Status Quo After billions of dollars in campaign costs, thousands of TV and radio advertisements, hundreds of campaign rallies, fundraisers and speeches, the voters spoke on Tuesday. What was the result? We are essentially right back to where we started.
The Republicans still control the lower chamber by a strong (albeit smaller) majority. In the Senate, the Democrats slightly expanded their majority. Finally, President Barack Obama was re-elected, and he will now move on to his second term. Despite all of the hand wringing by both sides of the political spectrum based on the supposed ineffectiveness of the federal government for the past two years, the voters decided to keep that structure largely intact.
First on the docket for the lame duck Congress and the president to tackle is the fiscal cliff. Senate Majority Leader Harry Reid and House Speaker John Boehner wasted little time, each staking out their positions the day after the election, stressing the need for urgent action. President Obama has invited congressional leaders to the White House later this week. Reid advocated that decisions be made before year-end, stressing that “I’m not for kicking the can down the road any longer … we should just roll up our sleeves and get it done.”
Of particular note were Boehner’s comments that revenues in the form of closing loopholes and limiting deductions are on the table in conjunction with broader tax reform (e.g., Obama’s Simpson Bowles Deficit Commission recommendations from 2010). During the debt downgrade debacle in late summer 2011, revenue increases were only discussed by the GOP in closed quarters. Public comments treated any form of revenue increases as forbidden territory. A noticeable shift in the comments has already occurred, and this provides reason for cautious optimism for a possible resolution before year-end.
Keep in mind that Boehner and Obama at one point were close to a deal in private negotiations. Expect each to return back to those negotiations as a starting point, with Boehner ceding more ground based on the election results. With no pending voters to appease, chances are higher for a resolution, and count us as optimistic that we will get one. However, investors should expect volatile markets until the speaker and the president shake hands in front of the cameras, announcing an agreement.
How should investors handle these expected volatile markets? Reactionary investing has a poor track record. Dalbar Inc. publishes an annual quantitative analysis of investor behavior, and their numbers are validating. According to their study, the average equity investor realized annualized returns of 3.49 percent over the trailing 20-year period that ended Dec. 31, 2011. In contrast, the S&P 500 returned 7.81 percent annualized over the same 20-year period. The net result is a 4.32 percent difference per year in the performance of the average equity investor compared to the S&P 500. Headline-driven, swiftly moving markets like the ones we had last week are exactly the kind of markets that create this gap, as investors make short-term decisions to the detriment of long-term returns. Prudent, diversified investing with a focus on mid to long-term strategies rather than the short-term noise is the recipe for investment success.
Mark Sorgenfrei Jr. is vice president and investment analyst for Waddell & Associates Inc.