Friday, 21 December 2012

Week in review: Plan B, is not to be, “what now?” is the question…


Equities were broadly higher over the week although the FTSE was lagging somewhat by Friday morning. Sterling and the euro also gained while Spanish and Italian bond yield spreads tightened. Overall these movements reflect a broadly positive week, but on Friday morning investors were fretting over weak UK public finances and the collapse of the Republican tax plan in the US.

Hard-line Republicans, who object to income tax increases for any salary bracket, ended Speaker John Boehner’s hopes of seeing his Plan B tax and spending deal signed into law. On the face of it this is not the end of the world (that’s a different story), President Obama had promised he would veto the bill and it would not have passed the Senate either.
Source: Brewin Dolphin/United States Congress
The difference this latest set back makes is that it leaves the Republicans in chaos. With polls generally indicating that they would shoulder more of the blame for any failure of talks, Boehner had already had to make concessions to the Democrats. Now, when they return to Washington after Christmas, he has to either watch America meet the fiscal cliff, or appeal to enough moderate Democrats to offset dissenters from his own party. It will be challenging to remain popular with such a stark choice but the first act of the new Congress (3rd January) will be to consider whether Boehner remains Speaker for the next two years - so he needs to be sending a lot of Christmas cards!

So what next?

As the dust temporarily settles, pressure mounts on the Republicans. Obama can have an offer introduced to the House and the Republicans will have to decide whether to pass it or not. Obama does have his own extreme fringe to appeal to which will temper concessions to the Republicans, but the GOP will be aware that this latest set back increases perceptions that it is they who are at fault.

If the President fails to agree a comprehensive tax and spending package with the Republicans, he has the option to lessen the blow by immediately proposing tax cuts in the New Year. Republicans, as we saw last year, struggle to vote against tax cuts even when they are proposed by Democrats. We hope for a better resolution, but at the very least the full burden of tax increases need not be shouldered.
Source: Brewin Dolphin/US Census Bureau

Meanwhile…

The US economy rumbles onwards – led by its housing market. The rate of house sales increased to 5m per annum, The Federal Housing Finance Agency now calculates houses as being 5% above their 2011 nadir. As well as housing transactions which help wider consumption, generally rising house prices grow wealth (and diminish negative equity) - after six years of declining wealth, US consumers are likely to take heart from seeing it finally back on the rise.

Furthermore the resurgence in the housing market is creating a need for construction – this is illustrated through the rise in monthly building permit data released this week. The US usually builds around 1.5 million houses per year but has never built so few as it did in 2008, 2009, 2010 and 2011. By our rough calculations this suggests a deficit of just under 2m homes which would need to be found, in addition to the 1.5m run rate generally required to allow the army of American thirty-somethings to move out of their Mom & Pop’s place.
Source: Brewin Dolphin/US Census Bureau
Unlike the trend toward increasingly mechanised manufacturing, which has weighed on jobs growth, home construction is wonderfully labour intensive meaning that its effects cascade through other parts of the economy like consumption and back into the housing market once more.

With US household affordability at all time highs – a by product of the sharp falls in the housing market and the all time low interest rates the Federal Reserve are providing to borrowers, the US housing recovery is well padded in case it does meet the fiscal cliff.


Guy Foster
Head of Portfolio Strategy


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