“There may be no candidates and no measures you want to vote for, but there are certain to be ones you want to vote against. In case of doubt, vote against. By this rule you will rarely go wrong. If this is too blind for your taste, consult some well-meaning fool (there is always one around) and ask his advice. Then vote the other way.”
Robert A. Heinlein
Every four years, I play the part of well-meaning fool, and offer my thoughts on how the Presidential election will impact investors. The point of this exercise is not to suggest how anyone should cast their ballot – our clients are of diverse political opinions, as are our staff members – but to try to separate economic signal from political noise.
I will start with the obvious. Any consideration of the potential effects of the 2012 Presidential election on your money must take note of the economic results of the last one. Whatever your opinions on President Obama’s various policies and pronouncements, we must recognize that his term in office has been unusually profitable for investors. If voters voted their wallets, and if every voter was substantially invested in the U. S. stock market, it seems likely the President would be re-elected in a landslide.
A good many investors of conservative political views, convinced Obama’s policies would doom the Republic, sold and went to cash early in his term. As a result, they have missed a more-than-100% market advance. (Their bad, not Obama’s.) This proves Principle #1: Keep your political opinions separate from your investment decisions.
Of course, there is more to the economic landscape than investment results. A peculiar aspect of Obama’s term has been the degree to which benefits have flowed in directions entirely distinct from the President’s expressed priorities. The 1% at the top of the economic pyramid have done well indeed, while middle-class incomes have declined and poverty has risen. This tells us something about the political influence of Wall Street – on both parties – as well as about the inherent limits of Presidential power. Principle #2: Focus on secular trends and structural challenges, not on partisan initiatives or disagreements.
Which of President Obama’s policies have been so peculiarly favorable for the markets? None in particular, though serial compromises with Congressional Republicans have kept tax rates on investment income at the low rates of the Bush years. The primary reason for the stock market’s advance is simple. Barack Obama took office during a perfect storm in the financial markets, when equity valuations were at their lowest level in almost twenty years. That storm ended early on his watch, and the subsequent stock market recovery has been robust, as recoveries from profound market declines usually are. Principle #3: Valuation trumps policy, narrative and/or news.
So what does the economic landscape look like today, which structural trends are likely to have investment consequences, and how will each party’s principles and policies intersect with those realities?
Keep in mind that the man who has had the greatest effect on the economy over the last four years, and is likely to be equally influential over the next few years, isn’t even on the ballot. Ben Bernanke, Chair of the Federal Reserve, has thrown the kitchen sink of monetary policy at the Great Recession, arguably preventing another Great Depression, yet failing to trigger a robust recovery. The danger of throwing liquidity at economic weakness is that it may trigger inflation before it drives economic growth. Portfolio strategy must contemplate the possibility of an inflationary episode.
Examining valuation provides a mixed picture. Stocks are on the high side of fair value. Bonds are at extreme bubble levels of over-valuation. Corporate profits as a percentage of national income are at all-time highs, possibly unsustainable. These facts suggest to us an investment posture of substantial commitment to equities, implemented in a defensive manner, combined with a lower-than-normal bond component and a higher-than-usual cash reserve.
We see two specific economic challenges that are likely to impact financial markets during the next Presidential term, one immediate and one longer-term.
The first is the “fiscal cliff.” Our dysfunctional political system will need to cope with an economic trap of its own devising. Unless Congress can agree on a fix, in early 2013 the Federal government will implement a combination of massive spending cuts (a result of the automatic sequestration that was part of the budget compromise last year) and huge tax increases (the result of the scheduled expiration of the Bush tax cuts, as temporarily extended). As Obama’s former economics advisor, Austan Goolsbee, noted in a speech I attended last week, next year that combination will have almost three times more depressive effect on the economy than the maximum positive benefit of the stimulus in its most effective year. We believe the looming fiscal cliff will ultimately be avoided by a bipartisan compromise, either post-election or in the new year. We think any resulting market dislocation is likely to represent a long-term buying opportunity.
The second challenge is the structural gap between the cost of our government programs and the inadequacy of the revenues we collect to pay for them. In recent years, that gap has driven annual deficits in excess of $1 trillion, resulting in the accumulation of $16 trillion in Federal debt, an amount equal to more than 100% of GDP. The failure of the United States to balance its books requires a policy of global diversification in both equities and bonds.
We expect the growing debt burden to lead to a fiscal shock at some point during the next Presidential term. This is likely to drive markets down sharply – how far will depend on how quickly and realistically our fiscal issues are addressed. If I expect a market break at some future date, why not go to cash now? Because the drop may come from a point 50% higher than today, it might be smaller than I predict, I might simply be wrong about the reality of our nation’s financial position, or the next President and Congress may quickly forge a responsible bipartisan compromise. (I can dream, can’t I?) Be ready for the shock, don’t panic, and be prepared and determined to buy the future at bargain prices.
Our political system is doing a terrible job of addressing our long-term budget challenges. One side has offered a serious but radical plan (the Republicans’ Ryan plan), while the other side walked away from the recommendations of its own blue-ribbon commission (Obama’s rejection of the Bowles-Simpson proposals).
Both parties are trapped by the fantasies of their most committed voters. Republicans understand that voters would in the abstract prefer cuts in the size of government to increases in taxes. (Just not their own Medicare and Social Security benefits.) Democrats understand that voters believe that their Medicare benefits and Social Security checks are funded by their own prior contributions. (They are not. They are funded by taxes on current workers.)
In the long run, it is impossible to have middle-class entitlements that are not paid for by middle-class workers. This requires a national conversation that we have not yet begun in earnest. How this unbalanced equation is resolved will determine what kind of country we pass on to our children and grandchildren.
Which brings us to voting. Whether you are a wealthy investor or a middle-class wage-earner, there are issues of crucial moment to the future of the Republic that do not find reflection in the behavior of the markets. On November 6, I urge all of my readers to exercise their precious franchise in accordance with their most deeply-held principles, regardless of which directions those principles guide them.
 To date, Obama’s four years has been the most profitable single Presidential term for investors since the 1950s.