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Don’t Jump Off the Fiscal Cliff Just Yet

Don’t Jump Off the Fiscal Cliff Just Yet

No matter what happens in November—whether we end up with a divided government or one-party rule—we’ll likely avoid a fiscal cliff, said Dr. David Kelly, chief global strategist and head of the global market insights strategy team for J.P. Morgan Funds. During a webinar last week, Kelly had quite a different perspective from the gloomy forecasts of the other money managers on the call. The economy, markets and U.S. government are not in as bad a shape as everyone is making them out to be, Kelly said.   

Whether it’s Obama or Romney who’s elected at the end of the year, neither president would want a fiscal cliff to happen, and they’ll likely keep that from happening, Kelly continued. If we end up with a dividend government, both parties have too much to lose from allowing all Bush tax cuts to expire and all the spending cuts to kick in at the same time. “They are other things to worry about, but do not worry about a fiscal cliff.”

The “fiscal cliff” is what people in Washington are calling the slowdown in GDP that would happen if taxes go up as high as they might, and spending goes down as much as it might.

The key, Kelly says, is to have a deficit that’s small enough so that growth of debt isn’t any bigger than growth in GDP. And we have been making progress. The U.S. deficit was 10.2 percent of GDP in 2009. This fell to 9 percent of GDP in fiscal 2010, 8.7 percent of GDP in fiscal 2011, and should land at 7.6 percent of GDP in fiscal 2012, Kelly said. If there are no changes in law, you could see this fall very sharply next year. That would have a drag on the economy, Kelly said.

“That’s what we’re worried about. It’s possible that you could have the expiration of all the Bush tax cuts and the imposition of all the spending cuts agreed to last August all happen at the same time. You don’t want to see that.

“Bringing the deficit down is like lowering a piano out of the fourth floor of a building. You got to do it slowly. We are doing it slowly.”

Frank Barbera, executive vice president at Sierra Investment Management, had a very different view on the U.S. economy, calling the U.S.’s exponentially rising debt, $1.5 trillion deficit and declining long-term interest rates “an irreconcilable problem.” We need to see Washington start acting and having an adult conversation on cutting spending, he said.

“Otherwise, within the next few years, we think the U.S. will be heading for a similar fiscal debt crisis, the same type of outcome that we see right now in Europe, and that would also force interest rates up here in the United States.”

But Kelly doesn’t think the U.S. is headed for another recession, because “recessions occur when the cyclical sectors of the economy collapse.”

In order to get another recession, these cyclical sectors—housing, autos, business equipment spending and inventories—have to get rebuilt again and then fall, Kelly said. But we’ve got five years of vehicle sales being below trend levels, and the average vehicle is 10.6 years old, meaning they’re wearing out and will need to be replaced. Housing starts are at a little over 700,000 now, an indication that there’s pent-up demand building for housing. Autos are also gradually moving up, Kelly said.

“I’m not saying the U.S. economy’s going to boom by any means. But we’ve seen improvement in consumer finances; people have refinanced mortgages; they’re in better positions to take on debt.”

The negative news and gloomy outlooks have an interesting impact on investor behavior, Kelly said. People tend to overreact to bad news, and underreact to good news.

“The cumulous effect of all these overreactions and underreactions have left two things really out of wack. Investors are on average way too conservative and valuations on average are way too extreme, favoring risky assets over safe assets.”

TAGS: Investment
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