November 13, 2012

Special Post-Election Analysis

With the election behind us, what's next for the economy and the financial markets? In this special analysis, we'll take a look at what the election means, how the markets are reacting, and where we go from here.

What the Election Means

For starters, the political makeup of the country hasn't changed much. President Obama remains in the White House, the Democrats are still in charge of the Senate, and the Republicans retain the House. With no significant change in the balance of power, both parties will have to find ways to compromise in order to keep the country moving forward and to avoid the economy falling off the looming fiscal cliff.

Economically, our politicians need to tackle two major issues - the fiscal cliff and unemployment.

The fiscal cliff is perhaps the biggest and most immediate of the two. As a result of previous legislation, deep, automatic federal spending cuts and tax increases will take place in January unless the President and Congress agree to some alternative plan. If they fail to reach an agreement, going over the cliff, "would not only risk another recession, but would intensify anxiety about the dysfunction of the U.S. political system," according to The Wall Street Journal.

On a related note, our ever-growing national debt is deeply entwined with the fiscal cliff issue. If Washington can effectively solve the cliff issue, it might also put the deficit on a path to sustainability and that could be great news for the economy and the markets.

The second issue is unemployment and it is deeply entwined with economic growth. While the unemployment rate has come down, it's still too high as, "roughly 3.6 million Americans have been without work for a year or more and are still looking," according to The Wall Street Journal. Government policies and regulations have a major impact on corporate America's desire to hire and expand. If our leaders can enact pro-economic growth policies, it might encourage businesses to reinvest and hire more people.

Here are several other things to keep in mind as a result of the election:

• Health care overhaul. Love it or loathe it, it's here to stay. Among other things, companies with 50 or more full-time equivalent employees will be required starting in 2014 to provide health-insurance benefits or pay a penalty. While small businesses may not be happy about that, at least they can now plan for it.
• Tax increases. President Obama has said he'd like to see taxes rise for couples earning more than $250,000 a year. Also, tax rates on dividends and capital gains may rise. Of course, these won't happen unless Congress passes them.
• Tax breaks. Both sides seem to agree that certain tax breaks and loopholes will have to go as part of any compromise. And, while this might avoid raising tax rates, it would mean a tax increase for those affected.
• Entitlement reform. Any "grand bargain" on the deficit will likely mean changes to Social Security and Medicare. In other words, we could see Democrats agreeing to reductions in benefits in exchange for Republicans agreeing to tax increases or closing tax loopholes.
• Easy money. With the President's reelection, Federal Reserve policy is likely to remain "easy." This could mean more rounds of quantitative easing and continued low interest rates.

The economic issues facing our country are serious and the folks in Washington know it. They also realize it will take compromise to get things done. As CNN said, "Both sides agree the best outcome would be a broad deal addressing the overall need for deficit reduction, including reforms to the tax system and entitlement programs such as Social Security, Medicare, and Medicaid." Let's hope our politicians put politics aside and do what's best for our country to get us growing strongly on the road to economic prosperity.

How the Markets Are Reacting

With the polls showing the President in the lead going into Election Day, the financial markets shouldn't have been surprised when he won - but it appears they were. U.S. stocks dropped 3.6 percent in the two days after the election before finishing slightly higher on Friday, according to data from Yahoo! Finance.

Looking at history, it's interesting to note that the stock market performed quite well during President Obama's first term. The S&P 500 index rose 76 percent from inauguration day to last week's Election Day. By contrast, it declined 13 percent during George W. Bush's first term, rose 60 percent during Bill Clinton's first term, and rose 25 percent during Ronald Reagan's first term, according to MarketWatch. How much of those returns can be attributed to each President's policies is anybody's guess, so it's hard to draw solid conclusions from them.

In terms of sectors to monitor, MarketWatch says the following might benefit from the election results:

• Healthcare. Drug companies and insurers might benefit from the healthcare mandate as coverage expands over time.
• Home construction and real estate. Continued quantitative easing and low interest rates may bode well for the housing market. This could be very beneficial for the economy as housing plays a significant role in economic growth.
• Precious metals. Gold prices rose last week as investors think continued quantitative easing could be bullish for the shiny metal.

Where We Go From Here

Putting the election behind us has removed one hurdle to moving the country forward. With campaigning out of the way, Washington can get back to work.

As Congress and the President engage in posturing and gamesmanship over the fiscal cliff and the tax and entitlement reform issues, be prepared for volatile stock prices over the next couple months. Ironically, politicians may not take decisive action on these issues until forced to through the pressure of lower stock prices.

Aside from the pressing issues, is there a reason for optimism on the economy? Yes. According to Bloomberg, "The median prediction of 37 economists surveyed by Blue Chip Economic Indicators is that during the next four years, economic growth will gather momentum as jobless people return to work and unused machinery is put back into service." Bloomberg also pointed out the following positive indicators:

• Banks have strengthened their balance sheets.
• Most households, which borrowed too much during the housing bubble, have pared their debt back to normal levels through a combination of frugality and default.
• Upper-income households' balance sheets are in good shape, although mortgage debt remains a heavy burden at lower-income levels, says Mark Zandi, chief economist of forecaster Moody's Analytics as quoted by Bloomberg.
• Housing prices have gone from falling to rising, buoying confidence.
• Increased consumer spending should induce more business investment in a virtuous circle.
• There's pent-up demand for residential and commercial construction.

Stepping outside the U.S., we still have major economic and budget issues in Europe, China is going through a once in a decade leadership change while its economy slows down, and the Middle East, as always, is a wildcard.

As you can see, we have a lot on our plate to monitor! And, as your advisor, we're doing our best to keep you well positioned to benefit no matter what Washington throws at us.

Data as of 11/9/12	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	-2.4%	9.7%	12.3%	8.1%	-1.0%	4.7%
DJ Global ex US (Foreign Stocks)	-1.9	6.8	3.1	-0.3	-6.8	7.1
10-year Treasury Note (Yield Only)	1.6	N/A	2.0	3.5	4.2	3.9
Gold (per ounce)	3.2	10.4	-2.6	16.2	15.9	18.4
DJ-UBS Commodity Index	0.3	0.1	-5.3	1.8	-5.3	3.2
DJ Equity All REIT TR Index	-2.0	14.4	20.3	19.6	3.6	11.7

Weekly Focus - A Salute to Our Veterans

As we honor our Veterans, we'd like to share an excerpt from the President's Veterans Day Proclamation:

"Whether they fought in Salerno or Samarra, Heartbreak Ridge or Helmand, Khe Sanh or the Korengal, our veterans are part of an unbroken chain of men and women who have served our country with honor and distinction. On Veterans Day, we show them our deepest thanks. Their sacrifices have helped secure more than two centuries of American progress, and their legacy affirms that no matter what confronts us or what trials we face, there is no challenge we cannot overcome, and our best days are still ahead."

Thank you to all who are serving, who have served, and to the families and friends supporting our Veterans. We truly appreciate all you do for our country.

Best regards,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

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