About once a year I do the rounds among portfolio managers in Boston and New York to get a different view on markets than may be available by speaking to investors in Asia.
The result is usually a mixed bag, and I do my best to synthesise disparate views into a feature for AsianInvestor magazine.
I’ve just completed a week of such interviews, braving the Arctic conditions that have engulfed the east coast (and eating some really good hamburgers along the way).
This time around, what struck me most was the uniformity of argument. Admittedly my sample isn’t too scientific, but after nearly two dozen interviews with managers of equities, fixed income and real estate – from long-only shops, hedge funds, US-oriented and global or emerging-markets managers – a clear consensus can be deduced.
I’ll save much of the detail for our magazine’s next edition, due out in the first week of February. For now, as our website closes down for the holiday period, let me just outline a few points from the US.
First, the tax deal between Barack Obama’s administration and the lame-duck Congress, signed into law on Friday, is as important for the politics as for what it should do for the economy.
The deal is being touted as a second fiscal stimulus, exactly what Federal Reserve chairman Ben Bernanke has said is needed to complement the central bank’s asset-purchasing programme.
Most of the provisions are extending the status quo, such as the George Bush-era cuts in individual income taxes (maximum rate, 35%). But there are a few provisions that are more ‘shovel-ready’ than most aspects of the original Obama fiscal stimulus of 2009, including a one-year cut in payroll taxes.
But the most important is probably a measure to allow businesses to depreciate new equipment investments at 100% in 2011 and 50% in 2012, which should help cash-hoarding companies to begin to invest and, ultimately, to hire.
The irony of the Democratic defeat in the November mid-term elections is that they probably got a far bigger stimulus through this tax agreement than the ornery Senate would have countenanced otherwise – because the hard left wing was forced to compromise on keeping taxes low on the richest income earners, including estate taxes.
The US economy is already recovering at a fairly normal rate, given the severity of the financial crisis. Private-sector hiring has been steady this year, but overshadowed by cuts among ailing state and municipal governments. This fiscal deal puts a little more wind at the economy’s back, and most investors expect US GDP growth of 2.5-3% for next year.
The fear is that growth is actually a little too robust, necessitating a hasty rise in US interest rates. But for the first time in several years, in my interviews with PMs, the risks to their investment scenarios tend to involve upside surprises: unemployment falls more quickly than expected, or companies invest more quickly than expected.
The only ‘bad’ surprise is that the fiscal package, the Fed’s QE2 programme and the general resilience of the US economy fall flat, the US enters Japanese-style deflation, and consumer psychology becomes bearish. This scenario cannot be discounted, and some fund managers recommend that investors hedge themselves by buying US long-dated Treasuries. But deflation is seen as increasingly unlikely.
Instead what we have going into 2011 is modest growth, gentle inflation, low interest rates, and a gradual improvement in employment. Given the incredible profitability and free cashflow among companies, fund managers agree that equities are very attractive relative to fixed income and to real assets.
This is true worldwide, including for emerging markets, but high-quality US blue-chips seem to offer the most compelling valuations. They are cheap (even compared to European peers) and not only benefit from sales into emerging markets, but are also positioned to exploit domestic growth. Emerging-market stocks should also do well in 2011, but valuations are simply less compelling.
There are also some important parts of fixed income that investors agree should do well for at least the early parts of 2011, notably high yield, but also loans and floating-rate notes (another hedge against a back-up in rates).
The biggest risk is an unexpectedly sharp hike in US interest rates. This is a ‘when’, not an ‘if’, but the consensus expects this to be a problem in 2012. In the meantime, despite the obvious dangers in bonds, buying will continue for reasons other than seeking total returns. Asian central banks have no choice but to put their expanding foreign reserves into the most liquid markets, while many pension funds in the US are now pursuing liability-driven investment strategies.
Looking beyond the first half of 2011, the true risk for the US is political. The tax deal has added $858 billion to the deficit. America is trying to grow its way out of recession but it has little time left to make a credible attempt to address its long-term budget issues, if it is to assure creditors that it does not represent a sovereign debt threat.
The recent tax deal is the first meaningful bipartisan effort between the Obama administration and the Republicans. That alone is encouraging. The Republican victory in the mid-term elections means that the incoming House of Representatives will now have to govern, not just oppose the White House. The reality of a GOP-dominated House means that the Democrats have to compromise.
It’s notable that, for the first time in his administration, Obama was seen as leading the Democrats in Congress, rather than allowing party powerbrokers there such as the outgoing speaker of the house, Nancy Pelosi, to dictate legislation.
So there is a new atmosphere in which the possibility of serious deals can be cut between now and the 2012 presidential election. One is addressing the flaws in social security, which can be saved by extending the retirement age and making fairly modest adjustments to contributions and pay-outs.
The big kahuna, however, is a comprehensive tax reform, in which overall rates on individual income are lowered (and taxes on dividends possibly raised) while loopholes are closed and the entire code is simplified. Ronald Reagan did it in the 1980s with a Democrat-controlled Congress.
And, by 2012, if unemployment has fallen to 8% and growth has boosted tax receipts, conditions should support such a deal.
Moreover, the day after the tax deal was passed, the Senate rejected a separate $1.1 trillion spending package. Although most of this was meant to fund Obama’s healthcare initiative, the package was also laden with pork, notably some big-ticket items (called earmarks) that would have benefited Senate Republicans.
The rejection shows a new-found willingness in the GOP to stop the tide of questionable spending. This, combined with the elevation of moderate Democrats, suggests that there is hope for bipartisan measures to tackle the deficit.
But it’s too early to say this will, in fact, happen. The Republicans are still hell-bent on unseating Obama, and too often advance this goal ahead of the national interest. House Democrats in the next term will still be led by Pelosi, doyen of the hard left.
The debate on tax issues has been kicked down the road to 2012 and the presidential election. But for 2011, the investment picture looks about as clear as one could ever expect. It’s time to overweight equities, particularly high-quality US stocks, as well as junk bonds. It’s likely that 2011 will see emerging-market and other risk assets do well, but US risk assets do better.