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Obama wins: America’s voted, what’s next?

David Mazza of State Street Global Advisors discusses the implications of the US fiscal cliff and debt ceiling debates.

President Obama and Mitt Romney talk in the Oval Office after the election

Even though Mitt Romney’s impressive performance in the debates made this a tight race, investors around the globe have had their eye on the implications of Barack Obama’s successful re-election. Over the course of the campaign season, the now President outlined certain proposals that he plans to move forward during his second term.

More specifically, President Obama is looking for corporations to pay taxes of 28%, but would like to give breaks to manufacturers in the US. Another proposal involves increasing income taxes for the highest two tax brackets from 33% and 35% to 36% and 39.6%, respectively. Even with the potential for higher taxes, it is unlikely that municipal bonds current favourable tax status will be altered, making the after-tax benefits of these securities appealing to investors in affected tax brackets. In addition, under the President’s proposals, there would be an increase in the capital gains tax to 20% on high earners and dividends would be taxed as ordinary income for individuals making over $200,000 and couples making over $250,000. This may decrease some of the appeal that dividend-paying US companies have offered investors in this low yield environment.

Thus, the appeal of Reits could increase relative to other high yielding equities. Obama has made it clear that he would like to continue focusing on infrastructure spending and companies exposed to that industry may stand to benefit relative to what the Republican ticket was proposing. Lastly, with the Supreme Court decision and a second term, it seems unlikely that the Affordable Care Act will be challenged, allowing investors to express their opinions on the healthcare sector with increased clarity.

Asset classes or markets that investors may consider for President Obama’s second term include: municipal bond, Reit and sectors such as infrastructure, healthcare and biotechnology.

Uncertainty lingers post election
While investors now know that President Obama has been re-elected, two significant sources of uncertainty in today’s marketplace remain: the so-called fiscal cliff and the debt ceiling. In a market where political and economic uncertainty continues to prevail, investors will be best served to consider the scenarios that could play out for various economic events.

The fiscal cliff
When the lame duck Congress begins on November 12, politicians will begin working on addressing the fiscal cliff. The tightening impacts of the fiscal cliff include the expiration of the Bush-era tax cuts, the expiration of the payroll tax cuts, sequestration, emergency unemployment insurance benefits expiring, depreciation incentives expiring, the Alternative Minimum Tax fix not being patched and Medicare payments to doctors not being extended. Politicians in Washington will need to make decisions as to whether they wish to kick the can down the road, cross the political divide and make comprises, or allow for the full force of the fiscal cliff to come to fruition, potentially causing a serious shock to the US and global economy. Under a re-elected President Obama, the resolution of the fiscal cliff has the potential for a few different outcomes.

Kick the can (best case for 2013 GDP growth)
If politicians extend these measures for the short term to avoid the fiscal cliff in early 2013 and there is no resulting fiscal drag, the State Street Global Advisors (SSgA) Economics Team estimates that US GDP in 2013 will register at 2.7%. While this is a plausible scenario and one that would result in the best short-term growth prospects, it may not pass muster with Congress. In addition, another round of can kicking the can may push eventual resolution into future years, but may not bode well for bolstering faith that Congress can work together to solve the big issues that were a central tenant of the Presidential debates.

Measured compromise (base case for 2013 GDP growth)
It seems more probable that President Obama will look for Democrats to cross the aisle with Republicans and work on a resolution before the end of the year. While the ambitions might exist to do so, having both parties come together for a broad-based resolution may be difficult. More likely, some compromise will take place, which will generate a certain amount of belt tightening. For example, it seems likely that the payroll tax, which is worth approximately $120 billion, will be allowed to expire because it has not been popular with either party. Thus, the SSgA economics team GDP estimates that 0.7% will be knocked off GDP as a result of these measures, bringing growth next year to a slower 2%.

No agreement to avert the cliff (worst case for 2013 GDP growth)
If Democrats and Republicans fail to compromise, the fiscal drag may reach 1.7%, bringing US GDP down to 1% in 2013. However, SSgA is forecasting that GDP could fall as low as -1.1% should the full impact of the fiscal cliff be felt. This would imply that the US would fall back into a recession, which would impact global growth and have serious domino effects to security markets.

The base case scenario braces for some impact to GDP growth, but nothing catastrophic. From a political point of view, this implies more of a status quo environment. In other words, while 2013 may see more productive discussions on the long-term fiscal condition of the US and the role of taxes and entitlements, investors may need to be prepared for continuing uncertainty. At the same time, investors will need to contend with the evolving political situations in the Eurozone and questions about Chinese growth prospects. Should economic prospects worsen, central banks are standing ready to prime the pump with additional liquidity, however some experts are beginning to question their effectiveness at this stage.

Asset classes or markets that investors may consider for prolonged uncertainty are emerging markets/Asian local currencies, gold or investments with an objective to drive real return.

The debt ceiling
While most headlines have focused on the impending fiscal cliff, the US faces another debt ceiling debate in short order. Estimates vary for when the current ceiling of $16.4 trillion will be breached, but based on tax receipts and expenditures it seems likely that it could occur between January and March 2013. While the Treasury department does have some leeway to manipulate their spending, which they did in 2011, this will only serve as a band-aid until a long-term resolution is reached. In August 2011, markets were whipsawed as politicians debated whether to allow the debt ceiling to be increased without cutting spending. Washington may have learned from this experience that inaction increases uneasiness in an environment that is already characterised as uncertain. Even so, global investors may continue to look unkindly at this kind of behaviour from the world’s largest economy. Thus, investors may begin to look for assets that are less correlated to the whims of Washington. One such option is non-dollar denominated assets, such as those denominated in local currencies, especially in emerging markets with the potential for high economic growth that is less burdened by the debts and deficits found in many developed markets.

With a renewed debt debate and the potential lack of commitment to aggressively reduce spending or plan for future austerity when it may be more palatable for the economy absorb, gold stands to benefit as it has served as a buffer against uncertainty and its value cannot be debased. In addition, with the potential for a long-term inflationary environment due to continued large-scale government spending, investors may wish to allocate a portion of their portfolio to real return assets.

About SPDR ETFs Offered by State Street Global Advisors, SPDR ETFs are a family of exchange-traded funds that provide investors with the flexibility to select investments that are precisely aligned to their investment strategy. Recognised as the industry pioneer, State Street Global Advisers created the first ETF in 1993, which is the world’s largest ETF. In 1999, SSgA introduced ETFs in Asia Pacific when it launched the Tracker Fund of Hong Kong. Currently, State Street Global Advisors manages about $337 billion of ETF assets worldwide, as of September 30, 2012. This AUM includes the assets of the SPDR Gold Trust (about $75.4 billion as of September 30), for which State Street Global Markets, LLC, an affiliate of State Street Global Advisors serves as the marketing agent.

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Important information The views expressed in this material are the views of David Mazza, Head of ETF Investment Strategy, Americas, SPDR® ETF Strategy & Consulting, State Street Global Advisors through the period ended November 6, 2012 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial adviser. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.

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