat for Millennials over their first decade as investors. This slow start delayed Gen Y’s job development and household formation, two huge contributors to economic growth. However, the Y Generation now accounts for $1.3 trillion of consumer spending and they are just hitting their stride.  The job situation for Millennials is improving and with it the prospect for increased spending on places to live, food to eat, clothes to wear, and cars to drive.  Notwithstanding a late start, Millennials are not only well educated but also understand the harsh realities of underfunded entitlement programs, which have made them more skeptical of and less reliant on future government assistance. According to Vanguard, Gen Y is investing and they aren’t afraid of stocks.  Mr. Market’s relentless move up to the right may, indeed, be discounting more than short term improving economic fundamentals and may be taking notice of the meaningful Millennial fire power in the years to come.

The demographic trends preceding Generation Y tells a story all its own. The aging baby-boom generation here in the U.S., once a magnificent growth engine, has peaked and now provides little help in pushing GDP growth to historic norms. There are now more Americans age 65 or older than at any time in US history and the number is estimated to more than double by 2050.  Not only are baby boomers getting older, but improving healthcare has lengthened life expectancies, the combination of which has swelled the ranks of those eligible for the entitlement programs known as Social Security, Medicaid, and Medicare.  It is no wonder that these programs are underfunded and subject to ongoing debate as to their fate.

If ever there was a poster child for the woes of an aging population it would have to be Japan. Japan’s demographic reality has been discussed for years by economists who have attempted to predict the country’s fate and by hedge fund managers who have bet that the aging population of Japan will be ruinous to their economy and their currency. While Japanese Prime Minister Shinzo Abe’s structural reforms (Abenomics) and the Japanese Central Bank’s American-styled quantitative easing policy ignited a rally in Japanese equity markets, it now appears that Japan’s bad demographics may be too much to overcome. There are a growing number of believers that Japanese demographics have baked-in a very dire outcome for the country. Time will tell.

Generation Y is a massive differentiator when comparing the impact of demographics on the US and Japan. The size and nature of the Millennial Generation has the potential to have a hugely positive impact on the economy.  Forbes Magazine noted the following: “No generation before has had as much access, technological power, or infrastructure to share their ideas as quickly as Millennials. They are used to speed, multi-tasking, and working on their own schedule. These can be great assets in a knowledge-based economy that values end results over process.”

Of course, Generation Y is not without its challenges.  Profligate spending of previous generations has burdened this new generation with a huge mountain of debt, the cost of which is mitigated by low interest rates, but the principal balance remains. Moreover, Generation Y has been saddled with a diet of trans-fatty foods and an exercise regimen of video games, the tragic combination of which has led to an obesity epidemic. It is sad to acknowledge that Millennials could be the first generation in over 100 years to see their lifespan level off or even decline.

The Millennial Generation appears to be relatively well-equipped to meet their inherited challenges and those yet to come. Generation Y has a deep bench of well-educated, socially-connected, tech-savvy Americans that will likely exceed the economic growth engine of the Baby Boom generation. Time will tell. 

David Post
Telemus Capital Investment Committee Chair
September 20, 2014

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only.  It is not intended as investment advice and does not address or account for individual investor circumstances.  Investment decisions should always be made based on the client’s specific financial needs and objectives, goals, time horizon and risk tolerance.  The statements contained herein are based solely upon the opinions of Telemus Capital, LLC.  All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

Energy Prices and the Middle East Conflict

History is littered with transformational changes resulting from new discoveries, inventions, and technologies. Over the past several years there have been significant energy‐related technological improvements which have the potential to be truly transformational in terms of the impact on our decades‐long dependence on imported oil and changing a geo‐political dynamic that has been in place for nearly 50 years.

In days gone by a crisis in the Middle East caused the price of oil to shoot higher and economic prospects to be impacted negatively. It has been interesting to see the price action in the energy market and the impact on the US economy in the face of the most recent conflict and escalation of hostilities in the Middle East. In fact, Brent crude is actually cheaper today than it was three months ago and new highs in the equity markets are signaling no adverse impact on the US economy. What makes today different than in years past? Our dependence on Middle East oil has been greatly diminished as a result of a huge North American energy boom. Today the US imports more oil from Canada than from all the major oil producers in the Middle East. Furthermore, US energy production is climbing at a record pace and satisfying a greater and greater percentage of our domestic energy needs.

The Return of the American Energy Boom

It’s been a long while since the words “America” and “energy production boom” have been used in the same sentence, but that is exactly what’s happening today. The Energy Information Administration (EIA) has reported that not only has the US oil production renaissance decreased our reliance on imported oil, it has also successfully stabilized world oil prices. Strong energy output is expected to grow rapidly over the next few years from the Bakken, Eagle Ford, and Permian regions. Coincident with this growth in supply, US energy demand is expected to increase only slightly. Multiple data points confirm that the current growth of domestic energy production will ultimately lead to energy independence, perhaps sooner than we ever thought possible. In fact, many economists and energy experts believe that America could be energy independent by 2020.

What Changed?

The obvious question is how did the energy dynamic change so quickly? The answer is twofold. First, technology‐driven improvements in horizontal drilling and hydraulic fracturing (fracking) have not only facilitated the discovery of new fields, but also served to dramatically increase production in fields whose reserves were either thought to be unrecoverable (reserves trapped in shale formations and in deep‐water locations) or exhausted. The U.S. Department of Energy (DOE) now estimates that our current reserves provide us with a 90‐year supply of natural gas! In just the past decade, America has gone from an expected importer of natural gas to potentially the world’s largest exporter of natural gas.

In order to ship natural gas around the world, it must be converted to liquefied natural gas (LNG). Once converted, it can be shipped via tanker all around the world. Even though the U.S. does not currently have sufficient infrastructure (LNG export terminals) to export natural gas on a broad scale, many projects are currently under construction and/or awaiting DOE approval, with the first terminal expected to come online by 2015. Eventually, LNG exporting could be a boon for the U.S. economy resulting in increased local and state revenues from taxes and licensing and increased demand for workers to construct these terminals. Moreover, an increase in exports will allow for a much needed reduction in our trade deficit.

How The US Energy Renaissance Impacts Investment Strategies 

Importantly, the energy production boom is impacting other sectors of the economy that are dependent on plentiful and inexpensive natural gas. For example, according to PwC (PricewaterhouseCoopers, LLP), while the U.S. manufacturing resurgence has benefitted from rising labor costs in markets such as China and South America, cheap and abundant domestic energy are playing a more prominent role in the decision by manufacturers to re‐shore or on‐shore to the U.S. Even the agricultural sector has been impacted as domestic fertilizer businesses realize the competitive advantages of an increasing supply of cheap natural gas. The US energy renaissance is creating a growing supply of energy and an increasing need for energy-related infrastructure to collect, store, and transport the product.

This dynamic has created some very interesting investment opportunities. While a number of our Telemus model portfolio investments are positively impacted by the growth in US energy production, none more than our investments in the energy MLP (Master Limited Partnership) space. We have made a “passive” investment in the Alerian MLP Index (AMJ) and an “active” investment in Salient MLP & Infrastructure II (SMLPX), both of which have meaningfully out-performed the equity markets in 2014i. Moreover, Salient has proven to be among the best in the MLP space with a number one ranking for the 3, 6, and 12 month-periods ending June 30, 2014. We believe that our investments in energy infrastructure have been well-placed and will likely be part of the portfolio as long as the current dynamic in the US energy markets remains in place.

David Post
Telemus Investment Committee Chair

iYTD through August 26, 2014 the S&P 500, AMJ and SMLPX are up 8.2%, 15.1% and 24.5%, respectively.

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances. Investment decisions should always be made based on the client’s specific financial needs and objectives, goals, time horizon and risk tolerance. The statements contained herein are based solely upon the opinions of Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

Large Capital Gains and Tax Shock

Whenever you are dealing with a large sales transaction (sale of a business, large stock sale, etc.) taxes are a key driver. This is more true today than ever, due to changes in the tax laws. The impact of higher income on the limitation of tax deductions, the surtax, higher capital gain taxes all resulting in gains being taxed at an effective tax rate of nearly 25% versus 15% not that long ago.

Advance planning can potentially reduce the tax impact by considering tax strategies including: 

         Use of charitable trusts to reduce the overall tax impact and timing of recognition

         Consideration of installment sales to defer taxes

         Family trust sales

         1031 (like-kind exchanges) to defer taxability

         Finally do “deferred sales trusts” make sense and are they viable?

Overarching Takeaways

It is important to understand that these tax deferral strategies are complex and could have significant tax risk if not properly structured. One of today’s hot topics is the “Deferred Sales Trust” transaction which is gaining interest due to the current higher effective tax rates. These trusts need to be considered in light of numerous risks including validity of the trust, the transaction, changing future tax rates, and transaction costs. Essentially these transactions are structured in a way that allows a complete sale with all sales proceeds being realized but allowing the seller to use the installment method to spread out the tax while still knowing that the proceeds are secure.