Archive for November, 2012


November 2, 2012


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Transcript: LaPerriere & Applegate 11-02-12 #919

November 2, 2012


#919- 11/02/12


CONSUELO MACK:  This week on WEALTHTRACK, it’s too close to call! President Obama and Governor Romney are neck and neck as they race toward Tuesday’s finish line. What’s at stake for the economy and the markets? Answers from ISI’s top Washington analyst Andy Laperriere and Morgan Stanley’s global strategist Jeff Applegate are next on Consuelo Mack WEALTHTRACK.


Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. “Could It Be Any Closer?” That was the headline WEALTHTRACK guest Andy Laperriere sent to clients recently and his answer was no! This one is just too close to call. The Washington policy veteran is tracking one election indicator in particular for guidance. It is the Presidential approval rating, in the fourth year of a first term, exactly where President Obama is now.


Looking back, you can see that President Carter’s approval rating had fallen dramatically, below 40% before his 1980 election loss to Ronald Reagan. At the end of President Reagan’s first term,  before winning re-election against Walter Mondale in 1984, his approval rating was rising and closing in on 60%. Contrast that to the end of President George W. Bush’s first term when his approval rating had slipped just below 50% before he ultimately beat Senator John Kerry in 2004. Now look where President Obama is: his approval rating has risen over the last few months to around 50%. It’s a nail biter!


The race might be close but for voters and investors, the stakes are significant and the outcome will determine some winners and losers. One of the pressing issues which could face the new president is the aftermath of the fiscal cliff- the Bush tax cuts, payroll tax relief and extended unemployment benefits are set to expire on December 31st and a massive automatic spending cut known as the sequester is scheduled to take effect January 2nd. The president will also make important decisions on health care and defense spending, and on the possible replacement of Federal Reserve Chairman Ben Bernanke whose term expires in January of 2014.


Joining us to discuss these election issues are two policy and investment pros. Andy Laperriere is senior managing director of top ranked independent research firm ISI and heads up its policy research team in Washington D.C. Laperriere has been a coveted Institutional Investor magazine ranked Washington team analyst for the past 14 years and the team has been ranked #1 for the past ten years. Jeff Applegate is the chief investment officer of Morgan Stanley Wealth Management, and is responsible for strategic and tactical asset allocation advice to clients. He leads the firm’s investment strategy team and chairs its global investment committee. I began the interview by asking Laperriere why he thinks the race is as close as it is.


ANDY LAPERRIERE:  Well, I think the race is close because you have a vulnerable incumbent. I mean, you’ve got a President with a job approval that’s been below 50% most of the last two and a half years. You’ve got a weak economy. The legislative agenda that passed in the last couple of years is not popular with the public, so you have an incumbent who is going into reelection in a weak position, a lot like you had in 2004 with former President Bush, and you have a reasonably strong challenger in Mitt Romney, someone who’s ideologically mainstream and was running a poor campaign until the Denver debate but has turned it around since then. So I think you’ve got the makings, and I think we’ve always had the makings of a pretty close race here.


CONSUELO MACK:  Jeff, you have a global clientele, and you talk to international clients all the time. So what’s the view from your international clients of this race and how close it is and what they’re thinking about the significance of this election?


JEFF APPLEGATE: Yeah, you know, I think broadly there’s somewhat higher comfort level with Obama which has nothing to do with his policies; it’s just they think they know him. Whether they know him or not, they think they do because he’s had a first term, versus Romney is more of an unknown quantity, so it’s not really clear in terms of, you know, foreign policy and those kind of issues and where’s he going to be on trade. Is he going to be supportive of trying to move WTO forward? Those are sort of open issues, I think, with non U.S. investors.


CONSUELO MACK:  Okay. Andy, you know, you think, you know, you’ve been a Washington analyst for a couple of decades at least, and you think that there is actually a lot at stake for investors in this election. What are the major issues that investors should pay attention to that, whomever wins the election, is going to make a difference?


ANDY LAPERRIERE:  Well, I think a lot of big decisions have to be made on fiscal policy, and I think those are going to matter to the markets, those decisions, and obviously we’re facing the fiscal cliff at the end of the year here, and as you get into next year, where all three of the major rating agencies have suggested we’re going to downgrade the U.S. debt, so this budget…


CONSUELO MACK:  If what happens?


ANDY LAPERRIERE:  If there’s not a significant long-term deficit reduction package. Basically, all three of the rating agencies want to see Congress stabilize debt to GDP, and if not, all three of them have suggested that they would downgrade the U.S. So we’re coming into a pretty critical period here where we both have short-term problems in terms of a fiscal cliff and it’s time now, I think, to address the long-term budget problems, or we’re going to see some ramifications of not doing that.


CONSUELO MACK:  And Jeff, as far as your concerned, again from an investment point of view and a market point of view, you don’t think this is such a big deal. Right?


JEFF APPLEGATE: Well, I think the fiscal cliff, for some aspects of the fiscal cliff have already been dealt with, so Congress has now approved funding the government into next year. The debt limit won’t be breached by year end. It’ll be breached some point in the first quarter. Not to say you don’t have to deal with those things, but they’re not all coming together at year end, so in fact, what you’ll get at year end most likely, and I don’t know if Andy would agree with this, but you’ll get expiration of the payroll tax relief and expiration of the extended jobless benefits. There doesn’t seem to be political support to extend those. So we think there’s going to be some fiscal drag but not enormous fiscal drag, and if that’s the outlook, then that should be positive for the markets, but I think the really key thing is really looking into next year, and can we pull together a credible deficit reduction package? Because if we don’t, to Andy’s point, the credit rating agencies are waiting in the wings, and the last time they got involved in this, just go back two Augusts ago, that was not exactly a picnic for the financial markets. So it’s going to be crucial to get that right.


CONSUELO MACK:  So let me ask you about that, the fiscal cliff. So regardless of what happens on Tuesday at the election, is that we’ve got this 12/31/2012 deadline for the fiscal cliff. We know when the Bush tax cuts expire, and we’ve got Obamacare and Medicare taxes going up, and we’ve got the two things that you think will be resolved before then. So what is your outlook for the fiscal cliff? How is that going to be handled? How is it going to be resolved, Andy?


ANDY LAPERRIERE:  Well, I think what Jeff said is the base case, but that requires a deal in the lame duck. It requires a deal to extend the Bush tax cuts. It requires a deal to delay the sequester, to deal with the AMT doc fix and a few other miscellaneous issues, so if they don’t get a package…


CONSUELO MACK:  And that’s Obama with the lame duck Congress before year end.


ANDY LAPERRIERE:  Right, so I think what Jeff outlined is the base case, and I think he’s right. The payroll tax cut is going to expire, and if there’s a deal, it’ll be a modest fiscal tightening. I do think that the odds of two different outcomes, one which would be real negative for the market and one which would be positive, are higher than the investor consensus. I think there’s a decent chance, say one in three, maybe even a little higher, that there’s no deal in the lame duck. The Bush tax cuts expire completely. The sequester kicks in, and so that would be a real negative outcome, obviously, for the market. There’s also a possibility of an upside surprise. I think this is pretty unlikely, maybe one in five, but I think it’s higher than maybe the investor consensus that they could reach the outlines of a deal on the grand bargain, the handshake between Boehner and Obama, assuming Obama is reelected President under that scenario, and if that happens, that would be very bullish for the market.


CONSUELO MACK:  So what happens if Romney gets elected? So what does the President and the lame duck Congress do in that case?


ANDY LAPERRIERE:  My guess would be that they would relatively easily be able to agree on delaying the sequester, dealing with AMT and a few other miscellaneous items in the fiscal cliff.


CONSUELO MACK:  Alternative minimum tax.


ANDY LAPERRIERE:  The alternative minimum tax, right.


CONSUELO MACK:  And forgive me for stopping you there, but dealing with that means what?


ANDY LAPERRIERE:  Well, under current law, there’s an exemption that gets indexed to inflation that wouldn’t be indexed to inflation, so it would be a big tax increase on people, and they would have to pay the AMT, the alternative minimum tax, about 20 million households that now don’t pay it, and so that would be a big surprise tax increase that people would actually find out during the tax filing season. So I think it’s very, very likely that’s going to get dealt with no matter who wins the election. What the difficult part would be is if Romney wins, Republicans will insist on a full extension of the Bush tax cuts, and the question is, well, will Obama sign even a one-year full extension of the Bush tax cuts if he loses the election? And I think that’s a tough call. So if he doesn’t, then the Republicans would probably try to deal with it relatively quickly, and with some support on the Democratic side on the Senate they could probably pull that off.


CONSUELO MACK:  So Jeff, the fiscal cliff. You are confident that the fiscal cliff will be resolved, that the sequester will not take effect where we have these massive automatic cuts in spending in the government. Why are you confident that that’s going to occur?


JEFF APPLEGATE: I think at the end of the day, most incumbent politicians would agree that it doesn’t make sense to let action occur which threatens to tip the economy into recession and throw their constituents out of work. So it’s really a very sort of simple political calculus on my part, and I think that will be shared on both sides of the aisle, so you’ll be able to get an agreement, and I think you can get an agreement whether it’s President-elect Romney, or whether it’s a second term for Mr. Obama. I think you get it under either scenario.


CONSUELO MACK:  And what if you’re wrong? What does that do to the market? What if everybody kind of digs in their heels and just says, “You know, we’re not going there.”


JEFF APPLEGATE: If we get gridlock, which is certainly above a zero possibility. Right?


CONSUELO MACK:  Right. We’ve had it before.


JEFF APPLEGATE: That’s right. That’s right. Then I think the market sells off potentially severely, and then we’ll see what the political response is to that, because obviously politicians do pay attention to what’s going on on Wall Street, but it may mean that it just gets pushed off until, you know, January, and again an Obama second term or a Romney first term, and a new Congress where the compositions arguably are going to be different.


CONSUELO MACK:  So let’s talk about that, because you sent recently a report out to your clients at ISI saying that the worst case scenario is a Romney win and a Democrat Senate. Why is that such a bad outcome?


ANDY LAPERRIERE:  Right, well, it’s a little bit complicated, but I think that basically if you look at all the other scenarios, Republicans and Democrats don’t have to compromise on the Affordable Care Act, the President’s health care law. They can just agree to disagree, and if it’s a Romney with a Republican government, they’re going to repeal a lot of it, and they’re not going to get Democratic votes. They don’t need Democratic votes. If it’s an Obama scenario with a Republican House, if the President’s reelected, he’s obviously not going to sign anything that’s going to undo his health care law, so the Republicans are just going to have to adjust themselves to that. Well, if Romney wins, Republicans are going to insist on big changes to the health care law, but now they don’t have the votes to that in the Senate.


CONSUELO MACK:  In the Senate.


ANDY LAPERRIERE:  So who’s going to give? Who’s going to give on that? And I think the answer is neither is going to give initially, and they’re going to duke it out, and they’re going to see who’s winning with the public on that. So that’s a scenario where I think you could have an extended period of where both parties are just going at it over the Affordable Care Act.


CONSUELO MACK:  So we’ve been there before, Jeff, and you’re the Chief Investment Officer of global strategy at Morgan Stanley Wealth Management, so you’ve got to deal with kind of the reality that is and the probabilities that are. So talk to us about your strategy. Number one, does the outcome of the election, how much will it affect your strategy, if at all, depending on who wins the election?


JEFF APPLEGATE: Yeah, I don’t think it… it affects it on the margin, but I don’t think it affects the core strategy. I mean, we’ve got a view that risk assets are the place to be, equities primarily.


CONSUELO MACK:  And that’s stocks, and that’s emerging markets.


JEFF APPLEGATE: Equities, emerging markets, but it’s also credit within fixed income, investment grade, high-yield—


CONSUELO MACK:  So corporate bonds. Right? Investment grade.


JEFF APPLEGATE:  Exactly. So economically sensitive sectors of the bond market. So it is a view that, yeah, the economy will continue to grow. Our earnings will continue to grow. Global growth will be probably on the order of, you know, two and a half, three percent even though Europe is in recession.


CONSUELO MACK:  And that’s real growth? That’s not including inflation.


JEFF APPLEGATE:  That’s real growth.


CONSUELO MACK:  That sounds very low to me. I mean, global growth–


JEFF APPLEGATE:  Well, keep in mind Europe is a big economy.


CONSUELO MACK:  Yes, and it’s in recession. Right.


JEFF APPLEGATE:  And U.S. growth is no better than two percent, and emerging markets are not immune to all this, so they’re not growing at seven, eight percent anymore. They’re growing at five and a half. So you put all that together. What falls out of that we think is about three percent, global growth, and then earnings growth probably on the order roughly double that, about six percent.


CONSUELO MACK:  But that tells me that that’s not really a great environment for business and for stocks. So why are you saying you can be more aggressive with your portfolios? And that’s a change from Morgan Stanley when you were kind of risk off until August. So what’s giving you encouragement that stocks and corporate credits are going to do well, and you don’t want to kind of batten down the hatches?


JEFF APPLEGATE:  Well, it’s really been what we haven’t talked about yet is monetary policy, so it’s been what the ECB has committed to do and Mario Draghi going back to the summer saying, you know, basically we’ll do what it needs to take.


CONSUELO MACK:  Right, whatever it takes.


JEFF APPLEGATE:  And it will be enough, so Europe is bit by bit working through that in the appropriate way, we think, and then you had the Fed embrace QE3 which we thought they would do, but what we didn’t know they’d do is that it would be open-ended. So the Fed is basically going to say, has said, “We’re going to be very accommodative for the markets for an extended period.” That’s generally overwhelmingly pretty good for risk assets.


CONSUELO MACK:  And let’s talk about that, because Andy, I know you have written an editorial, an op-ed editorial in The Wall Street Journal earlier this year, and you’ve been quite critical of this open-ended, you know, purchases of mortgage-backed securities and treasury securities by the Fed.  So why do you think that that is a dangerous course of action to take, and what impact do you think that’s going to have on the markets as well, this Fed policy, expansive policy?


ANDY LAPERRIERE:  Right. Well, I wouldn’t disagree with Jeff that this has been positive for the markets in the short term.


CONSUELO MACK:  Because it has been very positive in the markets, yes.


ANDY LAPERRIERE:  It has been. It has been. What I would argue is basically what the Fed is doing is it’s trying to encourage people to spend their wealth and increase asset prices and to encourage people to consume more than they otherwise would, and every economist, including Bernanke and others over time that have testified before Congress for the last 25 years, have said we need to save and invest more, and what we have is a policy that’s designed to discourage saving and investment, and so we’re sacrificing long-term economic growth for short-term positives which I think are very minuscule, and for the average person who doesn’t have that much in the stock market, they’re paying higher food and energy prices and they’re hurt from a weaker dollar, and they’re not really benefiting from higher asset prices and, in the long run, I think this is detrimental to long-term economic growth. And so I think the risk/reward and the cost/benefit analysis, I think for the average person and for the long run of the country, argues against what the Fed is doing.


CONSUELO MACK:  Of course, this is an election issue, because Governor Romney has come out and has been very critical of Chairman Bernanke and the Fed policy, especially the QE3.


JEFF APPLEGATE:  Actually, more so during the primaries than during the general election.


CONSUELO MACK:  However, my understanding is that Governor Romney has said, “I would replace Fed Chairman Bernanke,” but of course, Fed Chairman Bernanke’s term is going to end at the end of next year. So does that figure in in this election, the impact that this election could have as far as who’s going to lead the Fed?


JEFF APPLEGATE:  Yeah, not on a near-term basis, plus keep in mind obviously the Chairman of the Fed is a hugely powerful position, but monetary policy decision making isn’t simply one person, one vote. It is the FOMC, and the FOMC appears to have a fairly strong consensus that what they’ve done with quantitative ease in the latest version, people are on board with that.


CONSUELO MACK:  Right, with one dissent, I guess, recently.


JEFF APPLEGATE:  Exactly, so just changing the chairman isn’t then going to change the basic thinking of the FOMC overnight. That will take quite some time, because there is such a strong consensus that what the Fed is doing is appropriate for the economy.


CONSUELO MACK:  So, Andy, do you feel that way, too, that that really is not a pressing issue as far as Governor Romney would replace?


ANDY LAPERRIERE:  Right, right. Yeah, I mean, Jeff and I don’t agree on the merits of what the Fed is doing, but I think we do agree on the outlook for the Fed. I think Bernanke’s not going to be asked to step aside. Romney’s not going to do that. He’s going to serve out his term, and he is only one member, and so it will take time for the composition of the board to change, and so you’re talking about monetary policy being impacted slowly and over a long period of time if Governor Romney is elected President.


CONSUELO MACK:  Winners and losers with this election outcome. Jeff, you said it would make a difference on the margins. So are there margins that we should be paying attention to? I mean, are there some clear winners and losers that you would actually change, you know, adapt your portfolio and the margin, too?


JEFF APPLEGATE:  We would, and if we got a good outcome and then you had people talking about, yes, we’re going to take appropriate action on the fiscal cliff and long-term deficit reduction activity into next year, then I think that would be better for risk asset markets, and that would prompt us to revisit the debate we’ve had which is, should we actually increase the beta in the portfolios? So we would be responsive to that.


CONSUELO MACK:  And where would you increase your exposure to risk assets particularly? Which sectors would really benefit?


JEFF APPLEGATE:  Well, we really do it not so much by sector but by geography. So it would really probably go more to the U.S., because the last move we made was really to put money in the European equities. So the more U.S. but also, by extension, probably emerging market equities, because if growth is going to pick up here in the U.S., this is obviously a pretty important market for the global economy and for emerging markets, so those would probably be the two primary places, and we’d probably also increase our credit exposure.


CONSUELO MACK:  Right, and so those were equities you’re talking about. U.S. stocks, and I know you’re favoring large-cap growth stocks.


JEFF APPLEGATE:  Large-cap growth. Right.


CONSUELO MACK:  Right, and emerging market stocks.




CONSUELO MACK:  All right. Winners and losers. You’ve done a clear list at ISI depending on which candidate wins. So who are the winners? Who are the losers for each candidate?


ANDY LAPERRIERE:  Well, I think the big sectors you want to look at are health care, defense and energy. I think the health care names are especially sensitive to this whole budget debate. If Republicans do well, I think what they’ll do is they’ll leave in place a lot of the offsets in the health care law but take away the benefits.


CONSUELO MACK:  So what do you mean by that?


ANDY LAPERRIERE:  So meaning, so hospitals, for example, they were going to benefit from more people having health insurance coverage.


CONSUELO MACK:  Under Obamacare.


ANDY LAPERRIERE:  Under Obamacare, but what they paid for that was lower reimbursement rates. I think Romney might leave in the lower reimbursement rates but get rid much or most of the benefit coverage, and so that means that…


CONSUELO MACK:  So hospitals would lose under Romney.


ANDY LAPERRIERE:  They lose under Romney, gain under Obama, and you’ve seen those stocks have been the most sensitive to the swings we’ve seen in electoral fortunes here over the last several weeks. Medicaid HMOs is another example of that. They pay the tax in the President’s health care law, but they get 15 million more people covered under Medicaid. Well, they may keep the tax.  Romney may keep the tax, but they’re not going to get the 15 million additional lives covered under Medicaid.


CONSUELO MACK:  So HMOs would lose as well under Romney.


ANDY LAPERRIERE:  So Medicaid HMOs, although overall HMOs have been winners under Romney or seen as winners by investors under Romney, because Republicans believe in a greater role for the HMOs in the Medicare system, whereas Democrats would have a more reduced role for HMOs.




ANDY LAPERRIERE:  Energy, this is more of a regulatory change. I think very little legislation’s going to get through, but I think there will be a sense that under Romney it’ll be full speed ahead with all of the above; whereas under Obama, the EPA could be a lot tougher on traditional sources of energy, oil, coal, natural gas in a second term.


CONSUELO MACK:  And was there a third sector?




CONSUELO MACK:  Defense. Oh, duh, yeah.


ANDY LAPERRIERE:  So defense. Romney’s talking about increasing defense spending or at least not cutting it anymore. I think it’s going to be tough to actually increase defense spending.  I think they’ll actually live with these budget caps, but if Obama wins and there’s some kind of grand bargain- which I think there is going to be a grand bargain if Obama wins- then the caps will come down for defense, and defense will get cut more.


CONSUELO MACK:  If there’s One Investment, Jeff, that we should all make in a long-term diversified portfolio, what would it be?  What would your advice be for our long-term investors?


JEFF APPLEGATE:  It really hasn’t changed. It would still be emerging market equities to us, and we’ve been talking a lot about policy here. If you look at the policy mix in most emerging markets, it’s, for the most part, hugely superior to the policy mix, both fiscal and monetary, in most big developed markets, and you also have these economies where they’re at just a different point in their lifestyle. So their potential GDP isn’t one or two or three percent in terms of potential growth. It’s more like five or six percent, so much better fundamentals and a much better policy mix. Now, emerging market equities have actually underperformed U.S. equities, not by a lot, about a percent and a half.


CONSUELO MACK:  And price matters, so maybe this is a good time.


JEFF APPLEGATE:  Yeah, I mean, certainly the valuation is not daunting if you look at emerging market equities. They’re actually pretty much in par with developed market with a better set of fundamentals and policy options.


CONSUELO MACK:  And I know you’re not going to recommend a fund, but Morningstar has an ETF that they recommend that Vanguard puts out, an emerging markets fund.


JEFF APPLEGATE:  Precisely, which is passive and obviously low fee. It’s a good way, a good vehicle to use to play emerging markets, yes.


CONSUELO MACK:  So Andy, you can go anywhere you want with this question. What’s the One Investment that you think that we should all have in a diversified portfolio?


ANDY LAPERRIERE:  So a long-term investment, I think you need some protection against the risks of higher inflation. I think given the budget situation that we have, even though I’m relatively optimistic Congress will deal with it appropriately over time, that’s a real risk coupled with a very easy monetary policy. I think you need to have some protection against long-term inflation, not near term but in the long term.


CONSUELO MACK:  Okay, so we’re talking about real estate. We’re talking about gold potentially.


ANDY LAPERRIERE:  Some hard assets that provide some inflation protection, absolutely.


CONSUELO MACK:  And I’m going to ask each of you. So who do you think’s going to win the election on Tuesday? Jeff? And it could be personal. You don’t have to put Morgan Stanley on the line.


JEFF APPLEGATE:  You know, I think the incumbent is going to win.




ANDY LAPERRIERE:  I think it’s been close. It will be close, but I think, given Romney’s slight lead in the polls that we’ve had since the Denver debates, I think you give him the edge.


CONSUELO MACK:  All right, and so then that’s why we have a difference of opinion. We’ll find out on Tuesday. Thank you both so much for joining us. So Jeff Applegate, always a treat to have you, Chief Investment Officer of Morgan Stanley Wealth Management.




CONSUELO MACK:  And Andy Laperriere from ISI Group, the head of their top-ranked Washington team. Thanks so much for being with us.




CONSUELO MACK:  At the conclusion of every WEALTHTRACK, we give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: vote! This promises to be an extremely close election. The margin of victory can be razor thin. The closest election in recent memory was between John Kennedy and Richard Nixon in 1960. JFK won by a mere 36,000 votes in that one! President George W. Bush won the key state of Florida by just 500 votes over Vice President Al Gore in 2000, after the controversial recount. As we just discussed there is much at stake for investors in this election. Your vote can really make a difference.


Next week, after the votes are counted, we will look to the future: the message of the election, what you can expect from the executive and legislative branches, and how you might want to adjust your portfolios. We have a WEALTHTRACK exclusive with top Washington analyst Tom Gallagher, who now hangs his hat at The Scowcroft Group, but for many years headed up Andy Laperriere’s team at ISI. Until then, if you would like to watch this program again, please go to our website,, where you can also find additional interviews with WEALTHTRACK guests in our new and improved WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you for watching and make the election week ahead a profitable and a productive one.

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