In early November, Americans appeared to vote for more of the same. By giving a new mandate to a Democrat president but entrusting control of the House of Representatives to the Republican Party, voters may have all but guaranteed that political deadlock will continue to hamper the US economy.
Unless, of course, politicians from both sides of the divide show that they have learned the lessons of the past few years and start to work together to tackle the challenges that the country faces.
Recent experience suggests that the prospects are not good. Republican politicians have been unwavering in their opposition to anything that flows from the pen of President Obama. Their Democrat peers can hardly be described as models of open-mindedness either. But even such hard-nosed adversaries may be forced to sit around the table and finally agree on something. Otherwise, the US economy could find itself in real trouble in 2013.
As Federal Reserve chairman Ben Bernanke recently noted, the US economy has been recovering at a disappointingly slow pace since the recession of 2009. GDP growth has plateaued at around 2% a year, and unemployment, at a little less than 8% of the workforce, remains high. Although some positive signs have been spotted lately, and equity markets even rallied earlier this year, it is far from certain that the world’s largest economy is ready for a period of solid growth.
The fiscal cliff
Bernanke noted that the most urgent challenge faced by US policy makers is the need to put the finances of the federal government in order without endangering the recovery of the economy. This is the conundrum that has reached the global media under the tag of the ‘fiscal cliff’. It refers to a range of temporary laws that were implemented during the Obama and George W Bush administrations that will expire at the start of 2013, resulting in either tax increases or spending cuts.
At first sight, both kinds of measure could prove beneficial in a country where the public deficit has been high for years. But as Europeans have so eloquently demonstrated, a combination of higher taxes and lower spending generates neither growth nor jobs in the short run.
The bipartisan Congressional Budget Office (CBO) has estimated that, if all the automatic tax increases and spending cuts that will be triggered in January are summarily eliminated, US GDP could be boosted by about 3% next year – a significant gain, given that forecasts for economic growth in 2013 have hovered around 2%.
The flip side is that, if tax revenues and spending remain at their current levels, public debt – already running at 70% of GDP – will continue to swell, reaching 90% over the next decade, according to the CBO. A middle ground is required, and it needs to be one that will satisfy both tax-cutting Republicans and free-spending Democrats.
The stakes are high not only for the US but also the rest of the world. Europe could do with some help from across the Atlantic, in the form of brisker business. Emerging economies like China and Brazil, which appear to be on the mend, could also benefit from having one less source of bad news from abroad. From an investor’s point of view, a solid US economy would provide a wealth of options to make their money work, and boost markets around the world.
The expectation is such that, in November, a suggestion that both parties could be willing to talk helped lift US stock exchanges, albeit briefly. For some, there is simply no alternative to a deal, and as result the two parties will have to find a solution to avoid the problem. “The fiscal cliff is going to turn into a fiscal slight slope,” says Tristan Delaunay, chief executive officer of French fund manager Athymis Gestion. “It should not be a big problem for the American economy.”
That would be good news, but maybe not enough to boost the US and global economy. Joachim Klement, chief investment officer at consultancy Wellershoff & Partners, believes that an agreement will likely feature the reversal of some of the tax cuts for the wealthy that were implemented by the Bush government, coupled with cuts to the defence and public health budgets. As a result, no budgetary tragedy should ensue, although neither will the mediocre economy receive a substantial boost.
Return to recession
“We are quite pessimistic compared with the consensus,” Klement says.
Most forecasts for US GDP growth in 2013 point to somewhere between 2% and 2.5%, but he believes it will barely breach the 1% mark. If policy mistakes are made, he warns, the US economy could even slide back into recession.
The fiscal cliff is going to turn into a fiscal slight slope. It should not be a big problem for the American economy
CEO, Athymis Gestion
The case for investing in the US is not a compelling one, and poor economic growth would certainly reduce further the attractiveness of US securities to European investors. Treasury bonds, often seen as a safe haven for the cautious, are currently delivering dismal returns. Stocks of US firms, for their part, are paying the price of the rally earlier in the year, which has put them off the radar for many investors.
This blend of high prices and lacklustre economic performance takes the shine off many kinds of stocks. “We are sceptical about consumer staples in the US, as stocks are valued above their historical average right now,” Klement says. Companies that rely on domestic consumption could struggle to deliver returns if recent data showing lower consumer confidence becomes a trend.
Better value elsewhere
Even those investors who believe that equity markets are due a bounce have less enthusiasm for US stocks than in previous recoveries. Delaunay, for example, is upbeat on the prospects for the US economy, which could benefit from the performance of China and improvements in Europe. He even sees US stocks ending 2013 around 8% or 9% higher. However, he identifies more value for investors elsewhere. “The American equity market is a little expensive compared with other parts of the world,” he says.
Many American companies have hoarded cash in recent years as they did not have enough confidence in the economy to make investments
Vasco Nuno Jesus
BPI Gestao de Acti
Klement also expects European and Asian equities to outperform their US counterparts next year. So staying away from US markets might not be a bad idea. “We would advise investors to significantly underweight American stocks,” Klement says. Some asset classes like gold and commodities should also benefit from policies pursued by the US Treasury and the Fed – such as so-called ‘quantitative easing’, which has kept the dollar weak relative to other currencies.
Even so, opportunities might still be found in US stock exchanges during 2013, particularly in areas related to policy developments implemented by the Obama government.
•If the tax hikes and spending cuts that were planned for the start of 2013 are all scrapped it would give a 3% GDP boost to the US economy.
•Scrapping the tax hikes would massively increase the US deficit, but keeping them would damage the economy – so a compromise must be found between Democrats and Republicans.
Pharmaceutical and health firms, for instance, should benefit from the green light that American voters have given to the president’s health insurance reforms. The growing shale oil and gas sector could also offer some juicy pickings for investors, according to Klement.
And investors might do worse than to position themselves for the time when confidence in the US economy picks up, according to Vasco Nuno Jesus, a portfolio manager and senior analyst at investment manager BPI Gestão de Activos in Lisbon. He says: “For investors with a long- term investment horizon, it could be a good moment to get into equities markets in the US, and in Europe too.”
He notes that a positive outcome of the financial crisis, and of the deleveraging that has taken place, is that firms are showing better financial health. “Many American companies have hoarded cash in recent years as they did not have enough confidence in the economy to make investments,” he says. “This is one of the reasons why I think that equity markets in the US could perform well next year.”