Late last year, it was a rarity to go one day without hearing the term, “fiscal cliff” – that point in time when we would go “over the edge” causing drastic cuts to spending and tax increases if a political settlement wasn’t struck by the new year. Eventually a deal was worked out at the very last moment before markets opened for the first day of trading in 2013.
The behavior of the stock markets since mid-November was fascinating in retrospect. With one crisis after another emerging domestically as well as in Europe since the crash in 2008, the train wreck to come prognosticated daily after the presidential election was met with a stock market increase of over 5%! The market had finally concluded that it could no longer take the politicians seriously and that a deal, albeit one that pushed off all the difficult decisions for only three months, would be reached.
And now with the S&P 500 gaining a further 6% so far this year, is the market discounting correctly the political fights and dire warnings likely to lead in to the month of March? Or is this the time to be more concerned about what’s happening in Washington and take seriously the draconian spending cuts and potential government shutdown that may slow the economy? In the near-term there is reason to be concerned, but on balance especially with a long-term time horizon, buying opportunities for stocks will likely be the result.
THE ECONOMY CONTINUES TO GROW & STOCKS CONTINUE TO RISE
Coming into this week, the S&P has gone up seven straight weeks. Most companies just completed reporting their quarterly financial results: 63.4% beat the expectations for their earnings and perhaps more impressively, 64.0% beat their sales/revenue expectations (sales figures can’t be “managed” as easily as earnings and can be thought of as a truer metric). The dividend yield provided by S&P stocks is still higher than the yield from 10-year Treasury bonds (2.15% vs. 2.04%), a simplistic way to judge that stocks may be more attractive investments than bonds with higher yield currently and historical potential for prices to move higher in the future.
The US economy continues to roll along with methodical growth and the typical mixed bag of economic indicators – some positive, some negative. Recently initial jobless claims have started to fall and surprise the markets which have been expecting higher rates of joblessness. This is good for the economy and historically good for the stock market.
But as the stock markets continue to move up, there’s a sense in the financial press as well as professional and individual investors alike that we are due for a correction. There will likely be a pullback, but selling in advance of one is the worst form of market timing and has not been a strategy that’s worked in recent years. I would argue that it’s better now to stay close to your target allocations to stocks and bonds and view any pullback in stocks as an opportunity to buy at low prices for the long run.
MARKETS IN THE NEAR TERM: POLITICIANS & THE FED
Back to Washington for the near-term – the deal struck to resolve the fiscal cliff accomplished all the relatively easy things and left all the difficult issues to a likely deadline of March 1 – not a good way for a government to function. President Obama was able to get some tax increases as his hoped-for first step, but any further increases are likely impossible without a much larger tax reform effort. Republicans dropped their threats for the time being to fight over the debt ceiling, but are taking a very tough stance on spending and appear willing to let the fiscal cliff cuts occur to defense and social spending, as well as force a shutdown of the government.
The Federal Reserve continues to keep interest rates low but is showing signs of reconsidering their policy now if it’s no longer working, no matter the rate unemployment and economic growth. This is a factor we will keep a watch on as the old investor rule of thumb is to “not fight the Fed.” If the recent era of loose monetary policy is coming to a close, we’ll want to consider lightening up on stocks in advance of this.
As for the political theatre, the stock markets are taking it in stride – I think there’s a good chance of a realization next month that spending cuts are going to come and the market will correctly read that as a slowdown to the economy. Stock prices will fall a bit especially given the recent run-up, but for the long term this will be a buying opportunity. The Congressional Budget Office estimates that fiscal cliff spending cuts will shrink the US economy by 0.5% in the following 12 months – not terrible damage to the economy and maybe an opportunity to make spending cuts that never end up happening in the normal course of governance.
I encourage you to take the long view!
CHINA SEES U.S. STRENGTH (MORE THAN THE U.S. SEES IN ITSELF)
In an unpublished study a year ago by the Chinese Institute for Contemporary International Relations, a Chinese think tank known for its straightforward assessments, it was judged that the United States had strengths that were more permanent than its weaknesses. The permanence might be expected to last two to three decades. Some of the strengths were as follows:
· Stable political system
· Strong military and intelligence capabilities
· Technological and intellectual breadth
· Powerful alliances abroad)
· Cultural influence on the rest of the world
· Natural resource wealth – the growing natural gas industry in the US will potentially make it an energy exporter in the future and less dependent on the Middle East in stark contrast to China
· Security of geography
· Relative resilience to climate change
The weaknesses are not necessarily permanent – hopefully cyclical and are up to us to correct:
· Political gridlock
· Social polarization
· Rising Debts and Deficits