Men are at their best when scrambling from the abyss -- Michael Burry (Vanderbilt Chancellor's Lecture, April 5, 2011)
The election may be over, but the analysis continues. Sadly, it seems we spent billions of dollars, years of time, and an immeasurable amount of stress to end up almost precisely where we were before the election. One interpretation is that the voters decided they wanted more of the same. My interpretation is that the electorate decided they have no clue what needs to be done. Like a deer in the headlights, when you don't know what to do, the reaction is usually to do nothing.
Meanwhile, those of us in the capital markets need to sort out how the politicians are likely to solve the looming economic issues. Until Tuesday, we had competing economic visions. The Democrats wanted to raise taxes on high earners in order to help reduce the deficit. They argue that higher tax rates don't matter, look at the 1990s. The GOP argued for lower tax rates for all, as a proxy to force lower government spending and stimulate growth. They point to the 1980s for proof of concept. The principal problem is that other than one or two data points, which hardly make up a statistically significant sample, neither side has <i>any proof</i> whatsoever that their prescription is the right one. The "debate" quickly degenerates into both side repeating their philosophy over and over, as if repetition makes reality.
After Tuesday, we no longer have competing visions. The Democrats campaigned plainly on the promise that they would raise taxes on high earners, and the electorate voted for that option. Rather than have more empty debate and gridlock, it is time to implement the people's choice and see what happens. This is the only rational strategy. If the approach works—higher taxes reduce the deficit and spur growth—then we all win. If the approach doesn't work and tax revenue declines push the economy into a recession then, then the debate will be settled and we will know what to do next. Absent actually implementing one plan or another, we will have nothing but stagnation and mind-numbingly unproductive conflict.
Here is a little-discussed trivia fact that matters: The rich voted themselves a tax increase. Of the states with greater than average per capita income, 85% voted for Obama. Of the states with below-average per-capita income, only 29% voted for Obama. So we can't complain that the poor are voting to soak the rich. The rich are voting to soak the rich. If the rich do not believe that higher taxes are going to hurt their economic prospects, who can argue? The majority of them have given the endorsement: Let the experiment go forth, and let's see what happens. If higher taxes do not boost the economy, I have no doubt that this decision will be quickly rescinded four years from now.
My working investment assumption is now that higher tax rates are inevitable, either by design or by gridlock triggering the fiscal cliff. I also did the math: Even extremely higher tax rates on the wealthy cannot begin to close the deficit, so monetization will continue and greater inflation is highly likely at some point. I am skewing toward inflation defenses such as gold and businesses with pricing power, such as tobacco. I am not shying away from "superior goods" that are purchased by the well-to-do. The richest citizens are likely to maintain their current level of consumption even when their taxes increase -- savings will decline instead.
I am avoiding cyclicals and other economically sensitive sectors at the moment, since any change in the tax regime -- voluntary or automatic -- is likely to cause a near term economic dislocation. That is inevitable. The experiment will answer the question of what the long-term economic benefit is, or isn't.