2012 Economic and Political Outlook: Hang Onto Your Hats

Happy New Year, and welcome to 2012. Here are a few predictions and observations that provide you with our economic and political perspectives for the New Year. You may want to sit down with a favorite beverage or even an aspirin. In general, we’re certain this will not be a nice steady year:

1. We appear to be nearing the end of an oscillation period. Since 1903, the market has been behaving in 13-year oscillations, followed by upswings (1903-1915, 1929-1942, 1968-1981, 1999-2012?). Each oscillation is marked by technological growth, economic downturn then growth, and usually some ‘tipping point’ at the end. We could be at the end of an oscillation, given the right tipping point.
2. Europe is still messy. The EU still has an immense amount of work cut out for it. The ‘fixes’ of the ECB are still only symptomatic and don’t reflect the underlying problem: Greeks are different from Italians, and Irish are different from Germans. Unless the underlying economies have some governance, the EU will continue to suffer and will probably spend a part of 2012 in recession.
3. The market has room to run. The S&P 500 has a relatively low valuation (the Price to Earnings ratio is quite low by historical standards); interest rates are so low that bank deposits of CDs don’t offer much of an alternative. Money has been flowing out of stocks, it could very easily flow back in, but probably before late fall (can you guess why?).
4. The economy has room to grow. Despite all rumors to the contrary, the US economy has grown for nine straight quarters through the end of 2011 (since the 3rd Q of ’09). With low interest rates, we could see real estate start to move, car sales starting to pick up, and companies making more money. Don’t be surprised that our next threat is not recession but inflation.
5. We have met the enemy, and it is Washington. On November 6, there is a presidential election which we predict will be narrowly decided. Importantly, 33 seats of the Senate are up for grabs, including 22 Democratic Senate seats. It seems very unlikely that the two parties will get along before the election, and barring a Republican sweep (and a senate supermajority), it seems unlikely the two parties will get along after the election. More gridlock seems likely.
6. Unemployment will likely continue to slowly decline. Corporations have wrung almost every drop of productivity out of their workforce, and it seems likely that the only solution to expansion is to continue hiring. Note that the government workforce is shrinking and the private workforce is growing.
7. The Bush Tax Cuts Expire 12/31/12. This is a significant issue that no one seems to be taking seriously right now. Expiration of the cuts raises taxes on virtually every taxpayer, changes the rates on dividends to ordinary income, raises capital gain rates, brings back the marriage penalty, eliminates the child tax credit and raises the Alternative Minimum Tax (AMT). Roth conversion and municipal bond purchases will become more useful as the year-end deadline ticks away.
8. The Sequestration Cuts take place 01/01/13. The failure of the Super-Committee to act will cause an across-the-board cut in Federal spending. Following the normal mentality of bureaucracy, that will go to the employees first (fat chance Congress will cut their pay!). Job cuts by the Feds could lead to more unemployed people.
9. The Unearned Income Medicare Contribution (UIMC) starts in 2013. The UIMC adds a 3.8% additional tax on upper-income individuals (over $200K on single and $250K on married) on all unearned income, like dividends, interest, and capital gains.
10. The Debt ceiling expires again in 2013. Remember the fun we had in August of 2011? Well, it happens again, in early 2013.
11. Iran is a wild card. Iran is being very aggressive about its nuclear program, including trying to block shipping in the Persian Gulf. It is completely plausible that this could escalate into a military situation either with the US, NATO, or Israel (we bet on Israel).

Bottom Line: To say the least, 2012 doesn’t look boring. Be ready to take advantage of opportunities and avoid the downdrafts. And consider whether this combination of events might cause a ‘tip’ in the market that has had virtually no upward movement since 1999.