Don’t fear the cliff

With the presidential contest in the rear view mirror, investors can now focus on the resolution of the Fiscal Cliff negotiations between the White House and the GOP-led House. Against that backdrop, Morgan Stanley held it “Post-Election Financial Market Outlook for 2013” in Manhattan yesterday during which several Morgan Stanley executives gave their predictions on what lies ahead for the market and where they are placing their bets in the coming year.

Overall, they expect a tough period of political wrangling that will unnerve the markets until a deal of some kind is ultimately concluded. Both parties, they stressed, have too much at stake to let the U.S. economy plunge into another deep recession.

First up was Thomas Gallagher, principal of the Scowcroft Group and a consultant who sits on Morgan Stanley’s global investment committee. He said since the election pretty much cemented the status quo-Democrats hold the majority in the Senate while the GOP controls the Houseneither side has a real incentive to compromise. “They owe (their victories) to their base, not the swing voters,” he said.

For example, Gallagher, who termed himself a “political economist,” said if the GOP agrees to tax hikes on the upper income brackets, they may expect some spending cuts in return.

Yet he didn’t envision either party digging in their heels too resolutely. President Obama may be concerned about his legacy and, therefore, is poised to compromise, and Republicans do have an interest in coming to the table ready to bargain. “No one wants to be blamed for a recession if there is gridlock in Congress,” Gallagher said.

Working through the politics of the deal “will be difficult and inject volatility in the market,” Gallagher said. “We are a long way to a smooth resolution to the Fiscal Cliff.” He said he doesn’t anticipate an outright recession, but slower GDP growth.

One challenge is that too much is expected from tax reform, namely, that it will erase the deficit and cure other economic ills, Gallagher said.

In Europe, he said the Continent has taken positive steps to deal with solvency issues, but still lacks a clear policy to stimulate growth.

Charles Reinhard, deputy chief investment officer for Morgan Stanley, concurred that with the election now behind us, a plan to deal with the Fiscal Cliff will be hammered outif for no other reason that elected officials don’t want to see a huge number of their constituents out of work.

Reinhard noted that the stock market has done well in the past when there was a Democratic president and a Republican-controlled House. He added there are some good economic signs in the U.S., such an uptick in manufacturing and consumer confidence as well as a rebounding housing market. Inflation, he said, “was not a clear and present danger.”

As for actual investment strategies, he said Morgan Stanley is looking to overweight in U.S. equities, particularly large cap stocks, and emerging markets; underweight in Japanese equities; and to hold a neutral position in European equities.

Global equities may not be loved, “but they had a good year,” Reinhard said.