US Election Cliffhangers October 2012
Total Page：16
File Type：pdf, Size：1020Kb
US ELECTION CLIFFHANGERS OctoBER 2012 BLACKROCK INVESTMENT INSTITUTE Peter Hayes What Is Inside Head of the Municipal Bonds Group, BlackRock First Words and Summary .......................................................... 3 Alpha Strategies Cliff Watching ............................................................................... 4 Russ Koesterich A Dangerous Disconnect .........................................................5–6 Chief Investment (Limited) Options ...................................................................... 7–8 Strategist, BlackRock iShares Sky Dive, Bungee Jump or Hard Stop? ...................................... 9 Debt Hangovers ...........................................................................10 Barbara Novick Don’t Raise My Taxes ...........................................................11–12 BlackRock Vice Chair and Head of Don’t Cut My Benefits ................................................................13 Government Relations Magnificent Munis ................................................................14–15 Dividend Shields .........................................................................16 Bob Shearer Lead Portfolio Manager of the Equity Dividend Fund, BLAckrock investment institUte BlackRock The BlackRock Investment Institute leverages the firm’s expertise across asset Alpha Strategies classes, client groups and regions. The Institute’s goal is to produce information Ewen Cameron Watt that makes BlackRock’s portfolio managers better investors and helps deliver Chief Investment positive investment results for clients. Strategist, BlackRock EXecutiVE DIRectoR CHieF STRategist EXecutiVE EditoR Investment Institute Lee Kempler Ewen Cameron Watt Jack Reerink SO What DO I DO With MY MoneY?TM Cliff Insurance Tired Equities Guard against a sell-off in risk assets in the run-up to the US stocks have outperformed but have become relatively fiscal cliff. Volatility has been very low, so out-of-the- expensive and linked to monetary easing. If economic money options have been cheap. No hedge comes for momentum weakens further, it may be time to head for the free—but this one may pay off (and give peace of mind). US departures lounge. Destination: emerging markets. US Downgrade—Part 2 Dividend Shields Another US debt downgrade is likely if Washington A dividend tax hike is unlikely to kill the sector’s makes no progress on fixing the budget. This is unlikely renaissance. Investors are desperate for income and to shock risk assets as much as it did in 2011: We have US companies historically have raised payouts to seen this movie before. offset rising taxes. Details on page 16. Tireless Treasuries Magnificent Munis Treasuries are likely to remain de facto AAA assets. Municipal bonds are likely to retain their sheen—despite Reports of the Treasury bull’s death are greatly prophecies of doom about their tax-exempt status. The exaggerated. That said, we prefer spread products such market’s selling points hold up: income at relatively low as mortgage-backed securities because Treasuries carry risk, and the powerful mix of strong investor demand big price risks at their ultra-low yields. and shrinking supply. Details on pages 14 and 15. [2] STANUS ELECTIONDING STILL… CLIFFHANGE BUT STILLRS STANDING First Words Cliff Fears Chances are risk assets will sputter well before the fiscal bomb is set to go off on Jan. 1. Businesses are curtailing and Summary investments and freezing hiring. Consumer confidence is wobbly. Uncertainty is a killer for business and markets. Fed Rescue? Financial markets can only focus on one scary thing at a Fiscal cliff = market disaster. Or does it? A mix of tight time. The European debt crisis has been the shark closest fiscal budgets and loose monetary policy may boost risk to the boat for years. Now the US fiscal cliff—a perfect assets. This view does have a lot riding on Fed action. storm of tax hikes and spending cuts that may go into effect Jan. 1—is moving to the fore. Limited Options Once the focus shifts across the Atlantic, markets will likely Doing nothing is not an option. Gaping deficits have created zero in on a familiar but depressing picture: A big budget a pile of debt that will likely brake growth for decades. We hole and plenty of political dysfunction. The background? need to see at least the outline of a comprehensive budget An economic recovery losing steam and an election showing deal to turn things around. Closing the budget gap is a long, an increasingly bitter divide. Our main conclusions are: painful road of tax hikes and spending cuts. Dangerous Disconnect The “T” Word Washington insiders are sure political dysfunction will push Simple math says the US government will have to increase the nation off the fiscal cliff—if only briefly. The ensuing revenues to make a dent in the deficit. The complicated tax scare would provide political cover for compromise and a code desperately needs an overhaul. We are, however, afraid budget deal in the second half of 2013. By contrast, most this effort will end up in the “too difficult” box next year. financial experts believe in an 11th-hour rescue that will The “B” Word enable the country to avoid a recession. The other part of the budget equation says spending Scenario Plotting must come down—even on benefits. Social Security This disconnect between political and market pundits and healthcare eat up a huge chunk of revenues, and are is scary. We have laid out three scenarios: a sky dive, a set to grow with a greying population. This is unsustainable. bungee jump and a hard stop. All involve lots of acrobatics. Call to Action Sky Dive The country is on the wrong fiscal path. Mathematically, A second term for President Barack Obama could result in a it is pretty easy to change course through a combination sky dive off the cliff, with a risk of broken limbs on landing. A of tax givebacks and spending cuts. Politically, this is very deal on income tax could be done, but another ugly fight over tough to do—unless Washington rediscovers the art of the debt ceiling would be brewing. The US Federal Reserve compromise. It is time to do just that. would be key in supporting the economy and markets. Bungee Jump BlackRock’S Election FORUM A victory by contender Mitt Romney and a Republican The US elections and “fiscal cliff” of tax increases and sweep of Congress could entail a bungee jump with a well- spending cuts are looming large. The first of a series of broadcast plan to get back up. Tax hikes would be reversed discussions organized by the BlackRock Investment retroactively and the debt ceiling would be raised ahead of Institute focused on the US budget. a full budget deal. The Fed would be constrained. It included presentations by leading BlackRock portfolio Hard Stop managers and speakers such as Peter Orszag, former A third scenario would be a screeching halt just before Director of the US Office of Management and Budget, the cliff. Lawmakers would agree to some spending cuts and budget reform advocate Maya MacGuineas. This and then hammer out a budget deal in the summer of publication captures the event’s highlights. All views 2013. The impetus? A market plunge and/or public disgust are BlackRock’s. with Washington. Fed action would take center stage. The opinions expressed are as of October 2012 and may change as subsequent conditions vary. BLACKROCK INVESTMENT INSTITUTE [3] Cliff Watching MARKET Hard Stop Ingredients SKY Dive Lawmakers extend most Ingredients programs in return for some Obama wins the election. No deal spending cuts. They then work BUngee JUmp in the lame-duck session. Possible toward a comprehensive budget income tax deal in early January. deal in mid-2013. Ingredients A Republican sweep of the Expect wrangling on the debt Market Reception presidency, House and Senate. ceiling—again. Bliss—if there are enough signs No deal in the lame-duck session. Market Reception and specifics to indicate a real A well-telegraphed plan to reverse High anxiety in December that is budget deal is in the making. Fed tax increases in January. likely to spill over into 2013 if actions dominate trading. Market Reception Washington cannot compromise. Wild Card Initial euphoria. Possibility of Fed policy takes center stage. Risk assets could sell off if the later disappointment if no real Wild Card deal is seen as another Band-Aid. progress is made to address Expectations for sound fiscal structural budget issues. policy are sub-zero. This makes it Wild Card easy for Washington to surprise on Can one party really make the the upside—and ignite a risk rally. tough calls (including cutting benefits) without the political cover of compromise? [4] US ELECTION CLIFFHANGERS Even a realistic scenario—the extension of most income A Dangerous tax benefits but a hike in payroll taxes and a few spending cuts—would hurt GDP growth by about 2% in 2013, we Disconnect believe. This could negate (at least economically) the effect of the Fed’s open-ended quantitative easing, or “QE Infinity” in market speak. You can always count on Americans to do the right thing— These are big, scary numbers—especially considering the after they’ve tried everything else. US economic recovery is the feeblest in post-WWII history by almost any measure. Yet markets are giving very low This quote, attributed to Winston Churchill, sums up the odds to the possibility that the country will actually go off market consensus on the fiscal cliff: Washington will do the the cliff. Consider: right thing—at the 11th hour. } 79 economists polled by Bloomberg in September all Pretty much everybody agrees the country needs to start predicted positive GDP growth for the first quarter and narrowing its fiscal deficits and slowing the growth of its full year of 2013, with the consensus calling for 2.1% colossal debt load—just not so fast and all at once. The annual growth. reason? The fiscal cliff—a term coined by Fed Chairman Ben Bernanke earlier this year—is high and the fall is deep. } Equity analysts expect S&P 500 companies to increase earnings by 12% next year, according to Thomson Reuters.