Valliere at SSG: Economy Is ‘Healing’ but Watch Out for Iran

Chief political strategist at Potomac Research is optimistic on economy and markets, but warns of fallout from possible Iran attack and of increased ‘paralysis’ in Congress after elections

Greg Valliere has been covering the ins and out of politics and the economy for more than 30 years in a non-partisan way, and last Friday he provided attendees at Shareholders Service Group first annual conference with a generally optimistic forecast for the economy, markets and employment, tempered with his concern over a possible attack on Iran and the likelihood of continued “paralysis in Congress” after the November elections, regardless of who wins the presidency.

Greg ValliereValliere (left), whom many advisors know from his near-annual appearance at Schwab Advisor Services’ annual Impact conference, began his presentation in San Diego by suggesting that U.S. GDP will likely be at 2.5% in the current quarter and in the second quarter, and that unemployment will remain in the “low 8%” range for the rest of the year (in February the jobless rate was 8.3%).

“The labor market is healing,” he said, and “by Labor Day it may well be below 8%,” though he worries that a number of previously disillusioned job seekers may reenter the job market, which will keep it from falling lower. As for inflation worries, “CPI will be tame, despite a [rising] gas price blip,” and he thinks it unikely that there will be a QE3.

As for other good news, he said an underreported story is that the budget deficit is actually declining, and that government spending has leveled off and will stay that way, and that tax receipts are picking up. Internet sales, he said, are a big reason why some state tax receipts are not going up.

“So how can Washington screw up” this improving economy? For one thing, he doesn’t expect Congress to pass an extension any time soon of the Bush-era tax cuts. “It wouldn’t surprise me if they don’t act until Dec. 26,” which he said might have a negative effect on the markets in the fourth quarter. But in December, he suggests we may well see a “grand compromise,” which would include extending the Bush tax cuts for those with annual incomes under $250,000; perhaps an end to sequestration, though Valliere thinks there’s a good chance that the defense budget may not be cut, making “defense stocks an interesting play”; and domestic discretionary spending. One other reminder, he noted: the debt ceiling will also expire in December 2012.

While Valliere said that some of the details on the “Grand Compromise” will depend on who wins the election, “nobody in Washington knows for sure.” In fact, he argues that November 2012 “may not be a cathartic election.” While who wins the presidential election is still up in the air, the makeup of Congress is more likely to be further right than it is currently. Partly due to the number of retirements in Congress, he expects a “very conservative House,” and that there’s a chance the Senate will be GOP controlled as well. “Their magic number is four,” Valliere said about the number of seats in the Senate that the Republicans need to take over leadership there, and even if the Democrats remain a majority in the upper house, “the Senate will get more conservative.” In general, “paralysis in Congress might increase” partly because of the many ‘moderates’ in both parties who are retiring.

As for the presidency, Valliere said he could see either Mitt Romney, whom he assumes will win the GOP nomination, or Barack Obama winning the election, though both have their own drawbacks. Romney can be tone deaf when talking to the electorate, he said, but because of pressure from the Tea Party Republicans, Romney will not be able to “pivot to the center” in the general election, which may hurt him. Obama, he said, is “not a shoo-in,” however. Among his problems: “rising gas prices are a de facto tax … 25% of U.S. mortgage holders remain under water,” and while the jobless rate is falling, those “people with new jobs are getting paid less.”

Either man would likely address Social Security reform in 2013, including raising the retirement age, and “in private, Obama says that would be his legacy” in a second term.

As for geopolitical stories, Valliere lists two big ones: Iran’s nuclear ambitions and “who owns CDSs in Europe.” He sees a recession likely in Europe this year, except in Germany, even though Europe’s “getting better since last month,” thanks to ECB President Mario Draghi “throwing money everywhere” which he characterized as “triage to save the patient,” though now he’s “talking about austerity.”

A possible military strike by Israel on Iran’s nuclear sites is likely in July or August, but “Iranian retaliation worries me the most,” since not only would Iran likely launch missiles into Israel, but also into Turkey and Saudi Arabia. Oil prices would likely spike in the event of military action, even if the U.S. Navy kept the Straits of Hormuz open with its mine-sweepers. “There’s already a cyber war going on” against Iran, he said, and reminding his audience that he’s cynical about Washington, “Obama won’t complain" about any possible Israeli strike because "he needs New Jersey and Florida votes."

Responding during the Q&A portion of his presentation to a final question on likely Social Security reforms, he suggested that the most likely steps would be to change the formula for the cost of living adjustment (COLA), to raise the retirement age, and perhaps some forms of means testing. Means testing for Medicare benefits would likely be on the table as well, he suggested.

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