The Next Four Weeks

October 15, 2012

Over the next four weeks, we’ll learn who will be President for the next four years, how companies performed in the third quarter, and Europe’s plan for further integration of its financial system. That’s a lot of news, and that news is likely to create movements in the market. As we parse through all the information, we’ll be watching for the news that will actually move the market from what we believe is just noise. We consider market-moving news to be:  news that gives us clues to companies’ future earnings, and news that gives us clues to the future of interest rates.

The presidential election is important because it may have an impact both on how much companies earn and on interest rates. Up for debate is how to deal with the United States’ growing deficit. As we see it, there are three ways to deal with the deficit:  First, raise taxes. Second, raise growth, which increases tax receipts. And third, raise inflation so that the dollars we have to repay are worth less than the dollars we borrowed. Growth is everyone’s first option, but few economies have ever outgrown their debt issue. Tax changes and inflation seem to be more likely occurrences. Higher corporate taxes could weigh on corporate earnings and thereby equity prices. More inflationary policies would signal higher future interest rates and as a result likely lower stock prices. How each candidate would deal with the deficit as President is a major consideration.

Over the next four weeks, companies will report third-quarter earnings. Ever since the depth of the recession, U.S. corporate earnings have continued to surprise Wall Street analysts to the upside. During the last three years, most of the gains have been from greater efficiency (e.g., cost-cutting or increasing worker productivity), as opposed to strong revenue growth. At some point, all the costs will be cut and earnings growth will require some degree of revenue growth. As earnings start to be reported, we’ll be looking to see if earnings are benefiting from the recent quarter’s uptick in spending and employment. We would like to see corporate revenue growth as a sign that future earnings growth rate projections are sustainable.

Finally, there is Europe. Spain may ask for a formal bailout in the next four weeks. That bailout will be the final test of how well Europe has managed to build its backstop to put a halt to its slow-moving debt crisis. Almost more importantly, we expect to see some movement over the next four weeks in Europe’s plan to produce a continent-wide bank regulator. Such a move would do a lot to calm market fears about a eurozone breakup, and thereby reduce interest rates in Europe and aiding stocks overseas.

There is going to be a lot of action to watch over the next four weeks. We will be monitoring the situation closely, and then looking to take advantage of opportunities where applicable and updating you with our thoughts.

 


The Fiscal Cliff

July 3, 2012

Have you read about or heard about the “fiscal cliff” the U.S. is facing? In 2011 an agreement was reached in Congress to raise the amount of debt the government could issue so that the U.S. wouldn’t default on its obligations. There was a catch however, if Congress couldn’t come up with offsetting cuts by the beginning of 2013, $641 billion in spending cuts and tax hikes would automatically go into effect.  The impact of these cuts, which are equal to almost 5% of the US Gross Domestic Product (GDP), could be devastating, sending the U.S. back into recession. 

At the time these cuts were set in place, 2013 seemed like a long way away and the cuts that were laid out were so draconian, that an agreement seemed all but certain. Now 2013 is approaching, and a solution has not yet been proposed; the impending drastic spending cuts and tax hikes are the fiscal cliff you will be hearing more about in the media in the coming weeks and months.

Wealth Enhancement Group isn’t alone in worrying about the impacts of this fiscal cliff. Chairman Bernanke expressed his concern in a statement during a June meeting before the Joint Economic Committee of the U.S. Congress and said that if Congress failed to address the fiscal cliff, it would “pose a significant threat to the recovery.”  Former President Bill Clinton stated that we need to “find some way to avoid the fiscal cliff, to avoid doing anything that would contract the economy now” on a CNBC interview.  And, Treasury Secretary Larry Summers added that the top priority should be not taking “gasoline out of the tank at the end of this year.”  Federal Reserve Bank of Dallas President Richard Fisher added fuel to the fire, sharing his view that Congress has had “reckless fiscal policy.”  Making matters even more complicated, political observers don’t expect any action before the presidential election in November, which provides very limited time to actually address these important budget issues. 

So with these spending cuts and tax hikes our politicians have put a trigger in place that could lead to slower growth and even recession. At Wealth Enhancement Group, we have enough faith in the political system of the U.S. that we believe a deal will be reached that will avoid “yanking the rug out” from under what is already a fragile economy.

In the end, politicians are usually rational and if they don’t find a solution, they’ll be responsible for what may clearly be bad decisions and one that won’t help them win votes.  The best-case scenario for the economy and markets would be a grand bargain that maintains short-term spending, but reduces the country’s long-term, unfunded liabilities. While a grand bargain may still be out of reach, we believe that smaller compromises are more likely than not.  So while we’re concerned about the fiscal cliff, we ultimately think that the worst case scenario is unlikely.

Wealth Enhancement Group