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 January 2012 The Election Year Economy This year's markets depend more than ever on the politicians
The only thing that was easy to do in 2011 was to be wrong. A year ago with interest rates near all-time lows and the Federal Reserve struggling to keep them there, we confidently predicted there was nowhere left to go but up. That seemed reasonable at the time, but the benchmark 10-year Treasury yield still managed to decline from 3.29% at the end of December 2010 to a six decade low of 1.67% late in September. This was even lower than during the credit crisis of 2008. We'd beg your pardon for missing this one.
We fared better on stocks. Observing that U.S. stocks were starting to look overbought a the end of 2010, we concluded, "After two years of double-digit gains, stocks are once again divorced from their fair value. You'd have to be extremely bullish about the prospects of a strong economic recovery to be an aggressive buyer at today's levels." That proved to be on target. We were also right about the economy, pointing out banks, which still held a tremendous amount of bad debt, couldn't possibly lead the economy to growth. Although they traditionally have led economic expansions, their current crippled state continues to preclude that. The same is true for consumers and housing. In essence, the debt that precipitated the 2008 recession was still around and until it's directly addressed, there's little reason to believe there can be a lasting recovery. And that brings us back to historically low yields in the credit market. All else being equal, interest rates would have risen in 2012, but the Fed's efforts to hold them down to provide liquidity for recovery made the situation much less than equal. As 2012 came to a close, new attempts -- both monetary and fiscal -- were in place, yet third quarter GDP fell below 1.8%. If the economy was a living patient, it would barely be capable of steaming up a mirror.
Spending is Easy The real problem continues to be the failure to confront the key issue: runaway government spending. Although military spending is often blamed to the soaring national deficit, the real culprit is the ever expanding
entitlement programs, soon to get yet another big jolt when Obama Care kicks in. While that, Social Security, and Medicare are long-term drains on the nation's wealth, the stimulus programs have all been short-term in nature. One-time funding for pent-up pork-barrel projects, cash for clunkers, first-time homebuyer's tax credits, extended unemployment benefits, and short-term term credits for business hiring the long-term unemployed are fleeting. Individual taxpayers, consumers, and businesses can't use any of this for long-term planning which is the basis of actual budgeting.
Rather than face their spending addiction, Congress and the President, the keepers of fiscal policy, simply keep putting it off. When the impasses almost closed down the federal government and led to default on Treasury obligations, the House and Senate simply threw the real issue to a 12-person "Super Committee" charged with coming up with earth-shattering solutions by Thanksgiving. When the Super Committee failed, even without showing much effort to take on their charge, nothing -- absolutely nothing -- happened. No promised sequesters or suspension of government services. No tough mandatory spending cuts, Instead it was just business as usual. So much so, the Senate had to pass a two-month extension of the 2% Social Security payroll tax holiday and then slink out of town so Congress would have no option but to go along with it. Without a doubt, the biggest irony is that all of these short-term "stimulus" maneuvers are purely political attempts to score points with gullible voters. They never have a chance of having a real economic impact although you'd never hear that from their sponsors, particularly those running for re-election this year.
Saving is Another Matter The national debt hit an all-time record $14 trillion (that's trillion with a "t") at the end of 2010. The final trillion was added in just the last three months of the year. This isn't speculation or political spin, it's just the facts. Currently, thirty-three cents of every dollar spent by the federal government is borrowed. Interest expense on the existing national debt is the country's largest spending item. It will only grow bigger over time as we borrow more to pay interest on prior borrowings. Indeed it did get worse. The budget impasse last summer was over raising the limit and then in the last few days of the year President Obama went back to Congress with a request for another $1.2 billion increase. What no one seems to notice (or perhaps what everyone tries to avoid noticing) is that this problem won't just go away. In fact, it will continue to get worse the longer it's ignored. Pushing politically distasteful decisions down the road may be expedient in the short term, but it comes at the cost of slow growth and a weakened economy. Europe offered a striking example in 2011. Greece, Italy, and to a lesser extent Ireland and Portugal required bailouts to avoid defaulting on their sovereign debt. Dissent within the European Union placed the euro itself in jeopardy as Germany and France, two of the stronger EU nations, struggled over how much funding they could continue to provide to shore up the spending of their profligate neighbors. Austerity measures were met with strong opposition in Greece and Italy. The EU economy was the major casualty, ending 2011 on the verge of recession. The biggest difference between the EU's response and that of the U.S. politicians was the fact that those on the Continent are actually confronting the problem while Congress and the President are playing political games. Mr. Obama has gone so far as to make class warfare the touchstone of his re-election campaign, attempting to paint himself and his democratic colleagues as champions of the middle class, fighting to force "millionaires" to pay their "fair share" in increased taxes. Sadly, even if these unfortunate targets faced a 100% tax rate, the country's deficit would be hardly fazed. It's not the revenues, it's the spending that's the problem. Unfortunately, election year politics won't be likely to produce any real solutions. Elections are often swayed by perks and favors elicited for the voting populace by incumbent candidates. That's yet more spending. What's really needed is spending cuts but that can only come at the expense of funding someone's pet project or entitlement. It's much harder to win votes that way. As a result, you'll hear a lot of lip service to deficit reduction this year, but in the end it's a safe bet that the national debt ceiling will need yet another increase (or increases) next year, too.
The Impact on Investors Last year at this time everyone was looking to a sustained recovery in the second half of the year. Fourth quarter 2010 GDP was up, annualized consumer spending -- roughly two-thirds of GDP -- was growing at a healthy annual rate of 3.6%, and perhaps most encouraging, monthly new job creation was around 135,000. The stalled economy seemed poised for recovery. Stocks responded as expected, moving to near term highs in late spring. But as the budget crisis surfaced, and credit woes spread throughout Europe, it became obvious the fundamental problems that led to the recent recession still persisted. Stocks sold off during the summer's budget crisis only to recover somewhat when Congress and the President kicked the can down the road to Thanksgiving. As the Super Committee's impending failure became obvious, stocks again swooned. The year ended with GDP barely growing at a rate of 1.8% and job creation averaging less than 100,000 a month. There are few things in life that can be known with complete certainty. One is that if you consistently spend more than you have, your financial status will consistently deteriorate. Efforts to stimulate the economy, artificially suppress interest rates, and short-term tax relief may briefly cloak the effects, but the underlying problem will continue to grow. A second certainty is that stocks, bonds, and virtually any investment will perform better in an environment of financial stability and economic growth. By their very nature, investments (not trades) are long term commitments. Investors can act with greater confidence if they feel comfortable with their long term projections and estimates. On the other hand, short term stimulus efforts aren't helpful because they're long gone before many investments are expected to pay out. Unfortunately, the long term solutions investors need are quite unlikely to appear in 2012. Given that, 2012's equity market will probably look a lot like 2011's. Although investors demonstrated their willingness to jump in and buy on last year's dips, they can't be expected to establish a sustainable rally without the long term confidence that's been so sorely lacking. Just as 2011's fits and starts failed to establish a true trend, either up or down, 2012's will equally unlikely to do so. That, of course, leaves fixed income. With prevailing rates even lower than at the end of 2010, the easy call would again be to expect an increase back toward historical averages, along with the corresponding drop in value. However last year demonstrated just how determined the Fed is to provide liquidity and spur the economy. Their pledge to keep interest rates down through 2012 (and now possibly through 2013) may be enough to offset normal market forces. In fact, given the events of 2011, it's probably best not to fight the Fed. Unfortunately, it's also best not to count on the politicians to come up with any real solutions this year, either. If you liked 2011's markets, should be equally pleased with 2012's. Search this site! Just enter you key word or words:
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AST YEAR WAS A TOUGH ONE for investors. Stocks rode a roller-coaster only to finish the year virtually where they started. Bonds surprised everyone, particularly good old U.S. Treasuries. Foreign investment, which had been a winning strategy for the prior years, trailed stodgy domestic dividend-yielders. Economic signals were equally mixed. Although consumer spending remained strong, growth -- as measured by quarterly GDP -- stagnated. The headline unemployment number showed slight improvement in the late fall, but that was more attributable to discouraged long-term unemployed workers simply dropping out of the labor force rather than new jobs
actually being created. The housing market remained mired in what seems like a never-ending slump.
