February 27, 2013

Citing ‘Washington Math,’ Pioneer’s Taubes Sees Little Sequester Drag on GDP

Fund firm CIO says $85 billion in sequester cuts would only slow down economic growth; Valliere sees no significant tax reform for years

Pioneer Investments’ chief investment officer, Kenneth Taubes, and Potomac Research Group’s Greg Valliere agreed Tuesday that the sequester cuts due to take effect March 1 would have little effect on the U.S. economy and the markets.

Speaking on a conference call with advisors, one of a series hosted by Pioneer, Taubes first addressed the potential drag on the economy from the sequester’s scheduled $85 billion cuts in discretionary spending, pointing out that even with those cuts “total spending will still be up $14 billion” in the current fiscal year, “so we’re talking Washington math”—Instead of “actually, really cutting, they’re spending less than anticipated.” 

“From a GDP perspective, it just has less of a positive impact,” Taubes said, “it won’t cut GDP but will slow down growth of GDP.” Putting the $85 billion in cuts into a broader perspective, Taubes said that “on a $16 trillion economy, we’re just talking about a reduction in the rate of growth; mandatory spending continues to grow at unsustainable levels. I don’t view this as an economic disaster, and the markets aren’t terribly concerned with it.”

Going beyond the budget numbers, Taubes admitted “we’ve got a lethargic rate of growth,” owing in large measure to government spending cuts on both the federal and local levels.

In the private arena, however, he said “we’re in fourth year of recovery, and only last year did we see the interest-rate-sensitive sectors start to rebound, like autos.”

He further pointed out that auto sales remained on a healthy track so far this month, despite “higher gasoline prices and FICA cut.” Among those higher sales are pickup trucks, which Taubes laid to the recovering housing market.

“Housing continues to improve every recent month,” he said. “I suspect we’re beginning to be average or slightly below in inventory” of housing, while companies like Lowes and Home Depot are seeing better earnings “on the back of a recovering housing industry.”

Returning to the possible drag on GDP from sequester cuts, Taubes said the improving employment situation may “well be ameliorated by higher employment and salaries.”

As for other economic issues, Taubes projected that as corporate America was “feeling more confident,” that mergers and acquisitions—some of which we’ve seen already this year, such as Heinz and American Airlines—would “have a big impact” on the economy.

As U.S. companies “are beginning to feel their oats,” and since corporate managers are “compensated on equity returns,” Taubes said that there would be “continued pressure to improve” those equity returns at their companies. Combined with “very low” financing rates and with credit markets being “more lenient” than is commonly perceived, he expects to see “an increase in M&A and companies will be big buyers of their own stock.”

Looking overseas one day after the Italian elections, Taubes said, “every single poll says people in the [eurozone] peripheral countries want to remain within the euro.”

What does he read from the Italian election? “Italians are saying we want the euro but we need to see some easing up on the fiscal tightness.

“The pain of implementation can’t be fixed in one or two years,” he said, noting that it took a good 10 years for Italy to get into its current state. “So if the message is received” by eurozone policymakers—and if “the Germans can stomach those changes”—the results of the Italian election “might be better for the markets over the next year or so.” 

Turning over the telephone to Valliere, a regular presence at many advisor conferences (such as at FSI’s annual meeting in January), the political expert first agreed with Taubes’ take on the sequester cuts’ impact. “The economic impact will be modest,” he said. “Not zero, but modest.”

He then turned his ire against the news media.

“Over the next several days we’ll be having an extraordinary media event—the scare stories” over the sequester, Valliere said, “have been extraordinary even by hyper Washington political standards."

The real problem, he said, is the media—“CNBC is bad for a lot of your clients"—before predicting that “somebody will blink within the next few months” and there will be a political fix for the sequester.

Greg Valliere of the Potomac Strategy Group.Speaking again to advisors on the call, Valliere (left) said that “a consensus has come out of the Christmas to New Year’s debacle that ‘That’s it with taxes.’”

While he suggested that “maybe something will happen” with the Buffett rule to increase taxes on millionaires and on the carried interest issue, “I don’t see major tax reform this year or next; nobody wants to take a whack at mortgage deductions.” For advisors’ HNW clients, the message is “no significant tax for some time to come.”

Within Washington, he said, there is “recognition that a grand compromise along the lines of Simpson-Bowles won’t happen; I don’t see the leadership in place, either with Boehner or the White House, to do it."

Moreover, there isn’t any market incentive to prod movement in DC on entitlement reform, taxes and spending cuts: “The markets are fat and happy.”

Arguing that those markets “have been neutralized to a large extent by the Fed," Valliere went on to predict that Chairman Ben Bernanke would “step down in January of next year; he wants to return to Princeton to write and study,” and that Janet Yellen would replace him. “This Fed will stay remarkably accommodative; maybe next year they start trimming back QE3.”

He finished his remarks by listing two geopolitical concerns. One, which he called the “sleeper issue of the decade,” is cybersecurity. He referenced the recent allegations that part of the Chinese military has been behind cyber attacks on U.S. companies and government agencies. 

It’s outrageous,” he said, predicting that not only that “eventually there will be retaliation” but that “this will be a dominant issue for the next few years.” His second big concern: Iran’s nuclear ambitions. “The Israelis must be concerned that the Iranians may be able to produce a crude bomb, a dirty bomb," he said, "by this summer.”

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