Most often the breakout is to the upside as the uncertainty surrounding the fiscal policy and regulatory policy environment resolves; however, 2008's dismal fourth quarter performance -- as the global financial crisis erupted from the failure of Lehman Brothers -- lowered the long-term average to reflect a fourth quarter dip, as you can see in Chart 2.
The 2012 election is likely to be consequential for investors. There is a growing consensus that a plan to save about $4 to $5 trillion over the next decade is necessary to stabilize the debt-to-GDP ratio in the United States. Despite the efforts of the "super-committee" tasked with finding the $1.5 trillion agreed to in the terms of the debt ceiling deal crafted in early August, a package this size is unlikely to become law before the election.
Since Congress is unlikely to pass a major deficit reduction bill before the 2012 election, the outcome will have major implications for investors. The party that emerges in control following the November 2012 elections will forge the decisions that will represent one of the biggest shifts in the federal budget policy since WWII.
Failure to pass a major deficit reduction package in the wake of the 2012 election, regardless of what the rating agencies do, will likely result in a loss of faith by investors that the federal government will get on a fiscally sustainable path absent a financial crisis. Of course, this loss of faith would help to produce the crisis, with major implications for the markets, and force a major deficit reduction deal.
Regardless of the details of the plan -- and we have many proposals to choose from that blend a mix of tax increases and spending cuts -- most proposals phase in the impact so that it is not until five years from now that the full impact would be felt. The cuts would likely be equivalent to about 3% of GDP, or about 14% of the federal budget. This would be one of the biggest policy shifts in modern U.S. history. While the markets may welcome a resolution of the uncertainty and a path to fiscal sustainability, certain sectors may feel the brunt of the cuts, such as the health care and defense industries. Other asset classes may be impact as well if changes are made to the tax-advantaged status of municipal bonds for some taxpayers.
As we look out to the next few years, the old adage that the market likes "gridlock" or balanced government between the two parties may not hold. It is apparent in recent market performance that investors recognize that substantial, defining fiscal policy changes -- difficult to forge in a divided Congress -- are needed.
We will be watching as the election battle heats up -- the first presidential primaries are only four months away --to gauge the market impact of what will likely be a very consequential election year.
Readers Also Like: