For the First Time in Years, Fiscal Policy Turns from Headwind to Tailwind

Fri, Dec 27, 2013 - 1:32pm

A proper understanding of what’s driving the market often requires an examination of at least three things: the fundamentals—economic data, valuation measures, etc.; the technicals—what are the charts saying; and, lastly, the “politicals”—what sort of fiscal and monetary policy environment are we operating in. Together they form a sort of “three-legged stool” working to form a complete picture of the market.

Although, at times, one area may trump the importance of another, without paying attention to the influence of all three an investor risks having a serious blindspot to what’s driving the markets at any point in time.

For example, the technical environment of the market is rather strong with a large number of stocks in long-term uptrends. However, stocks are also getting more expensive and many are worried about valuation levels. How about the "politicals"? What sort of environment are they creating for the market?

One of the best experts in this area is 30-year veteran Kim Wallace, senior advisor and Head of Washington Policy at Renaissance Macro Research. In a recent interview on Financial Sense Newshour we asked him a few questions about some of the major events taking place on this front.

FSN: Janet Yellen is set to take over the Federal Reserve early 2014. How similar do you think her policies will resemble that of Bernanke's?

Kim: In terms of the transition, the similarity I think is obvious. I think that their scholarly training and their experience in central banking will lead the Yellen Fed to look a lot like the Bernanke Fed in this one aspect: what those scholars have learned—or at least my takeaway from what they’ve learned about financial crises—is that the deeper they are, the longer you need to stay in an accommodative mode to make sure you don’t have backsliding. You saw some of those worries in both the middle of 2010 and early in 2011, but they’re really going to stay vigilant so you don’t have a backward step that requires you to go back deeper in extraordinary policy.

[Also] I do believe that Dr. Yellen, soon to be chairwoman Yellen, has serious scholarly chops—not that everyone is going to agree with her view of the data, the history, the information—but that she’s driven by analysis, and rigorous analysis. I would add very quickly that if this rumor of consideration of Stanley Fisher as number two there actually is real and comes to pass, I would say that one-two punch from an analytical-scholarly viewpoint and a practical-application policy standpoint would be as powerful a one-two punch the Fed has had in its 100-year history, in my view at least.

FSN: How significant was the recent budget deal made in Washington and what does this mean for the markets?

Kim: I think it’s a bigger deal for the markets than what we’re willing to give credit for...In terms of practical work here in Washington, it’s healthy I think for the process that you’ve returned to what we call "regular order". That is, the budget committees got together and passed budget resolutions from both bodies for the first time I believe in seven, maybe nine, years. They were very two different documents. And although what they achieved in the budget conference was fiscally and economically insignificant (when you look at the numbers—clearly), it does allow more members…to be a part of the process.

It’s been quite some time in this divided government, outside of emergency measures back in ’08, that we’ve had majorities of both parties in the House support anything, and so that’s good…all in all, it looks as though the factions in Washington in both parties who over the last four years have sought leverage or attention in fiscal negotiations by pushing things to the brink no longer have control inside their various caucuses. And, more importantly, I think, the last three years—particularly this last episode in the fall—has demonstrated to people that you can come to a point in fiscal policy where politics begin to actually adversely influence the economy and the American people. And I don’t think that Washington is going to return to that anytime soon. Of course we will have fiscal battles—we should. There should be disagreements over the fiscal way forward and certainly we’ll get a taste of that in the first quarter as they debate what to do about the debt ceiling, but even then I think the lessons learned in the last year…there’s only so much endangering of full faith and credit, or the psychology of full faith and credit, one can do before you start doing real damage. So, my guess is, in the first quarter they’ll be a little bit of debate because neither party is going to come forward with a multi-year plan that is both politically viable and economically sensible—those are my two standards for fiscal policy, not very complicated—and, if that’s the case, they’ll be playing more politics looking towards the 2014 mid-term elections but they’ll be doing that in the old-fashioned way: stressing points that they hope resonate with people as opposed to actually getting close to default or anything silly like that.

FSN: In summary, when you look at the policy front—whether in the U.S., Europe, or elsewhere—do you think the current outlook is favorable or unfavorable for the market?

Kim: All in all, still bullish from a policy standpoint in terms of response, with the obvious risks, but when you come down to it I still, as I said before, like the position of the U.S. both from a macro-economic and micro-economic standpoint; and I would throw in for the first time in probably five years, from a political standpoint as well.

If you'd like to listen to this entire interview with Kim Wallace where he also addresses the influence of the Affordable Care Act, U.S. demographics, and other important topics, you can do so by CLICKING HERE to subscribe. In addition to hearing from money managers, institutional investors, and other experts regularly interviewed for FS Insiders, you’ll also gain access to our entire archive of past interviews with noted heavy-weights like Kyle Bass, David Rosenberg, Gary Shilling, Marc Faber, and more.

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