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The Global Investor Newsletter - Special Edition: Election 2012

Election Edition 2012

Welcome to the Special Election Edition of Euro Pacific Capital's The Global Investor Newsletter. Our investment professionals are standing by to answer any questions you have. Call (800) 727-7922 today!

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Extend and Pretend
By: Peter Schiff, CEO and Chief Global Strategist

The 'Day After' Sell Off
By: Andrew Schiff, Director of Communications and Marketing

Four More Years of Job Loss
By: Michael Finger, Communications Specialist

California: Falling Off the Political Cliff
By: Neeraj Chaudhary, Investment Consultant 

The Global Investor Newsletter - Special Edition: Election 2012

 

Extend and Pretend
By: Peter Schiff, CEO and Chief Global Strategist 


Now that President Obama has been re-elected, the media is finally free to focus on something besides the clueless undecided voters in Ohio, Florida, and Colorado. The brightest and shiniest object that has attracted its attention is the "fiscal cliff" that we are expected to drive over at the end of the year unless Congress and the President can agree to turn the wheel or apply the brakes.

Fresh from his victory, the President took time today to let the nation know how he proposes to avoid the cliff: to raise taxes on those Americans who make more than $250,000 per year. He made clear that no one making less than that will be asked to pay any more. The two percent of taxpayers that the President is targeting earn 24.1% of all income and pay 43.6% (as of 2008) of all personal federal income taxes. Sounds like a fair share to me. But the four or five percent tax increases on those earners that are being proposed would only yield around $30 to $40 billion per year in added revenue, a drop in the federal bucket. Even if they were to double the amount that they pay our deficit would only be cut by about one third (even if those increases did not trigger an economic slowdown).

So what exactly is this looming menace, and why is it so dangerous? Stripped of its rhetorically charged language the fiscal cliff is simply a legal trigger that will trim the deficit in 2013 by automatically implementing spending cuts and tax increases. In other words, the government will spend less, and more of what it does spend will be paid for with taxes rather than debt. Isn't this exactly what both parties, and the public, more or less want? The fiscal cliff means that the federal budget deficit will be immediately cut in half, shrinking to approximately $641 billion in 2013 from the approximately $1.1 trillion in 2012. What is so terrible about that? I would argue that there is a greater danger in avoiding the cliff than driving over it.

If you recall, the cliff was created by a deal last year when Congress couldn't find ways to trim the deficit in exchange for raising the debt ceiling. When they failed to reach an agreement, Congress knew they had to raise the debt ceiling anyway. The resulting Budget Control Act of 2011, signed in August of that year, offered the pretense that they were dealing with our long-term fiscal crisis and not simply raising the debt ceiling with no strings attached. This was done not only to appease some House Republicans, who had threatened to vote against a debt ceiling increase, but to satisfy the bond rating agencies that had threatened a down-grade if Congress failed to act.

Now the focus turns to how Congress will dismantle the structure it created just 16 months ago. There can be little doubt that they will as economists are assuring politicians that driving over the fiscal cliff will immediately bring on a recession. The expiration of the Bush era tax cuts for all taxpayers will cost Americans an estimated $423 billion in 2013 alone. Hundreds of billions of across the board spending cuts, including the military, have been delineated. No politician would allow that to happen.

It is amazing that members of Congress can keep a straight face as they claim to want to address our long-term deficit problem while simultaneously working to avoid any substantive action. No doubt an agreement will be reached that will replace the looming fiscal cliff with another one farther down the road (which they can easily dismantle before we actually reach the precipice). Will the rating agencies buy this bill of goods a second time? If we lack the political courage to go over this fiscal cliff, why should anyone think we will be able to stomach going over the next one? Especially since each time we delay going over the cliff, we simply increase its future size, making it that much harder to actually go over it.

Many currently believe last year's S&P downgrade resulted from the same congressional dysfunction that resulted in the fiscal cliff agreement. The truth is that the downgrade would probably have been much greater, and more rating agencies would have likely joined S&P in taking action, had it not been for the fiscal cliff agreement. If further downgrades fail to be issued when the lame duck Congress inevitably comes up with another can kicking deal, then the agencies themselves could lose any remaining credibility. In my opinion, the only explanation for inaction by the rating agencies would be for fear of regulatory retaliation by a vindictive U.S government.

I do not think it is a coincidence that while the banks are suffering a regulatory backlash as a result of their perceived culpability for the mortgage crisis, the credit rating agencies have been relatively untouched. But the credit agencies played a key role in catalyzing the mortgage crisis by giving questionable ratings to the mortgage backed securities. My guess is the government simply does not want to open up that can of worms as similar mistakes are being made with respect to the agencies' ratings of government debt.

The truth is that regardless of what you call it, going over the fiscal cliff is not the problem, it is part of the solution. Our leaders should construct a cliff that is actually large enough to restore fiscal balance before a real disaster occurs. That disaster will may take the form of a dollar and/or sovereign debt crisis that will make this fiscal cliff look like an ant hill. 

Peter Schiff is CEO and Chief Global Strategist of Euro Pacific Capital

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The 'Day After' Sell Off
By: Andrew Schiff, Director of Communications and Marketing 


Stock market reactions to U.S. presidential elections tend to follow a "buy the rumor, sell the fact" dynamic. In six of the last eight elections markets either rallied or remained unchanged on election day and then sold off the day after the results came in. Over those 8 elections, the S&P 500 gained an average of .86% on election day and lost an average of 1.07% the day after. 

The only exceptions to this trend were two of the last three times (prior to 2012) that an incumbent was re-elected. In 1996, when Bill Clinton was elected to his second term, the S&P 500 rallied 1.05% on election day and 1.46% the day after. When George Bush was re-elected in 2004, markets were unchanged on election day and up 1.12% the day after. In both cases it appears as if the markets anticipated a continuation of the status quo and were relieved when that reality was confirmed. In the third instance of an incumbent re-election, Ronald Reagan in 1984, the market rally of election day was bigger than the subsequent sell off, making the election a net positive. None of these trends can apply with the re-election of the current incumbent. (see table below) 

 

S&P 500 on Presidential Election Days & Day After

 

 

   

S&P 500 Performance (%)

 

 

 

Election Date

Day Of

 

Day After (Entire Day)

 

Net Result

Reagan/Mondale

11/6/1984

 

1.09

 

-0.73

 

0.36%

Bush/Dukakis

11/8/1988

 

0.45

 

-0.66

 

-0.21%

Clinton/Bush

11/3/1992

 

-0.67

 

-0.67

 

-1.34%

Clinton/Dole

11/5/1996

 

1.05

 

1.46

 

2.51%

Bush/Gore

11/7/2000

 

-0.02

 

-1.58

 

-1.60%

Bush/Kerry

11/2/2004

 

0

 

1.12

 

1.12%

Obama/McCain

11/4/2008

 

4.08

 

-5.27

 

-1.19%

Obama/Romney

11/6/2012

 

0.93

 

-2.2

 

-1.27%

 

         

 

 

 

Average

 

0.86

 

-1.07

 

 

 

           

 

Incumbent Re-elected

 

 

 

 

 

 

 

 Source: Bespoke Investment Group  

 After four years of the Obama Administration, the markets appear to be far from pleased with the prospect of four more. (They weren't pleased the first time either - on Nov. 5, 2008, after Obama was first elected, the Dow sold off 513 points, which set a record for the decline on the day after an election).

Before the votes were counted in this election, many pundits had pointed to late momentum from the Romney campaign that could possibly put the challenger into the White House. On Election Day, the markets rallied .93%, which was more than the average of the prior seven Election Days.  But after it became clear that Obama had won a second term, the markets quickly reversed course and sold off 2.2%, a post election rout only exceeded by the performance the day after Obama's first election. As of close of business on Wednesday November 14, the S&P 500 has dropped 5.1% since Election Day. Not a good start for Obama's second term.

It's true that the 'day after' sell off on Wall Street came against a backdrop of negative global sentiment that had knocked down stocks around the world. Many investors may have been frightened by the chaos in Athens which grew as the Greek Parliament prepared to cast the decisive vote on its crucial austerity package. But the declines in the S&P 500 were 46% steeper that day than the 1.5% decline in the global MSCI index, which broadly tracks the performance of stock markets in Europe, Australasia, and the Far East. So clearly, American investors were more concerned than their counterparts in London, Singapore or Sydney.

Even more clues to market sentiment can be gleaned by looking at the relative performance of specific sectors as measured by the nine "Sector SPDR" ETFs that track the performance of the various segments of the U.S. market. The biggest losers of the day were the "financials" (including banks, asset management firms, and insurance companies), which sold off a hefty 3.7%. The U.S. financial service industry had spent heavily on the Romney campaign, apparently hoping that a Republican victory would blunt some of the more onerous aspects of the ill-conceived Dodd-Frank legislation. When those hopes were dashed, the financial ETF tanked.

Rounding out the top three of sector selloffs were the "industrials" which were down 2.5%, and "technology" which dropped 2.4%. Unfortunately, these are the important corporate and export sectors in which the U.S. needs to regain its lost economic competitiveness. Apparently investors do not believe an Obama re-election portends well for these crucial areas.

On the other side of the coin, the "consumer staple" and "consumer discretionary" sectors were down only 1.1% each, or roughly half the losses experienced by the S&P 500. It appears as if investors have more confidence that U.S. consumers will keep spending than they do that U.S. manufacturers keep producing.  Unfortunately, in order for the U.S. economy to re-orient itself for a more sustainable growth trajectory, consumers need to reduce spending so that more resources can be allocated for the productive areas of the economy.

Drilling even deeper, conclusions can also be made by looking into the post-election day performance of individual stocks. While the overall "healthcare" sector was down 1.8%, some of the biggest winners of the day were hospital management corporations. The $14 billion market cap HCA Holdings was up 9.4%. Smaller hospital companies, Health Management Associates, Community Health Systems, and Tenet Healthcare were up 7.3%, 6%, and 9.6%, respectively. But health insurance provider Humana declined 7.8%. One possible reason is that investors believe while hospital spending will rise under Obamacare, insurance providers will largely be left out of the party. In a macabre repeat of the last election, share prices of firearm manufacturers spiked as well: Smith & Wesson surged 9.6% while Sturm, Ruger & Co. tacked on 6.8%. Such moves do not indicate a particularly sunny outlook.

While it is no surprise that we here at Euro Pacific believe that the current Administration has no clue as to how to cure the economy, it is perhaps surprising that the majority of investors seem to feel the same way. The fact that a president could be re-elected under the current conditions of persistent unemployment, rising prices, and fiscal insolvency may be a sign that the majority of voters have simply given up on the possibility of a real economic resurgence.  

Andrew Schiff is Director of Communications and Marketing at Euro Pacific Capital

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Four More Years of Job Loss
By: Michael Finger, Communications Specialist


One of the biggest economic issues that affected the election was the perception that President Obama was more likely to fight against the trend of "outsourcing" American jobs to lower-cost overseas markets. Mitt Romney had been continuously slammed as the "outsourcer-in-chief" as a result of his corporate restructuring work with private equity firm Bain Capital. At a time of significant unemployment, the moniker became a hard one for the Republican to shake. 

Readers, then, may find it ironic that the New York Times ran a piece this week entitled "India's Outsourcing Industry Welcomes Obama Win." Intentional or not, that overtly-Democratic news source revealed that the campaign rhetoric will have little impact on reality. 

From our perspective, there can be little question that Obama's victory will bring more jobs to India. The question is why. The Times asserts that Obama's pro-trade foreign policy and his expected success in revitalizing the American economy will be responsible. We believe that it is more likely to result from the President's continued anti-business policies which will force American employers to outsource jobs or face chronic unprofitability. 

Why Are They Leaving? 

There is a widespread misunderstanding of why jobs are outsourced to foreign markets. Many blame free trade for allowing American jobs to easily slip across borders and over oceans. But this isn't the whole story. 

Free trade can send jobs overseas, but this only happens if Americans are getting jobs higher up on the value chain or have somehow become uncompetitive. 

After all, outsourcing is a pain in the neck. It's much easier to train and supervise employees that are in the same office, city, or country as upper management. And local employees speak the native language, understand cultural references, and often know their customers personally. In order to ship a job across the globe, American employers must be able to achieve a substantial reduction in cost, which may or may not be solely a function of wages, but also the overall costs of doing business in a particular country. 

Americans often groan when they are transferred to a call center in India, so why are companies continuing to build them there instead of here? Why are jobs that would be more easily performed by Americans being sent to India - while the unemployment rate here goes up and up? 

 

Free Trade Is Not To Blame

This is where Obama and his cohorts come into play. Decades of increasing taxes, regulations, and misguided federal interventions have simply made it too expensive to hire workers - even if they are willing to work for less! Through workplace safety regulations, a favorable environment for employee litigation, high rates of corporate taxation, and a myriad of other measures, American politicians have essentially made it illegal to hire low-skill American workers. 

So, of course Indian outsourcing workers should be welcoming Obama's win. It means more jobs will likely be headed their way. But the jobs do not come free of cost. 

The Indian government, much like China's, pursues a deliberate policy of currency devaluation and US debt purchases to manage currency exchange rates, subsidize American consumers, and "create jobs" for Indians. Unfortunately, that means Indians are employed servicing Americans instead of producing for their own wants and needs. It's a poverty trap of their government's own making.

Unfortunately, this co-dependent relationship between developed and emerging market governments will be painful to unravel. If New Delhi were to cut off the lifeline to Washington, then all those call center and IT workers in India would have to re-train to provide services to other customers - perhaps even their fellow countrymen. Meanwhile, American companies would have to find another market for inexpensive labor or use automated solutions. America will only maintain those jobs for domestic workers if we can manage some real domestic political reform that lowers costs and removes red tape for companies trying to compete in a global marketplace.

Investor Insight

The bottom line for investors is that the current situation is not ideal, but it strongly favors the markets creating new jobs and wealth over those benefiting from unfair subsidies. While people in India may be wasting their time answering our tech support questions in exchange for a bunch of IOUs, the fact that American companies continue to set up shop there is a sign of how the markets are liberalizing overseas.  

Many investors are looking one step behind when they should be looking five steps ahead. If the United States continues to re-elect anti-business politicians intent upon heaping more burdens and restrictions on employers, we can expect unnecessarily high domestic unemployment. Indians may now be happy to absorb the low-skill jobs that Americans cast off, but as they develop their own base of wealth, that will change. Perhaps then, in a poetic reversal, Indian companies will start outsourcing to an impoverished US.

Michael Finger is a Communications Specialist with Euro Pacific Capital

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California: Falling Off the Political Cliff
By: Neeraj Chaudhary, Investment Consultant


While Democrats celebrated Barack Obama's re-election on Tuesday, a more portentous election took place in California.

Often touted as a leader in political and social trends, progressive California swung even further to the left during last week's election. Voters in the once golden state tightened their vice-like grip on businesses and job-creators. Voters approved a series of propositions that make the state a more difficult place to run a business and provide jobs.

The biggest headlines go to the passage of Proposition 30 which raises the sales tax by ¼ percent for four years and retroactively increases state income taxes for seven years on the three percent of California taxpayers who make more than $250,000 annually. California's top tax rate now goes to 13.3%, by far the highest in the country. Interestingly, Proposition 30 was competing for passage with another measure, Proposition 38, which would have raised all state income tax rates. By rejecting the broader measure and choosing to soak only those earning more than 250,000, California voters have shown that class warfare is alive and well as a winning electoral strategy.

In addition to the income tax increase for the wealthy, voters also agreed to protect unions' ability to use payroll-deducted funds for political purposes (Prop 32) and to raise taxes on multi-state businesses by approximately $1 billion annually, spending a large portion of this money on "energy efficiency and alternative energy projects" (Prop 39). This is despite the fact that coal remains by far the cheapest source of energy in the world. Combined with higher taxes, higher energy prices, a higher corporate tax bill, and a continued ability for labor unions to influence policy, this will likely act as a deterrent for businesses to create jobs in the state.

But perhaps the most ominous election development was within the California State Legislature. After the votes were counted, Democrats now control two thirds "super majorities" in both the Assembly and the State Senate. Combined with the power of famously left wing governor Jerry Brown, the Democrats can now completely set the agenda in the state. The small Republican minority will not be able to prevent Democrats from unilaterally raising taxes or increasing spending.  Progressives are chomping at the bit to raise more revenue through the destruction of the decades old Proposition 13, which limited rates by which local governments could assess property taxes. 

In California, more than in just about every other state, many people have come to believe that the Democratic Party is firmly in the pocket of gargantuan public sector unions including the teachers, prison guards, police, and municipal workers. These interests have never shown the slightest regard for the needs of business or for fiscal sanity. It seems their only agenda is to secure higher pay and fewer work requirements for their members.

The last time any party in California held the governor's chair and a supermajority in both houses was in 1933. But Democrats have for decades controlled the legislature, albeit without a supermajority. In addition they have had to deal with a series of Republican governors, including the most recent "Governator", Arnold Schwarzenegger. Despite these obstacles, Sacramento has managed to make California one of the least competitive states in the nation. They now have the ability to approve spending and tax increases without any Republican support. 

In Washington, Democrats have not enjoyed that kind of power since 1978. In fact, the last time any party was so firmly in control was during the Johnson Administration in the 1960's (and to a lesser, and briefer, extent during the first half of the Carter Administration).The ruinous policies of Johnson's "Great Society," which many believe laid the foundation for today's fiscal disaster, would not have been possible if Republicans could have mustered 40 filibuster votes in the U.S. Senate. Republicans finally got that 40th vote in 1978 and have not lost it since.

For those of you who may have missed the news: California is in serious trouble. According to Forbes magazine, pensions for the state and local government employees are underfunded to the tune of $650 billion. That comes to roughly $17,000 per Californian. The state's yearly operating budgets over the last decade have featured deficits larger than the budgets of twenty states. California now boasts the third highest unemployment rate in the nation (10.2%) and some of the highest rates of home foreclosures in the nation. The Wall Street Journal reports that the state has also borrowed $10 billion from the Federal Government to pay for jobless benefits. In the last year, five major California municipalities have either filed bankruptcy or took steps to do so. Forbes also reports that since 1998, 4.4 million taxpayers have left the state in search of better economic climates.

Sacramento politicians seem completely unaware that their state is fast becoming an economic basket case. At present their biggest priorities seem to be going into deeper debt to fund a high speed rail line that no one wants and to saddle businesses with even more restrictive environmental regulations. As a result, the trend of California employers pulling up stakes for more hospitable markets has increased markedly in recent years. Last week Los Angeles voters even had the poor sense to saddle one of its stalwart industries, the adult film business, with unneeded condom regulations. Many speculate that the industry may just decide to decamp to Las Vegas.   

It's hard to underestimate the power that this unilateral political control offers, especially when it's wedded so firmly to the re-distributive impulses of public sector labor unions. As a result, we can expect the business defections from California to pick up speed. With tax paying job creators increasingly taking their businesses to more hospitable environments, look for California's already bleak fiscal picture to get even worse. At some point, our nation's biggest state may become a national albatross.   

If state voting trends carry to the rest of the country, we can look forward to continued class warfare, higher taxes, higher spending and a worsening of the general business climate across the nation. Worse than the much-ballyhooed fiscal cliff, it appears that California is headed off the political cliff. The only silver lining is that we may now have a clear test case that will illustrate the destructive nature of big government solutions. When California finally runs out of steam, the left will have to take all the blame. But given the size of the Californian economy, and its importance to the rest of the country, we may not survive the experiment.  

Neeraj Chaudhary is an Investment Consultant with Euro Pacific Capital

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This document has been prepared for the intended recipient only as an example of strategy consistent with our recommendations; it is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investing strategy.  Dividend yields change as stock prices change, and companies may change or cancel dividend payments in the future.  All securities involve varying amounts of risk, and their values will fluctuate, and the fluctuation of foreign currency exchange rates will also impact your investment returns if measured in U.S. Dollars.  Past performance does not guarantee future returns, investments may increase or decrease in value and you may lose money.

Opinions expressed are those of the writer and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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