In an earlier note this year we argued that full employment appears to be taking precedence over price stability: a higher tolerance for inflation might be justified by our society today – in the name of reducing unemployment. Underneath this policy shift and catalysed by the current crisis is a growing awareness of inequality – and the appetite to reduce it. The G7 agreement for a global minimum corporate tax rate is a new marker suggesting that burden sharing is set to change. The rich, whether individual or corporate, are likely to have to pay more to help the low-paid in the coming years. Within equities, these shifts may have important implications – likely supporting low priced assets whose value is based on today’s cashflows – and hindering those expensive assets whose valuation is based on the long-dated cashflows of tomorrow.
Major societal upheaval has often laid the ground for increased government intervention and expanded support. After World War I, the national political mood allowed Lloyd George to introduce the beginnings of government welfare, with legislation expanding the provision of education, healthcare and housing. During World War 2, the Beveridge Report argued for another leap forward, where the state should establish a support system “from cradle to grave”. Clement Attlee, incorporating the Beveridge Report in his manifesto, won by a landslide in 1945.
Whilst the current virus crisis is not war, it appears similarly inequitable. Certain families and businesses have been untouched from a health and financial perspective, whilst others have faced tragedy and major upheaval. As we all know, certain large corporations have flourished. The starkness of these differing fortunes and the inequality of outcomes are having a galvanizing effect and driving policy. Tax havens are an obvious target and are facing a hostile period ahead. So too are large corporations or financial structures using excessive engineering to avoid tax. Significant wealth, one way or the other, appears set to face higher taxation.
As equity investors, we view taxes in a similar way to interest rates: the longer the duration of the asset and the higher the valuation, the more sensitive to tax changes. The prospect and enactment of Donald Trump’s sweeping corporate tax cut helped ignite the rally in US equities, but it benefitted the Nasdaq the most. The largest multiple expansion came from those securities that were already the most expensive. Now we are set to see this work in reverse. Higher interest rates and higher taxes ought to have the greatest impact on the most expensive securities. The phenomenon may have started already. Value investors have a greater protection from this risk.
If history is a guide, the movement to promote equality and to raise taxes on the wealthy has the potential to last. At Lightman, we are invested on the basis of higher taxes and higher government spending for the foreseeable future. A larger share of government spending in the economy has historically been associated with higher inflation and as a consequence, higher nominal GDP growth.
We invest in a number of companies at low valuations that are positively correlated to higher nominal GDP growth. We own positions in leading companies in Materials, Financials, Industrials and Autos that are experiencing strong earnings growth. Many of these companies are supported by the investment cycle driven by the clean energy transition. Government legislation and spending plans are aligned directly or indirectly with the majority of our positions. Our companies also have solid balance sheets. 10% of the LF Lightman European Fund’s holdings have a net cash position and over 50% have less than 1x net debt to ebitda. The valuation of our companies are grounded in the reality of operational performance today, with large net assets and solid cashflows.
Value investing continues to recover. Expensive securities have started to underperform. The economic, political and social environment suggest value’s renaissance is likely to last. We remain optimistic about the absolute and relative return potential of the LF Lightman European Fund in the coming years.
Sources:
Lightman – May 2021
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