Capital Investment Advisors Governing & Campaigning In a De-Leveraging Environment a September 2012 Daniel Clifton Head of Policy Research Strategas Research Partners
Key Policy Themes The US Is Undergoing A Once In 70-Year Deleveraging Process Austerity Is Not A Winning Political Issue Fiscal Cliff Is A Symptom of the Larger Issues The Bill Comes Due In 13 & Congress Will Be Forced To Act On Tax/Spending Energy Becomes The New Jobs Policy
Election 2012 Themes Trajectory of the Economy Is Key Presidential Approval Rating Is Best Indicator To Watch Approval Rating Has Been Tied To Unemployment Rate Equity Market Is Pricing In An Obama Victory But Headwinds Remain House Likely To Stay GOP Senate is 50/50 At This Point
Mapping Out The Policy Landscape 1. 2012 Pre-Election 2. 2012 Election Outcome 3. 2012 Lame Duck Congress 4. 2013 Policy Implications
2012 Pre-Election
Countries Representing 50 Pct World GDP Changing Presidencies 8 # of G20 Presidential Elections & G20 GDP w/ Presidential Elections 40% 7 35% 6 5 # of G20 Presidential Elections (Left Axis) GDP of G20 Elections As Pct of World GDP (Right Axis) 30% 25% 4 20% 3 15% 2 10% 1 5% 0 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 0%
Struggling Economy = Unpopular Incumbents G20 Presidential Re-Election Trial Heats 70 65 60 55 50 45 40 35 30 25 United States Gallup 9/6/2012 48 48 45 Obama Romney France Election Results 52 Sarkozy Hollande
Large Budget Deficits & Debt Limit New Fiscal Policy Stimulus 100% Countries with Sovereign Rating of AAA 2011 Surplus/Deficit & Debt as Pct. of GDP Net Debt, Pct. of GDP 80% US 60% 40% UK Fra Can Aut Nld Ger 20% 0% Den Aus Che -20% Swe Lux -40% Fin -60% Deficit/Surplus, Pct. of GDP -80% -10% -8% -6% -4% -2% 0% 2%
The Challenge for Policymakers: Below Trend Economic Growth Real GDP has been below its long run average in 17 of the past 19 quarters
With A Rising Debt to GDP Ratio 120 100 80 Federal Net Debt To GDP If Current Polices Are Extended Keeping 2012 laws in place will send Debt to GDP to unsustainable levels. Austerity has to occur while the economy is growing below trend. 60 40 20 0 CBO Forecast 2012-2021 '40 '48 '56 '64 '72 '80 '88 '96 '04 '12 '20
Placing In Context The US Budget Challenge 200 Federal Debt Held by Public, Pct of GDP, 1790-2037 (CBO) 150 WWII If 2012 Fiscal Policy Is Extended 100 Great Depression 50 Civil War WWI 0 1790 1824 1858 1892 1926 1960 1994 2028
And Austerity Is Needed, Which Is Not A Winning Political Strategy House Seats Changing Hands Between Parties By Election Year 1936 1938 1940 1942 1944 1946 1948 1950 1952 1954 1956 Seats Gained by Dem ocrats Avg Change In House Seats 1938-1954, 39 Seats Seats Gained by Republicans -100-50 0 50 100
800 700 600 500 400 300 200 100 0-100 -200 The Bill Comes Due Post-Election Net Federal Fiscal Stimulus, $BN '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 The fiscal cliff approaching is about $537bn in 2013. The election will have an outsized impact on how the issue is resolved. But we are skeptical the entire drag can be offset in 2013. Forecast 2012-2021, Joint Committee On Taxation, Congressional Budget Office, Strategas
The Fiscal Cliff Could Serve As A Catalyst For A Grand Fiscal Deal Expiration of the Bush Tax Cuts Expiration of the AMT Patch Expiration of the Payroll Tax Cut/UI Obama Healthcare Tax Increases Begin 2009 Stimulus Spending Rolling Over Sequestered Spending Take Effect Debt Ceiling Will Need To Be Raised
Components of the Fiscal Cliff Fiscal Cliff Components, $BN, (CBO) Unemployment Benefits, 26 Sequestration, 65 Affordable Care Act Taxes, 18 Doc Fix, 1 1 2010 Tax Cut Extension & Index AMT For Inflation, 221 Other Expiring Provisions, 65 Payroll Tax, 95 This does not reflect the effects of Economic Feedback, -47 Other Changes in Revenue/ Spending, 105
2012 Election
Equity Market Is Pricing In An Obama Victory 110 108 106 104 102 100 98 96 94 Dem Relative to GOP Stock Portfolio & Intrade Odds Obama Is Reelected Strategas Democratic Sweep Stock Portfolio Relative To GOP Sweep Stock Portfolio Intrade Odds Of President Obama Being Reelected 66 64 62 60 58 56 54 52 50 48 92 Jan-12 Mar-12 May-12 Jul-12 Sep-12 46
Framework For Analyzing The 2012 Election Campaign Narrative Economic Outlook Swing States Which Is It?: Retrospective Referendum Prospective Choice Trajectory: Jobs, Gas Prices Real Per Capita Disposable Income State By State State Economy Demographics
Approval Ratings Dictate The Percentage Vote For An Incumbent 80% 70% President Approval Rating & Pct of Presidential Vote Approval Rating Pct of Vote October of Reelection Year, * Denotes Nov em ber, **Septem ber, & ***Two Party Vote 60% 50% 40% 30% 20% Johnson*Nixon* Carter** Reagan BushI Clinton***Bush II
Approval Ratings Are Key: Obama In A Grey Area 80 70 60 Presidential Approval Rating In September of Reelection Year Won Re-Election (Gallup) Lost Re-Election or Did Not Run 50 40 30 20 10 0 Truman Eisenhower Johnson Nixon Carter Reagan Bush I Clinton Bush II Obama
Will The Convention Bounce Last? 52 51 50 49 48 47 46 45 44 43 42 President Obama's Approval Rating, 7-Day Rolling (Gallup) Last Click: 9/13, 49.8% 1/4/2012 3/6/2012 5/7/2012 7/8/2012 9/7/2012
Ultimately, The Economy Is Driving The President s Approval Rating 50 48 46 44 42 40 President Obama Approval Rating & Unemployment Unemployment Rate, Right, Inverted Obama Approval Rating, Left Sept Av g = 49.1% 7.4 7.6 7.8 8.0 8.2 8.4 8.6 8.8 9.0 9.2 38 8/1/11 11/1/11 2/1/12 5/1/12 8/1/12 11/1/12 9.4
Obama Hoping For A Clinton Glide Path Effect 70 60 Clinton 1996 Election: Registered Voters (Gallup) Democratic Convention Aug 26-29 50 40 Dole 30 20 10 Perot Republican Convention Aug 12-15 0 Jun 19 Jul 10 Jul 31 Aug 21 Sep 11 Oct 2 Oct 23
President Still Needs Employment Growth Through The Election 65% 60% Pct Chg In Nonfarm Payrolls In Re-Election Year & Two-Party Vote Pct Pct of Two Party Vote Johnson Nixon 55% Clinton Reagan 50% 45% Bush I Bush II Obama Winning Campaigns Losing Campaigns 40% Carter Pct Chg In Nonfarm Payrolls (Jan-Sep Re-Election Year) -1% 0% 1% 2% 3% 4%
Consumer Sentiment Has Been A Good Predictor of Reelection 65% 60% Pct of Two Party Vote U Of Mich Consumer Sentiment & Two Party Vote Pct Nixon* Johnson* Reagan 55% Clinton 50% Obama Bush II 45% Bush I *Signifies November data 40% Carter University of Michigan Consumer Sentiment, Oct Of Re-Election Year 65 75 85 95 105
After-Tax, After-Inflation Income Is A Good Predictor of Re-Election Real Per Capita Income Growth & President's Re-Election Share of the Popular Vote 65% 60% Pct of Two Party Vote Nixon Johnson Reagan 55% 50% Clinton Bush II Winning Campaigns 45% Obama Bush I Losing Campaigns 40% 2010 Midterm Carter Real Per Capita Disposable Income, 4 QTR Rolling, Y /Y 35% -2% 0% 2% 4% 6% 8%
Key To States Is Watching Which Candidate Gets Over 50 Pct 10 7.7 Obama's Advantage Over Romney By State (RCP) 1 Monthly Change In President Obama's Advantage Over Romney In State Polling 0.6 (RCP) July 9 - September 7 5 0 3.5 3.3 2.4 2.3 1.4 0.7 0.6 0.6 0.2 0-1 -0.3-0.7-1.1 0.0-5 -10-15 -2.0-6.0-11.0 PA NH NV MI CO WI OH FL VA IA NC MO AZ -2-3 -4-5 -2.2-2.0-2.1-1.9-1.8-2.3-3.0-4.2 PA NH NV MI CO WI OH FL VA IA NC MO AZ
Undecided Voters Break To The Challenger In Mid-October 70 60 50 40 2004 Presidential Election Undecideds Break To The George W. Bush Incumbent 52.0 Challenger 50.7 (Gallup) John Kerry Challenger 44.0 48.3 80 70 60 50 40 1996 Presidential Election Undecideds Break To The Bill Clinton Incumbent 54.0 Challenger 49.2 (Gallup) Bob Dole & Ross Perot Challengers 41.0 48.9 30 30 20 Oct 16 Poll Election Result Oct 16 Poll Election Result 20 Oct 19 Poll Election Result Oct 19 Poll Election Result
Consensus Pointing To A GOP Sweep In Congress 100 90 Intrade Odds Of Republicans Controlling The Senate & House Republicans Control the Senate Republicans Control the House 80 70 60 50 40 1/1/11 5/1/11 9/1/11 1/1/12 5/1/12 9/1/12
Democrats On Defense In The Senate But Holding Strong 14 2012 Competitive Senate Races Democratic Seats Republican Seats 12 10 5 8 3 6 4 8 1 1 7 2 0 4 3 0 1 Solid Likely Lean Toss Up Likely Lost
No Wave Election But Democrats Are Gaining Momentum 55% 50% Generic Ballot, 4-Week Moving Average (Rasmussen) 2008 Election Mass. Special Election Midterm Election GOP 45% 40% 35% Dems 30% 25% 7/6/2008 7/6/2009 7/6/2010 7/6/2011 7/6/2012
Governing In Lame Duck & 2013
800 700 600 500 400 300 200 100 0-100 -200 REMINDER: NEW CONGRESS FACES A MASSIVE FISCAL CLIFF Net Federal Fiscal Stimulus, $BN '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 Forecast 2012-2021, Joint Committee On Taxation, Congressional Budget Office, Strategas The fiscal cliff approaching is about $537bn in 2013. The election will have an outsized impact on how the issue is resolved. But we are skeptical the entire drag can be offset in 2013.
Fiscal Drag Is Twice The Size Of The Largest Post WWII Tax Increase 4.0% 3.5% 3.0% 2.5% Size of Federal Tax Increases, Pct of GDP T he coming fiscal drag dwarfs the size of any previous tax increase 3.5% 2.0% 1.7 % 1.5% 1.0% 0.5% 0.4% 0.4% 1.1% 0.2% 0.6% 0.4% 0.6% 0.0% '68 '69 '80 '82 '84 '86 '90 '93 '13
Two Catalysts For A Lame Duck Tax Bill: Debt Ceiling & AMT 17 Federal Debt Outstanding (Monthly, $TN) 70 Taxpayers Affected By AMT Under Various Scenarios (JCT, Millions) 16 15 14 13 12 Debt Limit Last Click: $15.5TN 60 50 40 Bush Tax Cuts Extended Without AMT Patched 11 10 9 Total Public Debt Subject to Limit 30 20 Current Law Bush Tax Cuts Extended with AMT Patched 8 10 7 Jan- 05 Jan- 06 Jan- 07 Jan- 08 Jan- 09 Jan- 10 Jan- 11 Jan- 12 0 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20 '21 '22
Fiscal Cliff Implications Fiscal Cliff Is Not Binary: Most But Not All of the Cliff Gets Resolved By The End of the Year. Payroll Tax Cut Seems Unlikely To Get Extended At This Time Tax Increase of 3.8% on Investment Income Looks Difficult To Stop Regardless of Who Gets Elected
Tax On Investment Income Is A Backdoor Cap Gains & Dividend Tax Capital Gains Realizations & Capital Gains Tax Rates 8% '86 Tax Increase 45% 6% Cap Gains Tax Rate (Right) 35% 4% Higher Rate = Low er Realizations Higher Rate = Low er Realization 25% 2% 15% 0% Cap Gains Realizations, Pct. of GDP (Left) '54 '64 '74 '84 '94 '04 5%
2013 Fiscal Deal?
Growing Number of Catalysts For A Fiscal Deal In 2013 Elevated Debt & Deficit Levels Rising Interest Costs Rating Agency Warnings Subpar Economic Growth Expiring Tax Provisions Spending Sequester Social Security Unfunded Liabilities One Party Controlling Congress?
One Party Controlling Congress Gives Greater Fiscal Flexibility Reconciliation Background Legislative process established in Congressional Budget Act of 1974 Allows Senate to pass reconciliation bill with simple majority, rather than 60 votes Eliminates a Senate filibuster Debate limited to 20 hours Requires House and Senate passed budget resolution in place Designed to speed passage of laws impacting spending and taxes Takes about six months to pass the legislation into law. In recent years, is used to pass fiscal legislation lacking bi-partisan support such as the Bush tax cuts and Obama healthcare. 90 85 80 75 70 65 60 55 50 45 40 78 '96 Welfare Reform # of Votes for Passage Recent Reconciliation Bills 85 '97 Cap Gains 58 '01 Tax Cuts 50 '03 Tax Cuts 54 '05 Tax Cuts 56 '10 Health Care
Crowding Out Effect Coming 20 18 16 14 12 10 8 6 4 Net Interest Cost, Pct of Tax Revenues & Avg. Annual 10-Year Treasury Yields 10 Year Treasury Y ield, Right Net Interest Costs As Pct of Tax Revenues, Left Interest costs are set to explode despite rates being kept low. Source: OMB, Strategas, Forecast 2012-2021 '53 '59 '65 '71 '77 '83 '89 '95 '01 '07 '13 '19 16 14 12 10 8 6 4 2 0
Healthcare & Interest Costs: 43% of Total Federal Spending By 2017 50% 40% Healthcare Spending & Net Interest Costs As Pct. Of Total Federal Spending Forecast: OMB, Strategas Healthcare & Interest Will Be 43% of Federal Spending in 2017 30% 20% Healthcare Spending As Pct of Federal Spending 10% 0% Net Interest As Pct of Federal Spending '62 '68 '74 '80 '86 '92 '98 '04 '10 '16
Meaningful Defense Cuts Coming CBO's Projected Defense Spending In 2011 & 2012 Budget 950 850 750 650 550 450 350 $1.2 T rillion Reduction In Projected Defense Spending, -14.5% CBO's 2011 Budget Projections CBO's 2012 Budget Projections 250 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 '20 '22
Tax Reform Is The Best Way To Deal With The Fiscal Cliff But Challenging 100 90 80 70 60 50 40 30 20 10 0 Income Tax Shares, Pct of Income Taxes Paid 1986 2009 Top 1% Top 5% Top 10% Top 25% Top 50% Bot 50% Top Individual Tax Breaks for FY2014 With Expiring Provisions Extended Excl. of Employer Health Ins. Excl. of Employer Pensions Mortgage-Interest Deduction Excl. of Medicare Capital Gains Rates Earned Income Credit Deduction of Income Taxes Tax Breaks for Estate Assets Child Credit Charitable Contributions 58.4 54 51.9 51.7 51.6 7 6.2 7 1.4 99.8 164.2 162.7 0 50 100 150 200
Individual & Corporate Tax Reform Need To Move Together 35% 30% Effective Corporate Tax Rate By Industry, 2007-2008 55 50 Statutory Corporate Tax Rates By Region 25% 45 United States 20% 15% 40 10% 35 5% 0% Utilities Mining Leasing Transport Agriculture Real Estate Info Tech Insurance Manufacturing Avg. Eff. Tax Rate Finance Construction Whole & Retail Trade 30 25 20 OECD (ex -US) '81 '84 '87 '90 '93 '96 '99 '02 '05 '08 '11
Buffett Rule Is About Raising Capital Gains & Dividend Tax Rates 50 45 40 35 30 25 20 15 10 5 0 Buffett Rule Revenues & President's Budget Projected Spending ($ TN, 10-Year Estimate) 0.05 Buffett Rule Revenue 46.96 Obama's Projected Spending
Consensus Scenario Obama wins presidency GOP controls both houses of Congress Lame duck bill extends some, but not all tax cuts Contentious 2013 fiscal deal could get done Obama would need to sacrifice some HC measures to get GOP to increase taxes No deal = rolling debt ceiling increases Obama uses his regulatory levers
Out of Consensus Scenario Romney wins presidency GOP controls both houses of Congress All tax cuts get temporarily extended Republicans complete a fiscal package of tax and entitlement reform Green light on energy development Healthcare bill changed Small changes to Dodd-Frank
Need To Identify Sectors Not Impacted By Austerity: Energy 65% 60% Net Oil Imports: Share of U.S. Consumption (EIA) 55% 50% 45% 40% 35% 30% 25% 20% '73 '78 '83 '88 '93 '98 '03 '08
Energy Production Is Creating Jobs 20 16 12 8 North Dakota: Oil Production vs. Mining Employment Oil Production (Right scale, Millions of Barrels) 20 16 12 8 4 0 Mining and Logging Jobs (Left scale, in Thousands) '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 4 0
What To Watch For In 2012 President Obama s approval rating Unemployment Rate Congressional generic ballot test Federal Reserve/ECB Policy Fiscal cliff negotiations Iran negotiations Social unrest in the U.S.
The Big Questions For 2013 & Beyond Next Federal Reserve Chairman China Trade Policy Tax Reform: REITs, Home Mortgage Deduction, Capital Gains, Dividends, Carried Interest, Municipal Bonds, Estate Regulatory Policy
Questions?