WHEN reviewing the appropriate mix of assets to include in client portfolios, we spend time examining the most important issues likely to impact various investments over the coming months and years – and the US fiscal position has been topical for more than six months.
The looming “fiscal cliff” in the US represents approximately $650bn (around 4% of GDP) of expiring tax cuts mainly affecting wealthy Americans, automatic spending cuts (e.g. in defence spending following the failure of US politicians in 2011 to agree on a reduction in general government spending) and other fiscal tightening measures set to take effect in early 2013.
Republicans and Democrats are at odds over the solution to the fiscal impasse, with no obvious path to a deal until after the November election.
However, fears are growing that it could be hard to agree a deal late in the year which could damage consumer and business confidence.
Ultimately, some agreement to extend the majority of policy measures (however short term) is the most likely outcome. Some economists forecast about $200bn of fiscal tightening in 2013 (around 1.3% of GDP). This could slow GDP growth by about 0.8% to 0.9% relative to a scenario with no fiscal tightening (assuming a “fiscal multiplier” of around 0.7).
The IMF waded into the debate two weeks ago, warning of the effects of the fiscal cliff on the US and global economy.
The IMF recommends limiting the GDP contraction to 1% in 2013 and short-term measures to stimulate the economy e.g. infrastructure spending, housing initiatives, training for the long-term unemployed.
It also urged Congress to raise the debt ceiling to avoid a repeat of the same (negative) event in August, 2011, when the US Treasury was nearly forced to default on some of its debt.
The IMF expects the US to grow by 2% in 2012 and 2.25% in 2013.
Given the scale of the fiscal cliff, the backdrop of presidential and Congressional elections and the probable need for another increase in the debt ceiling in early 2013, market participants face another period of heightened uncertainty as the end of the year approaches.
The risk that no short-term agreement is reached in time (and, hence, a very sharp fiscal tightening is enacted at the beginning of 2013) is likely to grow as an investment challenge as the year-end approaches.
However, current investment thinking suggests that most of the fiscal issues will be “kicked down the road” until future years.
Combined with the other challenges investment markets are currently facing (such as a lack of resolution of the eurozone crisis, a slowdown in global economic growth including developing markets, deleveraging of the banking sector leading to a reduced supply of credit), the short term backdrop for equities is uncertain.
However, with earnings and dividends continuing to grow at a rate faster than inflation, equities continue to appear good value over the long term.
