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• Post Election Thoughts and the Market

Post Election Thoughts and the Market

written on November 23, 2010 by Frank Fantozzi

It’s been a couple of weeks since the American public voted and voiced its opinion.  The American people made themselves heard across a broad range of issues from lower taxation to smaller government (less spending), free enterprise, and the concept that Washington should stick to governing the country, not telling people how to live their lives (healthcare reform).  Yet, despite the short-term euphoria, positive changes will not happen overnight.  There is a lot of work ahead.  As we have come to realize over the last several decades, good government has been hard to find and good policymaking, like our judicial system, grinds finely but slowly.  As we’ve seen in the past, when the pendulum swings to an extreme (for whatever reason) there is usually a backlash that brings the pendulum back to the supposed American mean.  The recent elections certainly point to this being the case today.

Much of what of is happening today is not surprising.  If we look back at some thoughts from our prognosticating at the beginning of this year, we see many of these themes playing out today:

1. In the year preceding an economic recovery year, the markets tend to be sideways producing little appreciation.  The value is in yield during sideways markets.

• To the extent stimulus money hit the intended targets, it quickly ran out

• Banks were not lending money until late in the third quarter when the Fed put pressure on the banks for holding more money above the intended reserve requirements

• Companies reported record cash on their balance sheets due to fears regarding a perceived anti-business vibe emanating from Washington, concerns about what healthcare reform would mean to them, and the fear of rising income taxes that would directly impact small and midsize business owners

• Continued high employment.  Most recoveries from recessions are led by the consumers.  With 42% of GDP tied to housing and unemployment hovering around 10%, no one is buying existing homes let alone building new homes.

2. Increased income taxes have a dampening effect on future spending.  There are seven layers to tax attrition: FIT, SIT LIT, CGS, FICA/FUTA, ALT MIN, and SS Tax on Benefits.  With the top federal income tax rate scheduled to go from 35% to 39.5%, capital gains going from 15% to 20% and federal estate tax rates increasing from 45% to 55%, along with the gift tax increasing from 35% to 55%, there will be less money going into the system to fuel spending.  This does not include the many excise duty taxes we pay.

3. We also stated that if the Republicans made a strong move in the midterm elections, the markets would see this as pro free-enterprise and a pro consumer positive helping out the fourth quarter.  With the Gallup polls pointing to a strong showing for Republican candidates in September and October, the markets demonstrated strong positive movement in both September and October.

What does all this really mean for you?  People still fear the three dreaded “Ds”: Double-dip in the market, Deflation, and Democrats-Republicans in Washington getting nothing done on Capitol Hill.  If you recall from the Federal Open Market Committee (FOMC) Report in September, the Fed basically came out and said that there is no double-dip and we will instead be in a period of slow growth.  More importantly in this FOMC statement, the lack of inflation and its negative impact on the economy was discussed.  What the Fed was really saying was that they are going to create inflation through qualitative easing.

What Washington emphatically heard and what we believe this election was about was clearly the economy.  Americans tend to have short-term memories.  As long as the economy is strong Washington can do no wrong.  When the economy weakens everything is wrong with Washington.

If we look back to the days of our founding fathers, it is clear that economic freedom was a primary theme and continues to be today.  People from all walks of life have and continue to come here for an opportunity to live the American dream.  The American dream, in its truest form, is simple.  People want an opportunity to provide for themselves without government interference in how they live.  However, the waters quickly become muddied when 47% of the American public does not pay any federal income tax. It becomes even more of a concern when another 40% who never pay into the system receive money back in the form of credits the system simply pays out to them.  This is not economic freedom, but dependency created by Washington.

These percentages become long-term unsustainable because there is not enough money coming in to continue paying out.  Instead of the government just governing, the government acts as a self-appointed redistribution center, digging itself into an ever-deeper hole.  Having said this, Washington sees a clear mandate to get the economy and Americans working again.  As mentioned earlier, 43% of the GNP is in housing.  Without jobs our housing market cannot be fixed.  Without the housing market fixed the economy cannot fully recover.  So what does this mean to investors in the upcoming year?  Areas that tend to perform well in a reflationary period and potentially drive the market usually include: gold, silver, commodities, TIPS (treasury inflation protected securities), long treasuries, equities in the materials, industrials, and energy sectors; equities in emerging markets, and possibly international markets.  And what about the losers?  The dollar tends to weaken in reflationary periods and equities in the financial markets tend to fall.

As U.S. investors re-enter the markets, they are doing so somewhat tentatively.  As measured by the S&P 500, U.S. markets are up 18% in the four months since the beginning of the second half of 2010. Nonetheless, individual investors have remained net sellers during every week.  In the past twenty-five years of money flow data, this selling as markets have risen 10% over several months has never happened before.  The good news is that individual investors have not been avoiding investing entirely.  Interestingly, they have been putting money to work in foreign stocks and U.S. bonds, including more aggressive emerging market stocks and high-yield bonds, as they reallocate money from cash and U.S. stocks.

 

Frank Fantozzi

Planned Financial Services

phone (440) 740-0130      www.plannedfinancial.com  

If you or someone you know has a question about allocating investment assets in today’s economy, please contact me.

Securities offered through LPL Financial. Member FINRA/SIPC.