“The things you think are precious I can’t understand” – Becker/Fagen
“A house divided against itself cannot stand” – Lincoln
Lay people can be puzzled by the emphasis investors place on seemingly inconsequential things – quarterly company results, for example, or a decimal place on an economic indicator. They also get frustrated when markets fail to take seriously some obviously important things – such as next Tuesday’s too-close-to-call election of the leader of the free world.
Even as China narrows America’s economic lead, the US president is still important to global markets, as well as geopolitically of course. But historically, the wider economic backdrop has mattered even more than the occupant of the White House, and it is largely shaped by forces beyond the POTUS’s control. An added complication now is that the most pressing US political issue facing markets is the ability of Congress to reach cross-party compromise on the rapidly-approaching ‘fiscal cliff’ (discussed in September’s Compass). This is unlikely to be resolved as the general election results arrive in the small hours on Wednesday.
There are differences of course between the two candidates economically. President Obama favours bigger government and higher taxes. Other things equal, then, markets might prefer Challenger Romney (despite his saying that he would not offer Fed Chairman Bernanke a second term in 2014, which some commentators suggest – mistakenly, in our view – might imply less lenient monetary policy then). But remember that the US economic debate takes place in a much more liberal (that is, laisser-faire) context than the European one, and that these differences are small alongside the wider economic uncertainties.
Irrespective of the presidential result, the Congressional elections may return a Republican majority to the House of Representatives, but leave the Democrats with blocking power in the Senate (where only a third of seats are up for election). This likely divided Congress is what makes that looming fiscal tightening of more than 4% of GDP so dangerous. Its collective mood could be critically but unpredictably affected by the winners of key Senate and House seats, and by its interaction with the White House, and a quick resolution seems unlikely.
We still think a compromise will be reached, and the actual hit to the economy in 2013 will be a fraction of what it could be – a likely headwind, rather than a reversal – but only after some protracted brinkmanship extending up to and beyond the 1 January ‘deadline’. Our portfolio advice ahead of Tuesday has been to sit tight, but expect some resumed volatility into the New Year (the evolving euro crisis could have the same effect). That could be another chance for long-term investors sheltering in ‘safe haven’ assets – especially government bonds, which are still fiercely expensive – to rotate into the assets that we think offer the best risk-adjusted strategic returns, namely selected corporate securities (stocks and high-yield credit).
The corporate outlook has not been affected significantly either by Hurricane Sandy, despite its high cost in human terms, or by the latest batch of those quarterly earnings announcements. Expectations for the latter were managed down, of course – but stocks are not priced rigidly on analysts’ forecasts, and to us have long seemed to be implicitly expecting a much lower level of earnings again. Meanwhile, the latest macro data – including today’s jobs report – suggest the US economy is approaching that fiscal cliff with a little more momentum than feared.
Kevin Gardiner, Head of Investment Strategy EMEA