BlackRock’s Bob Doll looks for the edge of the cliff
Bob Doll, senior adviser to BlackRock, believes the US fiscal cliff is the primary short term factor affecting the outcome for investors in the US, as taxes such as those on dividends, could rise.
Earnings are coming through for the third quarter and have been guided down enough that most companies, we believe, should be able to beat the lowered estimates. At this point, it appears earnings will fall by 1%-2% for the third quarter and year over year. Notably, analysts expect the pause to be short-lived, with strong 10% growth expected in the fourth quarter and estimates in the mid-teens for 2013. For this to occur, we would need to see increasing margins, which we think is unlikely unless revenues accelerate. Our view, in fact, is for a deceleration in revenues, which would imply that estimates are probably too high.
The economic and profit outlook for the next year suggests that a continuing equity rally will require some decline in equity risk premiums. For this to occur, we believe investors need to see some signs that quantitative easing is paying off in terms of stronger economic activity.
Politics Paving a Bumpy Road
The US elections are only two weeks away, and the recent polls show a very tight race. There are significant differences, both perceived and real, in the policies of the two candidates and the impact they might have on financial markets.
The 2012 election is unique in that it comes against the backdrop of expiring tax cuts and potential spending reductions that are set to converge at year-end in what has become known as the fiscal cliff. The manner in which the fiscal cliff is resolved will determine in large measure how the economy, equities and sectors perform next year. Analysis of the cliff implications needs to take into account the current US macro-economic climate. In particular, the economy is still operating in the aftermath of the financial recession with ongoing deleveraging. In addition, the United States has a high and unsustainable long-term fiscal policy problem that will need to be addressed beyond the fiscal cliff.
Dividend tax rates, if nothing is done, are among the taxes set to rise on January 1. Our guess is dividend rates will increase but are unlikely to return to the level in place prior to the Bush-era tax cuts. More likely, they will fall somewhere between the current rate and that higher rate.
The US is not the only place where politics remain a source of economic uncertainty. The shift toward growth is in its early stages, and the key will be for global growth to become self-reinforcing. We think the odds of that are rising, but it’s nowhere near a done deal. The big swing factor for investors since the spring has been the shift in policy at the European Central Bank (ECB), with the blessing of German politicians.
Stay the Course in Equities
US households are growing in confidence and boosting their expenditures. At the same time, however, concern about the looming fiscal cliff appears to have businesses reducing capital investments. The outlooks for consumption and investment both depend critically on whether the fiscal cliff is averted. Potential tax increases, a key component of the cliff, are likely to weigh more on consumption as we near the end of the year.
Against this backdrop, the US economy continues to limp along, not because it isn’t particularly strong, but more so because uncertainty appears to have held the business sector back in terms of investment and hiring. Looking forward, a diminishment in this drag, even as fiscal policy tightens next year, would be a large positive for the economy and investor sentiment. In the short run then, while the consolidation in risk asset prices may continue, we think conditions for a full-blown correction are not present. As such, we would argue for a modest pro-growth, cyclical investment stance.