QE2 And Midterm Election Positions
What is the likely impact of the elections on the markets?
For months, markets have anticipated that the Republicans will gain control of the House of Representative and that this will result in more business-friendly government policy. Practically speaking, it is highly unpredictable what government policy will look like following this election. It seems doubtful there will be meaningful change, particularly as it relates to the paramount issue of getting the country’s fiscal house in order on a longer-term basis. Unless circumstances drastically change, the political climate simply doesn’t exist to enact serious reforms. Pragmatism, bi-partisanship and compromise will be in short supply, and most likely very little will get done. Markets may perceive gridlock as a positive for awhile, but time is running out to fix America’s fiscal mess, and if the government “kicks the can down the road” for another two years, we may find that a crisis is inevitable. In the near term, the stock market and economy still have to deal with the major uncertainty surrounding tax policy. Markets could be disappointed in November by a lack of legislative action on extending the tax cuts due to expire at year end (lame-duck Congresses rarely get anything done). At present, the top income tax rate is due to rise to 39.6%, the capital gains rate will rise to 20%, and dividends would revert to being treated as ordinary income.
Is it time to take profits in gold?
Gold is up 24% year to date, and is up 17% since its late July low at $1160. This is clearly not a low-risk time to be adding to gold positions. However, given government policies of currency debasement, we do not think it is time to take profits in core gold investments. Despite the fact that gold has risen for ten consecutive years, the end of the secular bull market in gold is probably still several years from now. We may well be entering the endgame for the U.S. dollar as the world’s dominant reserve currency, and the other major currencies in the world do not inspire confidence. Gold is rightly seen as an alternative to paper currencies and an attractive store of value. We expect the U.S. dollar price of gold to rise to at least $2,000 over the next two to three years.
Apart from gold, which areas of the financial markets appear to offer the best risk/reward characteristics on a medium to longer-term basis?
We continue to like high-quality U.S. stocks—large-cap companies with global franchises, solid balance sheets, and consistent earnings and dividends. The best ETF vehicles for accessing this asset class are the Vanguard Dividend Appreciation ETF (symbol: VIG) and the WisdomTree LargeCap Dividend Fund (symbol: DLN). We also favor emerging markets stocks— accessed through a core position in the Vanguard Emerging Markets ETF (symbol: VWO) and a complementary position in the dividend-weighted WisdomTree Emerging Markets Equity Income Fund (symbol: DEM). There is a tendency to extrapolate the problems of the U.S. to the rest of the world, but most emerging economies are experiencing dynamic growth and are in much better fiscal shape. Given that emerging markets account for 40% of global output, and emerging markets stocks account for 16% of global market capitalization, investors who are underweight emerging markets in the equity portion of their portfolios (i.e. emerging markets represent less than 16% of their stock allocation) should view global market sell-offs such as what we experienced in early summer as an opportunity to rebalance portfolios towards emerging markets investments. Emerging markets stocks are up nearly 30% from their early summer lows, so investors should wait for a correction of 10% or so to consider adding to positions.
If CalPERS is taking hedgies out, ETFs may be coming back in.
As valuations grow uncomfortably high, ‘quality’ ETFs makes more sense—if you can figure out just what quality means.
‘Smart beta’ almost surely means loss of more market share for active managers.
Be careful of your assumptions (and headlines!) about volatility ETFs.