Yesterday’s election resulted in no major change to the current leadership in Washington.  President Obama won with just over 50% of the vote, the slimmest margin ever for a re-election, but won a sizable 332 electoral votes (270 needed to win).  Democrats continue to control the Senate and are likely to expand their advantage to 55-45 following resolution of two undecided races.  Republicans get a consolation prize in keeping their control over the House.  Below are summary thoughts on the election implications:

  • Divided government in Washington means more gridlock near term.  Democrats will argue that the Bush tax cuts on the wealthy should expire.  In contrast, House Speaker Boehner last night stated that there is “no mandate for raising tax rates” on the American people.  Expect the rhetoric to worsen over the coming weeks as the fiscal cliff draws near, causing volatility in the markets.
  • However, the prospect of the largest tax increase in history, along with large spending cuts amounting to a “fiscal cliff” of nearly 4% of GDP, will force a compromise before year end.  The most likely scenario is to extend the expiring tax provisions and delay spending cuts until a deficit reduction package can be put in place in 2013.  An extension of the Bush tax cuts on the wealthiest Americans is in doubt, but perhaps there will be some compromise that prevents the top marginal rate from rising to 39.6%.
  • The election ensures that the major provisions of the Affordable Care Act (Obamacare) will remain intact.  Specifically, the new 3.8% tax on investment income will go into effect on Jan. 1, meaning capital gains and dividend tax rates rise to a minimum of 18.8% in 2013.
  • The debt ceiling must be addressed by the first quarter of 2013, and there is a chance that it will be part of a compromise during the lame duck session of Congress.  Debt ceiling negotiations in 2011 disrupted financial markets and represent a significant risk in 2013.
  • Obama’s re-election also ensures that the highly accommodative policy of the Federal Reserve will remain.  While Ben Bernanke appears to be set to leave when his term expires in 2014, he will likely be replaced with someone of similar views.  As a result, this is bullish for gold.
  • More attention on climate change (this was one of New York Mayor Bloomberg’s primary reasons for endorsing Obama) will result in an even more activist EPA, with negative implications for coal, oil and gas, and utilities.

Today’s market reaction: worries over the fiscal cliff and higher capital gains taxes are driving stocks lower and bond prices higher.  Gold is flat so far today, but crude oil is down 4%.  The worst selling pressure is occurring in those areas that have done well this year (technology and financials), and stocks that would have benefited from a Romney victory (coal and oil and gas).

Reasons to temper the pessimism: as discussed during our October 18thconference call, the global economy is gradually improving from the summer slowdown.  In the U.S., housing has ceased to be a drag on economic growth, and most of the recent data has come in better than expected.  Overseas, China’s economic activity seems to have stabilized, and the transition to new government leaders should support growth.  Central banks around the world have highly accommodative monetary policies.  Finally, movement on a credible deficit reduction plan in 2013 would be bullish.  As a result, continue with a balanced strategy of a conservatively positioned equity portfolio, high quality municipal and corporate bonds, mortgage-backed securities, and alternative assets including gold and MLPs.

Disclosures

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.

There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.

Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.