Four More Years...
By Kate Schapiro
November 13, 2012
Americans went to the polls this past Tuesday and re-elected President Obama to four more years in office. In addition, the partisan breakdown of Congress stayed roughly the same in both the House of Representatives (Republican majority) and Senate (Democratic majority). So after nearly two years and billions of dollars spent on campaigning, debating, polling, grand-standing and mudslinging, the leadership is unchanged. A good argument for campaign finance reform if ever there was one.
The US stock market did not take kindly to the outcome, declining sharply in the aftermath. With the election out of the way, investors turned their laser focus onto the looming "fiscal cliff" come January 1. Investors should have no doubts that public policy measures will continue to play a major role in determining the course of economic events for the foreseeable future. While there is certainly room to hope for a "Grand Bargain" of sorts, it is also possible that no agreement will be reached, an outcome that would put the US economy back into recession according to recent estimates by the CBO. The markets do not appear to be discounting either extreme possibility at the moment, perhaps expecting more "can-kicking" temporary measures instead: extension of some tax cuts in exchange for suspension of some spending cuts. Fortunately, because the US dollar remains the world's reserve currency, and the US economy remains the world's largest and arguably the most stable, funding costs to maintain the status quo will remain low for the foreseeable future.
With all the focus on the US election, perhaps developments elsewhere did not get as much air time as deserved. For the fifth month in a row, the European Central Bank left interest rates unchanged, despite the deterioration in the economic outlook for the region. Declines in the Eurozone Composite Purchasing Managers' Index and Economic Sentiment Indicator point to slower growth in Q4 over Q3. Talk about a fiscal cliff, Spain introduced an increase of its VAT to 21% and proceeded to see retail sales plummet nearly 11% year-on-year in September. Greece narrowly achieved parliamentary approval for another austerity package which included cutting salaries for public sector workers and pensions for the elderly, in order to secure another tranche of bailout funding. Once again, anti-austerity protesters took to the streets hurling stones. While a Greek exit from the euro bloc is unlikely this year, it can not be ruled out for next year.
Across the Pacific, China's Communist Party began its week long congress that will shepherd in the new party leaders for the next decade, beginning with Xi Jinping poised to take the reins of president from Hu Jintao come next March. Many China observers believe the new leadership will be more active in government reforms, such as greater transparency and lesser state controls over certain economic sectors. It is unlikely that such reforms will happen quickly; but with economic growth slowing and the wealth divide growing, maintaining a harmonious society could become more difficult. Still, it should be noted that China's economic slowdown appears to be taking a breather with signs that industrial output and fixed asset investment were a bit stronger in October and aggregate retail sales were growing at a double-digit rate. We believe Beijing has preferred the easing of restrictions to implementing stimulative policies, but with inflation rates down over the last 18 months, there is room to stimulate if necessary. China's growth rate at 7.5% or so still provides some welcome relief for global multi-nationals.
All this is to say that investors must not be complacent as we head into the final months of the year. For most markets, it has been a good year despite economic headwinds. There is reason to be cautious going into the year-end period, but stock markets tend to rise in the fourth quarter, so it may not pay to be overly pessimistic. Nevertheless, the re-election of Mr. Obama suggests that we will see many of the same trends over the next four years as we have over the last four. Markets, most likely, will continue to force the reduction of accumulated debts resulting from past excesses which will keep the issues of potential higher taxes and/or spending cuts on the front burner. Debate will continue over the unconventional monetary policies instituted by the Federal Reserve and increasingly adopted by other major central banks including the ECB and Bank of Japan, but these policies are unlikely to be withdrawn anytime soon. And it remains to be seen whether the fundamentally deflationary forces facing the world economy can be held at bay by ongoing massive doses of inflationary policy response. The range of potential outcomes remains unusually wide.
Bottom Line: For global equities, stay focused on owning businesses that can prosper in a variety of economic environments. Emphasize good companies, which we define as those that deliver high returns on invested capital, require little additional investment in order to grow, enjoy relative pricing power in their markets and so are able to defend profit margins, as well as generate good cash flows. Valuation is important, especially as the rising market becomes increasingly narrow in scope. Over the long run, these types of stocks should generate attractive returns no matter the short term policies coming out of Washington, Berlin, Tokyo or Beijing.
Sources: Sentinel Asset Management, Inc.
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