Behind closed doors U.S. politicians on both sides of the aisle acknowledge that something needs to be done about the future cost of entitlement programs and our growing national debt. The secular bear market view holds that the U.S. will not be able to fix these issues politically and the problem will eventually be resolved by a riot in the financial markets. In this view, stocks will not be able to mount a sustained multi-year rally until the structural risks posed by the U.S. debt mountain are resolved. But as we head into the election season, it is also worth considering the secular bull market view. If the U.S. election helps lay the groundwork for an acceptable long-term solution to our debt problems, then there is plenty of room for stock market multiples to be supported going forward.
Unfortunately, the last few weeks’ campaign rhetoric didn’t get us off to a very good start, and it may be that the barriers to an informed debate are just too high to overcome. Why do bearish investors (and many of the rating agencies) believe that our political system can’t address the problem? Let’s review:
- The issues are complicated. Trying to understand the logic behind the new health care law, or cap and trade, or even the structure of TARP and how the money was invested is extremely difficult. Bending the healthcare cost curve makes for a good debate for policy wonks, but bearish investors maintain that the average American doesn’t have the background to understand the nuances of the arguments.
- In a related point, the electorate isn’t educated enough to grasp the details. The education system fails to teach civics, history, and other relevant subjects needed to reach an informed opinion.
- The media is content to confuse news with entertainment. The U.S. population seems to be divided between those who watch progressive programming on MSNBC and those who watch conservative commentary on Fox News. It is frightening that many believe they’re receiving unbiased commentary when they turn on John Stewart and his wildly popular Daily Show, which specializes in spoofing political figures. (Full disclosure: I am a huge fan of John Stewart.)
- PACS and other special interest groups pound out highly partisan messages that are effective at appealing to a particular political base, but not very effective in educating voters about the issues.
- The timing is bad: Right now, there’s a large gap between the income growth of high income taxpayers and the rest of the country. “Taking” social programs away from the middle class is all but politically impossible in an environment where real incomes for the middle class have been flat or declining for decades.
- A republic may not be the best form of government when it comes to shrinking the size of social programs that are enjoyed by the voters. Politicians on both sides refuse to alert the public to the extent of the problem because they’ll be immediately accused of wanting to throw everyone’s grandparents into the street. The Simpson-Bowles report was a good example. The report was actually a political masterpiece that treaded very lightly on entitlement spending, yet political pros in both parties scrambled for cover since politicians who want to be reelected are smart enough to avoid enraging their political base.
Bullish investors maintain that while the obstacles to an adult debate over what to do about our mountain of debt are many, that doesn’t mean we can’t rise to the occasion. From the standpoint of portfolio strategy, it’s difficult to imagine that stock multiples could significantly expand in the face of “the new normal” and the deleveraging that must inevitably occur. But all accounts suggest that in private, politicians on both left and right agree that revenues must be raised and spending must be restructured. The upcoming debate about the fiscal cliff is sure to be a messy one, but the recent market rally suggests that investors believe that the can will be kicked down the road until after the election. Imagine if we were only a few quarters away from a grand compromise that would ignite the stock market and propel prices back to 2000 and 2007 highs.
I’m skeptical, but we shall see.