Another Four Years

First of all, let me say thank you to all those who attended yesterday’s 2013 Economic Forecast at the University of Delaware. I was honored to join the other speakers (the Honorable Michael Oxley and Jon Hilsenrath) for an annual event that has become an excellent forum for discussion about the economy and politics. Congressman Oxley presented an optimistic view of the long-term trends in living standards as well as the economy at large, but he also warned that more effective presidential leadership will be required to solve our current deficit and labor market challenges. Jon Hilsenrath, from the Wall Street Journal, provided a short but very informative history of the Federal Reserve. Jon’s coverage of and insight into the Fed have been unparalleled during an era in which Fed activity has been the primary driving force behind the markets. I was most struck by Jon’s belief that there was little risk of a material pull-back in stocks this year as long as the Fed maintains its current course.

For my part, I attempted to present a balanced analysis of the state of the economy and financial markets. As was the case in previous years, I warned about the risks of high federal budget deficits, the recovery’s dependence on aggressive fiscal and monetary policy, and the unbalanced nature of the recovery. However, I also talked about the many green shoots that are beginning to sprout for the economy, including an improving housing market, better consumer confidence, expanding consumer credit, and less onerous debt service burdens. My overall message with regard to the markets was that stocks remain attractive relative to the alternatives for long-term investors, but there is still no need to swing for the fences. I supported a strategy of defensive stock ownership, whereby high-quality, blue chip names are likely to provide reasonable absolute returns over time (7-8%) while handily outperforming the bond market. Four specific investment themes that I discussed were: 1) a possible shrinking in the wealth gap and reemergence of the middle class; 2) the housing market rebound; 3) reduced financial regulatory uncertainty; and 4) high-yielding blue chip stocks as a substitute for bonds.

In last night’s SOTU speech, President Obama gave us sixty minutes of reinforcement for the first of the investment themes mentioned above. The President remains intent on broadening the middle class through a combination of initiatives such as raising the minimum wage, better early-life education programs, expanded worker training programs, increased access to mortgage refinancings, infrastructure spending, continued low income tax rates, etc. At the same time, it seems that the President will continue to look toward wealthier Americans to help fund some of these initiatives as well as reduce the current level of deficit spending. In addition to the recently approved tax hikes for wealthier Americans, Obama now looks to close tax loopholes and reduce deductions for the well-to-do. Obama would also require wealthier Americans to foot more of their Medicare expenses.

It seems likely that over time, Obama’s legislative policies may reverse the long-standing trends of widening wealth and income gaps. Without making a political comment on the viability of this approach, it seems likely that those companies peddling goods and services to moderate-income households may fare relatively well in the coming years compared to those catering to the rich (which have well outperformed in recent years). Importantly, the President does not seem to strike a conciliatory chord with Republicans but will rather enlist the support of voters. From today’s Wall Street Journal, “Mindful of the long odds of passing a broad legislative package, Mr. Obama is pledging to use his executive powers when necessary and maximize his leverage by taking his case directly to voters.” At yesterday’s Economic Forecast, Congressman Oxley spoke about President Reagan’s ability to bypass congressional gridlock by going directly to the people. Will President Obama be successful with the same approach?

During the Q&A session yesterday, I was asked what I thought investors would like to hear from President Obama in the SOTU. I responded that I wanted to hear some evidence that he was willing to adopt a more conciliatory attitude that might help lead to compromise on some major issues (most notably the deficit). Well, we obviously did not get this. Instead, it appears we are in for four more years of gridlock based on strict ideological divides. The optimists might say that we did okay over the first four years, but I’m not so sure we can be as dependent on the Fed this time. Repeating the strong gains of the past four years will require some resolution to the current deficit situation as well as the problem of long-term structural deficits. Last night’s speech got us no closer to these objectives.