Let’s All Take A Deep Breath
At the time of this writing, President Obama has won the Electoral College and will serve another term as President. In Congress, Democrats have won a majority in the Senate while Republicans have maintained control of the House. In this letter, we’re going to briefly discuss the impact of the election from a financial perspective.
Markets slid on Wednesday as traders responded to concerns about the global economy, driving the S&P 500 down by 2.4%. Even more dramatic was a huge swing in the bond market as antsy investors plowed money into Treasuries, driven towards safe harbor investments by global economic worries. While it’s tempting to think that fear over a Democratic win drove the selloff, that theory simply isn’t supported by market action during the election. It is more likely that traders are uneasy about unresolved U.S. economic policy and a deteriorating European situation.
Now that the elections are finalized, the next big item on Wall Street’s and Washington’s agenda is the ‘fiscal cliff,’ a series of automatic tax increases and federal spending cuts that are due to take effect Jan. 1, unless lawmakers find a compromise. Some economists predict that the combined force of drastic spending cuts and tax increases could shave as much as 4% off GDP if they are not renegotiated. Already, business spending is down, and executives say that uncertainty over the outcome of the fiscal cliff debate is causing them to hold back on large capital expenditures.
Our primary concern is that a split Congress and deep divisions between parties could cause the debate to drag on through the New Year, to the detriment of the stock market and our economy. Democrats have called for increasing taxes on higher-income earners, a move which Republicans have resisted; if the Republicans do not give ground on the issue, it increases the likelihood that Democrats will allow the Bush Tax Cuts to expire in order to gain bargaining power for their own ‘middle-income tax relief’ plan. A more positive (albeit less likely) scenario would bring Republicans to the negotiating table for a bi-partisan plan to gradually phase in austerity measures instead of going over the cliff – similar to the 2010 Simpson-Bowles plan. This would set the stage for meaningful tax and budget reform over the next few years and reassure deficit-watchers that the U.S. is managing its debt.
In recent years, interest in the so-called ‘presidential effect’ or ‘election cycle effect’ on markets has been reignited and you may hear pundits say with great certainty that this or that term year is better for markets. The reality is that, statistically, there is very little relationship between the two and we cannot make market predictions based on the effect. However, we believe that there may be significant upside potential next year as the fiscal cliff is resolved and Fed policies further boost economic performance. In a post-cliff economy, we could see a significant rebound in business spending, as the private sector unleashes pent-up capital investment. There is also a good chance that we will see continued improvements in the housing market and consumer confidence.
In the short term, investors should probably expect additional volatility, making the market’s general direction impossible to call. While we expect that media attention on the fiscal cliff will pressure markets, we may experience a solid rally as a negotiated deal becomes imminent. Since we cannot predict the timing of the resolution, we counsel patience and urge you to remain focused on your long-term investments. One of the benefits of working with a financial professional is that we are ever vigilant for risks and opportunities and we work hard to position our clients for the economy of the future. We hope this commentary has been interesting and informative for you and we invite you to contact us with any questions.