The election is over (except in the state of Florida, where counting votes is a contact sport), President Barack Obama is back in the White House for a second term, and Congress is still divided, with a slightly less Republican House and a slightly more Democratic Senate. Now attention turns to the so-called “fiscal cliff,” which, with the help of continued gridlock, could end up sending the U.S. economy into recession next year.
Here’s the situation: In 2011, Congress established a mandated across-the-board cut of between $300 billion and $600 billion in federal spending unless a deal is struck by the end of this year to cut the budget and/or raise taxes to reduce next year’s budget deficit by that amount.
Given the history of congressional gridlock, and economists’ warnings that such a sudden cut in federal spending could throw the country back into recession, investors are understandably worried about their portfolios. They also have to worry about how any deal, should one be struck between the two parties, would affect markets and their existing investments.
Most political observers think that the two least likely scenarios for year’s end are a so-called “grand bargain” in which taxes get raised on the wealthy and cuts get made in social programs and other areas of the budget in a smooth reform that spreads the pain among all or most Americans, or an alternative where both parties stonewall and just let the country fall off the cliff. Republicans initially took that strategy with the debt ceiling deadline in 2011, but after losing congressional seats, not to mention the presidential race, in an election where exit polls indicated that the economy was utmost on voters’ minds, they are unlikely to do the same thing in this crisis, observers said.
Given that, what can advisors do to protect clients in these next uncertain weeks and months?
Dave Roda, southeast regional chief investment officer at Wells Fargo Private Bank, tells Bank Investment Consultant that he does not expect Congress and the White House to reach a deal before the December 31 deadline, but he also does not believe they will let the country fall off the cliff. “They’ll pass something to kick the can down the road past the president’s second inauguration and let the new Congress deal with it,” he says. At that point, he expects “some kind of a deal that will involve higher taxes on dividends, capital gains and the top income bracket.”
In the meantime, he says investors and their advisors and money managers should be prepared for a period of higher volatility. With that in mind, Roda says he is recommending reducing the amount of risk in portfolios, while doing “staged buying” when markets are down and present opportunities. He’s also “trying to capture a large share of cash flow” by investing in dividend-paying stocks -- especially those like technology companies, industrials and consumer cyclicals -- that are in a position to raise dividends. For the next couple of months, with the fiscal cliff being the “crisis of the moment,” Roda says the bank is dollar-cost averaging, and for clients who provide the appropriate documentation, is also offering options-based puts to mitigate downside risk.
In the case of investors with smaller portfolios, he urges advisors to make sure their clients have enough liquid assets to be able to “get through the next 18 months without being forced to sell when markets are down” just to met living expenses.