The Politics Of Alpha: Europe, China, And The U.S.

On the morning before the first U.S. Presidential debate of the general-election phase of this campaign season, Janus Capital hosted a roundtable on “Investing and Politics,” discussing what the outcome of the election, and other political shifts here and abroad, may mean for your portfolio.

Stephen Moore, a senior economics writer at The Wall Street Journal, and author of Bullish on Bush: How George Bush’s Ownership Society Will Make America Stronger (2004) moderated the event.

One participant, Jonathan Coleman, noting several aspects of the fiscal policy of the U.S. at present that he regards as unsustainable whoever is elected in November, observed, “We spend $750 billion a year in defense spending,” and that this isn’t merely more than anyone else in the world, it is more than the next 15 spenders combined. Such conditions “are unsustainable in the long run, the question is when does the breaking point occur.”

The panel also included: Peter W. Atwater; Gibson Smith; and John Taylor. Coleman is co-CIO for Janus, and co-author of Growth for the Long Run, a recent Janus report on the appeal of equity interests in “durable, long-duration growth companies.” Atwater is a consultant to money managers, hedge funds, foundations, and endowments. Gibson Smith, also co-CIO for Janus, is responsible for its fixed income strategies, and is a co-author of Redefining Risk in Fixed Income.

Taylor is in a sense the stand-out of the group. His research into monetary policy has led him to formulate the so-called Taylor Rule: a country or currency zone’s nominal interest rate, especially what in the U.S. is known as the federal funds rate, should track and somewhat exceed the inflation rate over the previous four quarters. Some central bankers have credited his work and namesake rule with the “transformation” of their practice.

Europe
Richard Weil, the CEO of Janus, also offered introductory remarks. “We’re more and more … disconcerted by messages we hear from the press” pressing politics – domestic and international – onto the attention of investors, asking: “what happens if Europe melts down” or if there is a hard landing in China, etc.

The panel would discuss both of those issues. On Europe, Taylor said that he really wants “to blame the euro” for Europe’s troubles, perhaps because that would put the whole crisis squarely into his field of recognized expertise. But he can’t blame the currency. The problem with Europe, rather, is the pursuit of “terrible fiscal policies” especially as to entitlements, and in any event the U.S. shouldn’t “blame Europe for our problems.”

Coleman spoke of the dynamics of the ongoing Euro crisis, or crises, in terms of the acronym CRIC (which also represents, fittingly enough, the way people in the western US pronounce the word “creek”). There is a pattern of Crisis, Response, Improvement, and Complacency. The complacency, inevitably, sets the stage for a renewal of the crisis, completing the circle.

Investors, he said, while paddling in the creek, “should brace themselves for these rolling waves.”

China
Moore said that he thinks “China is even more important at this point than Europe,” in terms of the future of economic policy in the U.S. China, not Europe, is an honest-to-goodness rival with the United states for position as “global economic superpower.”

The panelists generally agreed that some sort of slowdown is underway in China, but they reached no consensus about where that fits in the big picture, whether it is a bubble bursting or a small speed bump on a long road forward. Taylor was generally optimistic about China – thinking that it will continue to grow and that this will be good for the rest of the world, but he qualified this in certain respects one big issue there is the rule of law as exhibited for example on intellectual property issues.

Moore tried to lure Taylor into taking a swipe at Obama here, saying that the President has engaged in China bashing on the campaign trail. But Taylor didn’t take the bait. He said again that there are rule-of-law issues, and that perhaps China can stand some bashing.

Coleman brought another point of view to the Sinological talk, saying that the working age population in China will reach a peak in two years. Because of their adherence to a one-child policy, they’ll “have a real constraint on their growth.”

The U.S.
But in accord with the timing of the event, panelists spent more of their time figuratively at home than abroad. Atwater, for example, focused on confidence. Although to some degree our decisions determine our level of confidence, to an overlooked degree he said the opposite is the case. In the U.S., the population at large is “barely more confident than they were four years ago, a lot less confident than they were twelve years ago.”

Atwater also noted that if the prices of commodities start rising due to QE or otherwise, it will become more difficult for people at the low end of the income scale to feed themselves. “You have to feed people at an affordable level,” he said, “If food becomes unaffordable you end up with an environment that resembles Tunisia and Egypt and we don’t want to go there.”

Coleman said that the Affordable Care Act kicks in during Obama’s second term. If Romney is elected then the Republicans will try to “take away certain aspects” such as by repealing the Medicaid expansion.

Equity investors should “think about that environment going forward,” he said. Companies that can help control health care costs, such as pharmacy benefit managers, will likely benefit from the political and policy environment whoever wins the election. He also suggested that research oriented pharmaceutical companies, those developing breakthrough therapies, are likely winners. They can price their products at “attractive levels” for investors.