By Bruce Buerkle, CFA, Vice President and Manager, Securities Research Support
As the post-election dust cleared the morning of November 7 and it became evident that President Obama won re-election based on the popular vote as well as for the Electoral College, the reality of what needs to be accomplished quickly hit home with investors before they could even finish their second cup of coffee.
Market action demonstrates the high level of emotions that are tugging at investors’ confidence right now. On the day before Election Day and on Election Day itself the DJIA rose a combined 152 points, while DJIA closed 313 points lower (the largest one-day drop for 2012 to date) during the first post-election trading session, and then lost another 121 in the second session.
The U.S. House and Senate have about seven full weeks to accomplish the daunting task of avoiding the “fiscal cliff,” which includes $800 billion in tax hikes and spending cuts for full year 2013. This assumes they will work right up to New Year’s Eve, but we know they generally take extended holiday time off.
The outcome of the House and Senate races basically retains the status quo. In his first comment after the election, Republican House Speaker John Boehner went on record saying he is “ready to negotiate a budget deal with President Obama to avoid the fiscal cliff that includes new tax revenue, as long as the Democrats agree to cuts and changes to federal entitlement programs”.
Senate Majority Leader Democrat Harry Reid stated, “Asking wealthier people to pay higher taxes needs to be part of any solution to the government’s budget woes. Any solution should include higher taxes on the richest of the rich.” So where do these “pledges” leave us today? Exactly in the same place we were in February 2012 when the U.S. Federal Reserve Chairman Ben Bernanke first coined the term “fiscal cliff”.
President Obama delivered his first post-election talk today. It was very pointed and deliberate. While he did a good job portraying being in control, there was nothing new or revealing other than he acknowledged Speaker Boehner and the comments made earlier in the day about his willingness to begin productive conversations with the White House. The President disclosed that he has invited Congressional leaders to the White House the week of November 12 to begin conversations as “the American people voted for action.”
He mentioned three “C’s”- common sense, consensus and cooperation. “We cannot cut our way to prosperity, we must balance spending cuts with revenue increases and we must ask wealthier Americans to pay more taxes”. He also reiterated what he has said before “people like me making more than $250,000 a year should pay more taxes.”
At this point, the President is hopeful that there will be a meeting of the minds within just a few days, and there is likely to be a lot of weekend conversation in the media about the commitment and the possibility of all sides making productive talks and compromise happen.
While the fiscal cliff appears to be the most pressing issue for the “lame duck” session of Congress, in 2013 the divided body will need to address a multitude of issues including the stubbornly low level of job creation, health care, Social Security and Medicare, the budget deficit, and revisions to the tax code. If that list wasn’t long enough, add to it the need to handle ongoing issues like stagnant home prices, restrained consumer spending, the threat of inflation, and a lagging Gross Domestic Product. Immigration and foreign policy, including the Euro-zone and China will also be clamoring for attention. Our hope is that “new blood” in Congress can light a fire under the old establishment to prioritize these items and take action.
We will also likely see President Obama spend a lot of time and effort in attempting to win over the confidence of corporate executives, including those in the financial services industry, as more aggressive regulation or even the perception of such could affect the willingness to invest capital. The Patient Protection and Affordable Care Act (affectionately referred to using the “O” word) is going to require a multitude of new federal rules and regulations in order to execute the provisions of the Act. One major uncertainty at this time is the resources that the federal government will need to contribute to run the exchanges for states that do not run them on their own. With the exchanges set to begin on October 1, 2013, major capital expenditures at both the state and federal level will need to begin soon.
While the “fiscal cliff” and healthcare (you know, the “O” word) garner the most headlines, many other issues confront the second term. The President is going to have to devise a plan to work with the energy industry to address the potential for tighter regulations and the costs to the companies associated with them. Areas requiring attention include offshore drilling, trans-continental pipelines and renewable energy.
Given the multitude of food-borne illness events during 2012, additional regulations and funding for the Department of Agriculture will also need to be a priority. Another hot-button topic will be the consideration of financial incentives for manufacturing to move back to the United States from overseas. Greater co-operation with the states will be required to secure state-backed funding. Investments in technology and education to make these moves feasible must also be ramped up, despite the need for budget cuts.
Within his own administration, Cabinet and other key position vacancies are going to require prudent selection and vetting processes. Two key positions, Secretary of State and the Treasury Secretary positions are likely going to need to be filled as Secretaries Hillary Rodham Clinton and Timothy Geithner have expressed their intentions to step down with the President’s second term.
Given the combination of tax increases and spending cuts needed to make a dent in the budget deficit, the new Treasury Secretary will need to be a good negotiator capable of handling the divided Congress. As the second term moves forward, the President will likely face Supreme Court appointments and Senate politics, as four of the justices are now over 70 years of age.
What does this mean to your investment portfolios? It points to the basic tenet of portfolio construction. It’s vital that you have a diversified approach with investments that offer the potential to meet your goals and constraints. Portfolios should be diversified both across and within asset classes, the percentages of which depend on your investment objectives. Sector diversification is also important within the equity portion.
Strategically address any concentrated positions you may currently have. At this time, we do not know if the current long-term capital gains and qualified dividends tax rates will expire and go up after December 31, 2012. We do know that the Medicare tax on investment income will begin January 1, 2013. Estate taxes may also be revised upward as well as an employee’s portion of the Social Security tax. More investors may be subject to the Alternative Minimum Tax.
Numerous articles have been written discussing which businesses will do better or worse in an Obama administration. We’ve seen some prognosticators favor health care facilities and services, food and consumer staples, and construction, while viewing energy and financial services less favorably. Such fine-tuning in portfolios can increase the risk that our investment goals may not be met. In addition to being subject to these uncertainties at home, economic troubles across the globe will continue to influence the U.S. markets.
In the end, a diversified approach is a proven way to cope with the day-to-day market shocks. We all know how much better we feel if we can get a good night’s sleep.