THE BLOG
11/09/2012 10:27 am ET

Post Election Collapse

After flat markets during an abbreviated super-storm week, the Dow rallied about 250 points on Monday and Tuesday. Wednesday saw stocks open lower and continue lower. The 250 point gain of the previous two days was wiped out, plus an additional 60 or so points for good measure. Why?

The only correct answer to any short-term market move is "there is no way to know for sure." All of the talking heads who rush forward with steely certainty are definitively suspect. So with great uncertainty, I proffer the following:

  1. Markets were not surprised: InTrade and virtually every political analyst called for a "most likely" path for Obama to receive the necessary 270 Electoral College votes. Therefore, the sell-off was probably not an Obama-centered event.
  2. Yet there were clearly plenty of investors who were somewhat positioned for a Romney victory. How do we know this? If we look at yesterday's S&P 500 returns by industry sector, it paints a clear picture. The worst performing sectors Wednesday were Financials and Energy. According to the experts, these are the two sectors most negatively impacted by Obama's reelection. It's hard to say that an Obama victory was fully baked in when major financial institutions like Goldman Sachs, JP Morgan, Morgan Stanley and Bank of America fell anywhere from 5-8%. At the same time, the Consumer stocks (both Discretionary and Staples) held-up best. Investors may expect that continued support for lower-income and unemployed people will support the earnings prospects for a wide range of consumer-oriented companies. And finally, Health Care companies, many of which benefit from Obamacare, outperformed.
  3. Europe again! The European Commission cut its growth rate for the Eurozone on continued negative effects from the debt crisis. The Commission now expects growth of just 0.1% in 2013 for the 17-nation Eurozone compared to the prior estimate (May) of 1.0%. At the same time, ECB President Mario Draghi said that the crisis was beginning to negatively affect growth prospects in Germany, the Eurozone's largest and most important economy. Europe remains a mess. But is that news to anyone?
  4. Our most likely thought is that with the distraction of Election 2012 behind us, reality has finally set in. The "reality" is that the elections changed almost nothing about the dysfunctional state of US national politics. We have the same president, the Democrats maintain control of the Senate, and the Republicans maintain control of the House. We are just a few short weeks away from mandatory spending cuts and tax hikes worth over600 billion dollars and representing about 4% of GDP. Does anyone really believe that the passing of the election will somehow lead to a newfound sense of harmony among Congressional leaders?

What's at Stake?

Consider an example of a family of four earning $70,000 per year. The family spent $77,000 per year for the last four years on helping a sister in financial peril, covering a major car repair and replacing a furnace. They now have over $30,000 in new credit card debt. They recognize they have to either earn more and/or spend less. Mom or Dad might take on another job, but with two growing children, there are few places to cut expenses.

The US Economy, despite trillions of dollars in deficit spending and trillions of dollars of stimulus from the Federal Reserve, has been struggling to generate 2% GDP growth. The US, like our family of four, needs to earn more and/or spend less, must develop a real plan for reduced spending and higher taxes. BUT, if you reduce the Government and Consumer portions of the GDP formula, it becomes VERY easy to stall any type of economic recovery and plunge into recession or worse.

There is no easy solution to our current economic dilemma. Anyone who glibly suggests that "We should JUST do this or that" doesn't understand the fragile complexity of our predicament. A cursory glance at the government's fiscal situation reveals that its biggest expenses are Medicare and Social Security. This is the elephant in the political room. These future commitments MUST be reduced if the US is to return to prosperity.

It took a number of years and a great deal of leverage to dig a hole as deep as this, and it will take many years if not a decade to climb out. The time for excuses and dithering is over. The US must develop a thoughtful plan of attack and ACT on it NOW!

With a difficult growth forecast and exceptionally low interest rates and continued market volatility, we continue to favor solid balance sheets, strong earnings growth, and a defensive strategy.