By
The
Inflation Trader
:
Wow, where do we begin after a hurricane-induced hiatus? So much
has happened. Since I last wrote, the U.S. elections have fallen
into the rear-view mirror, the Bank of Japan has increased its
asset purchases again, Greek inflation has accelerated to 0.9% from
0.3% (while Greek Industrial Production contracted for the 49th of
the last 53 months, illustrating
again
how
helpful
it is to look at the growth rate of a country as a guide to
deflationary pressures), and the stock market has moved to 3-month
lows (and 10y note yields to 2-month lows) while the dollar has
strengthened.
By far the largest event of the last couple of weeks, besides
the restoration of power to my home, has been the U.S. elections.
The immediate weakness in equity markets is completely
understandable, but for the most part doesn't reflect a vote
against the President. Real equity market returns will be weaker
over the next couple of years, but that's because current valuation
levels are high and future earnings will be lower than they would
be under a more capitalist government. I don't think investors are
putting prices lower on
that
theory; indeed,
as I wrote just before Sandy
I thought that stocks are more likely to go higher than lower in
the short term with an Obama victory.
But let me define short term, because in that post I completely
neglected the
very
short-term effect of the days just after an Obama victory. I think
an important part of the selling of equities now is reflecting
investor realization of tax gains now, versus in the future when
capital gains and income tax rates are likely to be at least
somewhat, and potentially significantly, higher. That's not a
long-term effect, because those investors will also buy companies
they perceive to be relative bargains in the case of a profligate
spending policy (which is what everyone agrees we are likely to get
- although some people think that's a good thing; I suppose your
own feeling on that matter likely defines how you voted). So this
is mostly a cycling of positions, a re-setting of tax basis at a
higher level, and shouldn't amount to a major selloff by
itself.
There still may be some net selling while the twin risks of the
"fiscal cliff" and the Greek exit from the Euro remain uncertain
and near-term. And here is where I am getting somewhat uneasy with
my bullish argument (which hinged on the notion that typically
myopic investors would prefer a 2013 recession that is shallower,
due to heavy government spending, than a deeper one due to a
Republican shrinking of government aka "austerity"). I think there
are some bigger issues that are hard to look past right now, and
they are related to those twin risks I just mentioned.
One of those issues concerns the "fiscal cliff." Perhaps I am
cynical, but I have long expected the issue to be averted at the
eleventh hour (as usual - for example, see the annual 'doc fix' for
Medicare). But it now occurs to me that the Republicans have
absolutely no reason to compromise on their demand for no increase
in taxes. Under a President Romney, the Republicans would have been
able to leverage their control, make a few key concessions, and
avert much of the damage. Under a President Obama,
forcing the cliff to take effect is now the only way that the
minority party of smaller government can force any austerity over
the next few years
. Especially if you believe - and I think it's worth considering -
that the failure of the Republicans to unseat a President with
sub-50% approval ratings and an ~8% Unemployment Rate indicates
that the argument is lost that we should take short-term pain in
order to restore fiscal sanity, this represents the best remaining
hope for fiscal sanity. The only way I can see the Republicans
giving in on the 'fiscal cliff' is if (a) they sell their
principles, which is always a possibility, or (b) the Democrats
promise considerable compensation in terms of future legislation. I
can't imagine what that would be. So, in short, I think the odds
that there will be a resolution of the 'fiscal cliff' have dropped
considerably.
The second issue is the one of Greek exit from the Euro. I think
I have been very consistent on this issue: I do not believe there
is a viable future path in which Greece remains in the Euro.
Whether the exit is clean and negotiated or sudden and traumatic or
painful and drawn-out is the issue. This has been clear for months,
even years, now. Yet, for a couple of months there has been
relative quiet on this front, until the last week or two as the
Eurogroup considers the distribution of the next aid tranche to
Greece. We've also stopped hearing much about Spain, Italy, and
Portugal although the Spanish 10-year bond yield is creeping back
to 6% again (5.88% today). I don't think this silence heading into
the U.S. elections was accidental. The relationship between the
U.S. President and the citizens of the world ex-U.S. is a very
strong one, and I have no doubt that the politicians in Europe
recognized that their chances of getting help from U.S. taxpayers
would be much better after November 6th if Obama won re-election.
Now that he has, the European issue must be confronted as world
growth is weakening again. I have no idea whether the U.S. will try
and contribute to a solution (which would ensure a painful and
drawn-out resolution in which Greece would still, at the end, leave
the Euro), but in any event this set of events is back in motion,
and is not positive in the short-term for world growth or equity
markets.
So in short, while I still think we can trust the myopia of
equity investors to push markets higher over the next couple of
months, I am less sure of that than I was. The election was a
trigger for a lot of potentially bad outcomes, and with equity
markets remaining rich I would certainly be maintaining a
conservative risk posture here.
At least
something
can be conservative.
See also
Local Corporation's Patent Developments Set Table
For A Fundamental Breakout
on seekingalpha.com