Capital Investment Advisors Governing & Campaigning In a De-Leveraging Environment a September 2012 Daniel Clifton Head of Policy Research Strategas Research Partners Key Policy Themes • The US Is Undergoing A Once In 70-Year Deleveraging Process • Austerity Is Not A Winning Political Issue • Fiscal Cliff Is A Symptom of the Larger Issues • The Bill Comes Due In ‘13 & Congress Will Be Forced To Act On Tax/Spending • Energy Becomes The New Jobs Policy Election 2012 Themes • Trajectory of the Economy Is Key • Presidential Approval Rating Is Best Indicator To Watch • Approval Rating Has Been Tied To Unemployment Rate • Equity Market Is Pricing In An Obama Victory But Headwinds Remain • House Likely To Stay GOP • Senate is 50/50 At This Point Mapping Out The Policy Landscape 1. 2012 Pre-Election 2. 2012 Election Outcome 3. 2012 Lame Duck Congress 4. 2013 Policy Implications 2012 Pre-Election Countries Representing 50 Pct World GDP Changing Presidencies # of G20 Presidential Elections & G20 GDP w/ Presidential Elections 8 40% 7 35% 6 5 # of G20 Presidential Elections (Left A x is) GDP of G20 Elections A s Pct of World GDP (Right A x is) 30% 25% 4 20% 3 15% 2 10% 1 5% 0 0% '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 Struggling Economy = Unpopular Incumbents G20 Presidential Re-Election Trial Heats 70 65 United States Gallup 9/6/2012 France Election Results 60 55 50 45 52 48 48 45 40 35 30 25 Obama Romney Sarkozy Hollande Large Budget Deficits & Debt Limit New Fiscal Policy Stimulus Countries with Sovereign Rating of AAA 2011 Surplus/Deficit & Debt as Pct. of GDP 100% Net Debt, Pct. of GDP 80% US 60% UK Fra 40% Can 20% Den 0% Ger Aut Nld Che Aus -20% Swe Lux -40% Fin -60% Deficit/Surplus, Pct. of GDP -80% -10% -8% -6% -4% -2% 0% 2% The Challenge for Policymakers: Below Trend Economic Growth… Real GDP has been below its long run average in 17 of the past 19 quarters With A Rising Debt to GDP Ratio Keeping 2012 laws in place will send Debt to GDP to unsustainable levels. Austerity has to occur while the economy is growing below trend. Federal Net Debt To GDP 120 If Current Polices Are Ex tended 100 80 60 40 20 0 CBO Forecast 2012 -2021 '40 '48 '56 '64 '72 '80 '88 '96 '04 '12 '20 Placing In Context The US Budget Challenge Federal Debt Held by Public, Pct of GDP, 1790-2037 (CBO) 200 150 WWII 100 Great Depression Civ il War 50 0 1790 If 201 2 Fiscal Policy Is Ex tended 1824 1858 WWI 1892 1926 1960 1994 2028 And Austerity Is Needed, Which Is Not A Winning Political Strategy House Seats Changing Hands Between Parties By Election Year 1936 Seats Gained by Dem ocrats 1938 1940 1942 Seats Gained by Republicans Av g Change In House Seats 1938 - 1954, 39 Seats 1944 1946 1948 1950 1952 1954 1956 -100 -50 0 50 100 The Bill Comes Due Post-Election Net Federal Fiscal Stimulus, $BN 800 700 600 500 400 300 200 100 0 -100 -200 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 The fiscal cliff approaching is about $537bn in 2013. The election will have an outsized impact on how the issue is resolved. But we are skeptical the entire drag can be offset in 2013. Forecast 2012-2021, Joint Committee On Taxation, Cong ressional Budget Office, Strategas The Fiscal Cliff Could Serve As A Catalyst For A Grand Fiscal Deal • • • • • • • Expiration of the Bush Tax Cuts Expiration of the AMT Patch Expiration of the Payroll Tax Cut/UI Obama Healthcare Tax Increases Begin 2009 Stimulus Spending Rolling Over Sequestered Spending Take Effect Debt Ceiling Will Need To Be Raised Components of the Fiscal Cliff Fiscal Cliff Components, $BN, (CBO) Affordable Care Act Tax es, 1 8 Unemploy ment Benefits, 26 Doc Fix , 1 1 201 0 Tax Cut Ex tension & Index AMT For Inflation, 221 Sequestration, 65 Other Ex piring Prov isions, 65 Pay roll Tax , 95 This does not reflect t he effect s of Economic Feedback, -47 Other Changes in Rev enue/ Spending, 1 05 2012 Election Equity Market Is Pricing In An Obama Victory Dem Relative to GOP Stock Portfolio & Intrade Odds Obama Is Reelected 110 66 Intrade Odds Of President Obama Being Reelected 108 106 58 102 56 100 54 98 94 92 Jan-12 62 60 104 96 64 52 Strategas Democratic Sweep Stock Portfolio Relativ e To GOP Sweep Stock Portfolio Mar-12 May-12 50 48 Jul-12 46 Sep-12 Framework For Analyzing The 2012 Election Campaign Narrative Economic Outlook Swing States Which Is It?: •Retrospective Referendum •Prospective Choice Trajectory: •Jobs, Gas Prices •Real Per Capita Disposable Income State By State •State Economy •Demographics Approval Ratings Dictate The Percentage Vote For An Incumbent President Approval Rating & Pct of Presidential Vote 80% 70% A pprov al Rating Pct of V ote Oc t ober of Reelec t ion Y ea r , * Den ot es Nov em ber , **Sept em ber , & ***T w o Pa r t y V ot e 60% 50% 40% 30% 20% Johnson*Nixon* Carter** Reagan BushI Clinton***Bush II Approval Ratings Are Key: Obama In A Grey Area Presidential Approval Rating In September of Reelection Year 80 Won Re-Election (Gallup) 70 Lost Re-Election or Did Not Run 60 50 40 30 20 Obama Clinton Bush I Reagan Carter Nixon Johnson Eisenhower Truman 0 Bush II 10 Will The Convention Bounce Last? 52 President Obama's Approval Rating, 7-Day Rolling Last Click: (Gallup) 9/13, 49.8% 51 50 49 48 47 46 45 44 43 42 1/4/2012 3/6/2012 5/7/2012 7/8/2012 9/7/2012 Ultimately, The Economy Is Driving The President’s Approval Rating President Obama Approval Rating & Unemployment 50 48 Sept A v g = 49.1 % Unemploy ment Rate, Right, Inv erted 7.4 7.6 7.8 8.0 46 8.2 8.4 44 8.6 42 8.8 Obama A pprov al Rating, Left 40 9.0 9.2 9.4 38 8/1/11 11/1/11 2/1/12 5/1/12 8/1/12 11/1/12 Obama Hoping For A Clinton “Glide Path” Effect 1996 Election: Registered Voters (Gallup) 70 60 Clinton Democratic Conv ention A ug 26-29 50 40 30 Dole Perot Republican Conv ention A ug 1 2 - 1 5 20 10 0 Jun 19 Jul 10 Jul 31 Aug 21 Sep 11 Oct 2 Oct 23 President Still Needs Employment Growth Through The Election 65% Pct Chg In Nonfarm Payrolls In Re-Election Year & Two-Party Vote Pct Pct of Tw o Party V ote Johnson Nix on 60% Clinton 55% Bush II Winning Cam paigns 50% Bush I 45% Losing Cam paigns Obama Pct Chg In Nonfarm Payrolls (Jan-Sep Re-Election Y ear) Carter 40% -1% Reagan 0% 1% 2% 3% 4% Consumer Sentiment Has Been A Good Predictor of Reelection U Of Mich Consumer Sentiment & Two Party Vote Pct 65% 60% Pct of Tw o Party V ote Nix on* Johnson* Reagan 55% Clinton 50% Bush II Obama Bush I *Signifies Nov ember data 45% Carter 40% 65 75 University of Michigan Consumer Sentiment, Oct Of Re-Election Y ear 85 95 105 After-Tax, After-Inflation Income Is A Good Predictor of Re-Election Real Per Capita Income Growth & President's Re-Election Share of the Popular Vote 65% 60% Johnson Pct of Tw o Party V ote Nix on Reagan 55% 201 0 Midterm 35% -2% Winning Cam paigns Losing Cam paigns Bush I Obama 45% 40% Bush II Clinton 50% Carter Real Per Capita Disposable Income, 4 QTR Rolling, Y /Y 0% 2% 4% 6% 8% Key To States Is Watching Which Candidate Gets Over 50 Pct Monthly Change In President Obama's Advantage Over Romney In State Polling Obama's Advantage Over Romney By State 10 5 0 (RCP) (RCP) 1 7 .7 3.5 3.3 0.6 July 9 - Septem ber 7 0.0 0 2.4 2.3 1.4 0.7 0.6 0.6 0.2 -1 -0.3 -0.7 -1.1 -2 -2.0 -2.2 -5 -3 -6.0 -10 -11.0 -15 PA NH NV MI CO WI OH FL VA IA NC MO AZ -2.0 -2.1 -1.9 -1.8 -2.3 -3.0 -4 -4.2 -5 PA NH NV MI CO WI OH FL VA IA NC MO AZ Undecided Voters Break To The Challenger In Mid-October 70 2004 Presidential Election Undecideds Break To The 1996 Presidential Election Undecideds Break To The Challenger Challenger (Gallup) George W. Bush Incum bent John Kerry Challenger 60 52.0 50 50.7 48.3 44.0 40 80 70 60 50 (Gallup) Bill Clinton Incum bent 54.0 49.2 30 20 20 Oct 16 Election Poll Result Oct 16 Election Poll Result 48.9 41 .0 40 30 Bob Dole & Ross Perot Challengers Oct 19 Election Poll Result Oct 19 Election Poll Result Consensus Pointing To A GOP Sweep In Congress 100 Intrade Odds Of Republicans Controlling The Senate & House Republicans Control the Senate Republicans Control the House 90 80 70 60 50 40 1/1/11 5/1/11 9/1/11 1/1/12 5/1/12 9/1/12 Democrats On Defense In The Senate But Holding Strong 2012 Competitive Senate Races Democratic Seats 14 Republican Seats 12 10 5 3 8 6 4 8 2 1 1 4 7 3 0 1 0 Solid Likely Lean Toss Up Likely Lost No Wave Election But Democrats Are Gaining Momentum Generic Ballot, 4-Week Moving Average (Rasmussen) 55% 50% 2 008 Election Mass. Special Election Midter m Election GOP 45% 40% 35% Dem s 30% 25% 7/6/2008 7/6/2009 7/6/2010 7/6/2011 7/6/2012 Governing In Lame Duck & 2013 REMINDER: NEW CONGRESS FACES A MASSIVE FISCAL CLIFF Net Federal Fiscal Stimulus, $BN 800 700 600 500 400 300 200 100 0 -100 -200 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 The fiscal cliff approaching is about $537bn in 2013. The election will have an outsized impact on how the issue is resolved. But we are skeptical the entire drag can be offset in 2013. Forecast 2012-2021, Joint Committee On Taxation, Cong ressional Budget Office, Strategas Fiscal Drag Is Twice The Size Of The Largest Post WWII Tax Increase Size of Federal Tax Increases, Pct of GDP 4.0% T he com ing fiscal drag dwarfs the size of any prev ious tax increase 3.5% 3.5% 3.0% 2.5% 2.0% 1 .7 % 1.5% 1 .1 % 1.0% 0.5% 0.4% 0.4% '69 '80 0.6% 0.2% 0.6% 0.4% 0.0% '68 '82 '84 '86 '90 '93 '13 Two Catalysts For A Lame Duck Tax Bill: Debt Ceiling & AMT Taxpayers Affected By AMT Under Various Scenarios Federal Debt Outstanding (Monthly, $TN) 17 70 16 Debt Limit 60 15 14 Last Click: $15.5TN 13 12 11 50 20 9 8 Bush Tax Cuts Extended Without AMT Patched 40 30 Total Public Debt Subject to Limit 10 7 Jan05 (JCT, Millions) Current Law Bush Tax Cuts Extended with AMT Patched 10 Jan06 Jan07 Jan08 Jan09 Jan10 Jan11 Jan12 0 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20 '21 '22 Fiscal Cliff Implications • Fiscal Cliff Is Not Binary: Most But Not All of the Cliff Gets Resolved By The End of the Year. • Payroll Tax Cut Seems Unlikely To Get Extended At This Time • Tax Increase of 3.8% on Investment Income Looks Difficult To Stop Regardless of Who Gets Elected Tax On Investment Income Is A Backdoor Cap Gains & Dividend Tax Capital Gains Realizations & Capital Gains Tax Rates '86 Tax Increase 8% 45% Cap Gains Tax Rate (Right) 6% 35% H ig h er Ra t e = Low er Rea liza t ion s 4% 25% H ig h er Ra t e = Low er Rea liza t ion 2% 15% Cap Gains Realizations, Pct. of GDP (Left) 0% 5% '54 '64 '74 '84 '94 '04 2013 Fiscal Deal? Growing Number of Catalysts For A Fiscal Deal In 2013 • • • • • • • • Elevated Debt & Deficit Levels Rising Interest Costs Rating Agency Warnings Subpar Economic Growth Expiring Tax Provisions Spending Sequester Social Security Unfunded Liabilities One Party Controlling Congress? One Party Controlling Congress Gives Greater Fiscal Flexibility Reconciliation Background • • • • • • • • Legislative process established in Congressional Budget Act of 1974 Allows Senate to pass reconciliation bill with simple majority, rather than 60 votes Eliminates a Senate filibuster Debate limited to 20 hours Requires House and Senate passed budget resolution in place Designed to speed passage of laws impacting spending and taxes Takes about six months to pass the legislation into law. In recent years, is used to pass fiscal legislation lacking bi-partisan support such as the Bush tax cuts and Obama healthcare. # of Votes for Passage Recent Reconciliation Bills 90 85 85 80 78 75 70 65 58 60 54 55 56 50 50 45 40 '96 Welfare Reform '97 Cap Gains '01 Tax Cuts '03 Tax Cuts '05 Tax Cuts '10 Health Care Crowding Out Effect Coming Net Interest Cost, Pct of Tax Revenues & Avg. Annual 10-Year Treasury Yields 20 Interest costs are set to ex plode despite rates being kept low. 18 16 14 12 1 0 Y ear Treasury Y ield, Right 14 16 10 12 8 10 6 Net Interest Costs A s Pct of Tax Rev enues, Left 8 6 4 4 2 Source: OMB, Strategas, Forecast 2012 -2021 '53 '59 '65 '71 '77 '83 '89 '95 '01 '07 '13 0 '19 Healthcare & Interest Costs: 43% of Total Federal Spending By 2017 Healthcare Spending & Net Interest Costs As Pct. Of Total Federal Spending 50% Healthcare & Interest Will Be 43% of Federal Spending in 201 7 Forecast: OMB, Strategas 40% 30% Healthcare Spending As Pct of Federal Spending 20% 10% Net I nterest As Pct of Federal Spending 0% '62 '68 '74 '80 '86 '92 '98 '04 '10 '16 Meaningful Defense Cuts Coming CBO's Projected Defense Spending In 2011 & 2012 Budget 950 850 $1.2 T rillion Reduction In Projected Defense Spending, -14.5% CBO's 201 1 Budget Projections 750 650 550 450 CBO's 201 2 Budget Projections 350 250 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 '20 '22 Tax Reform Is The Best Way To Deal With The Fiscal Cliff But Challenging Income Tax Shares, Pct of Income Taxes Paid Top Individual Tax Breaks for FY2014 With Expiring Provisions Extended 100 Excl. of Employ er Health Ins. 164.2 90 Excl. of Employ er Pensions 162.7 80 2009 70 60 Mortgage-Interest Deduction 99.8 Excl. of Medicare 1986 50 7 6.2 Capital Gains Rates 7 1.4 58.4 Earned Income Credit 40 30 20 10 0 Top 1% Top 5% Top 10% Top 25% Top 50% Bot 50% Deduction of Income Taxes 54 Tax Breaks for Estate Assets 51.9 Child Credit 51.7 Charitable Contributions 51.6 0 50 100 150 200 Individual & Corporate Tax Reform Need To Move Together Effective Corporate Tax Rate By Industry, 2007-2008 Statutory Corporate Tax Rates By Region 55 35% 50 30% 25% United States 45 20% 40 15% 35 10% 5% 30 OECD (ex-US) Whole & Retail Trade Construction Finance Avg. Eff. Tax Rate Manufacturing Insurance Info Tech Real Estate Agriculture Transport Leasing Mining Utilities 0% 25 20 '81 '84 '87 '90 '93 '96 '99 '02 '05 '08 '11 Buffett Rule Is About Raising Capital Gains & Dividend Tax Rates Buffett Rule Revenues & President's Budget Projected Spending ($ TN, 10-Year Estimate) 50 46.96 45 40 35 30 25 20 15 10 5 0 0.05 Buffett Rule Revenue Obama's Projected Spending Consensus Scenario • Obama wins presidency • GOP controls both houses of Congress • Lame duck bill extends some, but not all tax cuts • Contentious 2013 fiscal deal could get done • Obama would need to sacrifice some HC measures to get GOP to increase taxes • No deal = rolling debt ceiling increases • Obama uses his regulatory levers Out of Consensus Scenario • • • • Romney wins presidency GOP controls both houses of Congress All tax cuts get temporarily extended Republicans complete a fiscal package of tax and entitlement reform • Green light on energy development • Healthcare bill changed • Small changes to Dodd-Frank Need To Identify Sectors Not Impacted By Austerity: Energy Net Oil Imports: Share of U.S. Consumption (EIA) 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% '73 '78 '83 '88 '93 '98 '03 '08 Energy Production Is Creating Jobs North Dakota: Oil Production vs. Mining Employment 20 20 16 16 12 Oil Production (Right scale, Millions of Barrels) 8 8 4 12 Mining and Logging Jobs (Left scale , in Thousands) 0 4 0 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 What To Watch For In 2012 • • • • • • • President Obama’s approval rating Unemployment Rate Congressional generic ballot test Federal Reserve/ECB Policy Fiscal cliff negotiations Iran negotiations Social unrest in the U.S. The Big Questions For 2013 & Beyond • Next Federal Reserve Chairman • China Trade Policy • Tax Reform: REITs, Home Mortgage Deduction, Capital Gains, Dividends, Carried Interest, Municipal Bonds, Estate • Regulatory Policy Questions?