Fixing the Debt Problem - What Does Success Look Like?
Winthrop Capital Management
By Gregory Hahn
December 21, 2012
While we do expect issues surrounding the “Fiscal Cliff” will ultimately be resolved, negotiations will likely go all the way up to the inauguration in January. The question is: What does success look like? We believe that in order to achieve sustained economic growth, we need to address the structural problems that are impeding business investment and commerce. These structural problems include the large deficits we are running as a country.
1. Fixing the deficit is not the same as fixing the debt problem. We have amassed over $16 trillion in debt which represents over 100% of GDP. So, assuming Congress can fix the budget deficit, what does success look like? We believe success will be measured by the decisiveness and clarity in what Congress produces.
2. Anything that looks like financial alchemy or pushes tough decisions further out will be viewed as more brinksmanship and not credible. In 2010, President Obama commissioned the National Commission on Fiscal Responsibility and Reform co-chaired by Alan Simpson and Erskine Bowles. As a bi-partisan commission, their charge was to identify policies to improve the fiscal situation in the medium term and achieve fiscal sustainability over the long run. They produced a credible plan that has served as a discussion for the country to address the deficit and growing debt burden.
3. While there is no real consensus on what it takes to fix our debt problem, Simpson-Bowles is the standard with which we will compare what comes out of Congress. In our opinion, a combined package of tax increases and expense cuts that totals less than $2.0 trillion will be considered a failure. Anything approaching $4 trillion we would consider a success.
4. Spoiler Alert.....We expect Congress to underwhelm on expense cuts.
5. What does a meaningful resolution of the "Fiscal Cliff" mean for investment portfolios? We expect any clarity in tax policy will result in businesses taking on risk next year including fixed investment and creating jobs. If you couple that with an environment where banks start lending to small businesses and we would expect to see acceleration in economic growth and investors taking more risk. This would be good for stocks and bad for bonds.
6. In addition, we would expect to see an increase in merger and acquisition activity and more shareholder friendly initiatives including special dividends. Our long time readers will note that we have been saying that we expect an increase in M&A activity for the past two years and it hasn’t happened. Recent deals by Honeywell, Ingersoll Rand and AIG may foreshadow an increase in activity.
7. A combination of large cash balances and the potential for an increase in tax rates next year have provided an incentive for companies to distribute cash to shareholders in 2012 before any expected tax changes take place next year. Here is our list of companies with the largest cash balances at the end of last quarter:
Chevron $43 billion
Google $44 billion
ConocoPhillips $45 billion
Ford Motor Company $51 billion
Exxon Mobil $52 billion
Cisco Systems $56 billion
Microsoft $73 billion
Apple Corporation $117 billion
GE $122 billion
Berkshire Hathaway $162 billion
We would much rather see a dividend to shareholders than a stock repurchase from management. This way we get to decide if we want to buy the company’s stock – not management.
Gregory J. Hahn, CFA
Chief Investment Officer
This report is published solely for informational purposes and is not to be construed as specific tax, legal or investment advice. Views should not be considered a recommendation to buy or sell nor should they be relied upon as investment advice. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Information contained in this report is current as of the date of publication and has been obtained from third party sources believed to be reliable. WCM does not warrant or make any representation regarding the use or results of the information contained herein in terms of its correctness, accuracy, timeliness, reliability, or otherwise, and does not accept any responsibility for any loss or damage that results from its use. You should assume that Winthrop Capital Management has a financial interest in one or more of the positions discussed. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Winthrop Capital Management has no obligation to provide recipients hereof with updates or changes to such data.
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