Biggest growth story is outside the US
By Russ Koesterich
With bad news priced in to risk assets, havens look expensive
The market had hoped for a “Grand Bargain”. Instead, it got a small, ultimately insufficient fiscal deal. The best to be said of the agreement hammered out on New Year’s eve is that it beat the alternative. While investors still cheered, nobody should mistake this for an economic, fiscal, or financial positive. Ideally Washington would have crafted a deal coupling long-term tax and entitlement reform with short-term stimulus. Instead, we got the opposite. The US now faces significant fiscal drag on an already sluggish recovery.
The drag might have been justified had the agreement actually addressed the long-term fiscal outlook. But it failed to tackle the US tax code’s dysfunction or the sustainability of major entitlement programmes. In abdicating any effort to stabilise the national debt, Washington now risks an eventual loss of international confidence in the US. Short term, it is not even clear that this deal does much to address the deficit. With significant fiscal drag still embedded in the deal, the economy is unlikely to grow as fast as current budget estimates assume. If growth disappoints, as it almost surely will, revenue will be below expectations and deficits above.
Investors face the same challenge of the past several years: how to generate positive real return in a zero-rate world. While the next episode of Washington’s fiscal soap opera – lack of clarity over the debt ceiling – will expose investors even further, they should fight the temptation to abandon stocks and other risky assets. Policy chaos has been the norm throughout the past three years. Despite the lack of progress, equities and other risky assets have climbed the proverbial wall of worry; those willing to take on risk have done well. The reason: while the world is far from perfect, much of the bad news is already reflected in equity prices. Ironically, it is “haven” assets that appear most expensive.
Rather than abandoning risky assets altogether, investors should tap market segments most geared to faster global growth and less exposed to US consumption. Practically, this suggests lowering exposure to small and mid-caps and favoring large and mega-cap companies, which benefit the most when global growth accelerates and are the least sensitive to a slower domestic economy.
https://www.ft.com/intl/cms/s/0/46e9851a-59cf-11e2-b728-00144feab49a.html#axzz2IEQA533y
