After listening to the rounds of Sunday talk shows and watching the Fiscal Cliff talks progress, it seems inevitable that some combination of tax hikes and budget cuts are ahead. Whatever the final budget and tax numbers turns out to be its almost certain to have a dampening effect on economic activity. The economy is growing at about a 2% rate and so far quantitative easing and has yet to ignite anything close to job growth. A less accommodating fiscal policy which seems a certainty may even reduce this torpid rate. Some initial observations and then I’ll offer some strategic investment action.
It is looking like another year of very low interest rates. We can only hope that too much austerity will not push us into a deep jobs recession like Spain and Greece. The social and economic cost of too quickly addressing our structural deficits could have very harmful and lasting results. On the other hand, there could be some unexpected benefits. A stronger dollar as a result of credible deficit reduction might do something to dampen the inflation that’s destroying the middle class’s purchasing power. Everything you need to buy like food, energy, and healthcare is on a relentless path higher while the things you don’t have to buy like computers, big screen TVs, and clothing keep the CPI lower. Now that rents are rising and home prices stabilizing or even rising, expect a lot more to be heard on the inflation front.
So how do we invest? That’s the point of this after all. Last week we wrote about the drubbing utility stocks took and how we thought it was a unique buying opportunity. The XLU (the most actively traded utility stock ETF) responded to our wishes on Friday rising a full percentage point on 3 times normal volume. I still think the hike on dividends income to pre Bush levels will be muted. Even if it does happen, there are still few substitute investment products that will be spared the tax hike. There could be limits to tax free income from munis or MLPs for high earners. Utility stocks are recession resistant and could offer some outstanding returns (4% dividend yield and 4% capital appreciation for 8% total returns).
Growth companies will most likely command an abnormally large premium to their slow growth peers. As always a few companies are in the right spot at the right time and will outgrow the economy. Finding them at the right price though will be challenging. These stocks usually command a premium and insiders are generally sellers not buyers so their behavior offers few clues. Investors’s Business Daily list of New America is a good first stop shopping list for growth stock investors.
I do think the market has substantial risk if the economy slows down due to fiscal policy. We can count on Bernanke keeping the monetary faucet running but I’m less optimistic about the White House and Congress. Neither seems inclined to provide economic stimulus programs that build the economy in lasting ways like a serious energy domestic energy plan. Instead the current administration seems to prefer transfer payments in lieu of capital investment ideas that are market driven. The Republican House is dogmatic when they need to be pragmatic. Neither party seems to be able to come up with the big idea that could usher in a wave of investment.
For the time being, I recommend keep large cash balances on hand and trading in and out of ideas. One that we mentioned earlier is Corning. The recovering housing market is helping their core LCD glass business. Tablets, smart-phones, and Windows 8 touch screen interface are consuming more of their Gorilla glass than anyone could have predicted.