With the world’s eyes turned to Greece ahead of its all-important national elections on Sunday, and Spain’s soaring borrowing costs, a managing director at Wells Fargo warns investors that the U.S. is probably headed down the same path as Europe. Ron Florance, who is in the investment strategies team, explains that “what’s happening in Europe today will happen in the U.S. in November,” noting that if with debt ceiling and fiscal cliff debacle isn’t fixed, the U.S. will fall into recession next year.
Europe is suffering from an economic and financial crisis that, because of the very nature of the European Union, has become political in nature. Like a deer, paralyzed by a coming car’s headlights, core Eurozone countries haven’t moved in with market stabilizing measures, and the peripheral PIIGS haven’t been as expedient in reforming their economies.
Wells Fargo’s Florance thinks the same thing is happening in the U.S. Florance explained that if the debt ceiling and fiscal cliff issues aren’t resolved, 5% of GDP will be shaved off U.S. economic growth over the next two years. Failing to extend the so-called Bush tax cuts would result in contracting GDP within a year, he added. Political risk could beget recession, then.
While he’s skeptical of the political class, he’s optimistic about the country’s economic prospects. Florance understands that uncertainty over future policy is hurting business and consumer confidence. Firms, sitting on record piles of cash, aren’t hiring, while people, unsure of what’s going on, are sitting on their savings as they continue deleveraging. “If you stand back and look at the US. Economy, you can see it’s not firing on all cylinders,” he said, “but once these issues are addressed, I see an immediate pick up in hiring.”
The problem is that the velocity of money has collapsed, while interest rates have fallen to zero. Further targeting interest rates won’t provide a solution, no matter how much Fed Chairman Ben Bernanke engages in monetary stimulus and accommodation. Florance agrees with Bernanke that the level of slack in the economy is lower than anticipated, meaning the rebound won’t be as robust as expected.
Housing could be one of the ways out of the mess. Florance suggested the real estate market had pretty much hit bottom already, despite regional discrepancies. Major banks like JPMorgan Chase, Citigroup, and Bank of America have seen their earnings pressured by the massive supply of foreclosed homes, directly or indirectly tied to their balance sheets. A housing recovery should ease these pressures, possibly spurring further lending.
Florance suggests that global and domestic equity risk looks cheap. Global companies with exposure to South East Asia, not necessarily China, but countries like Vietnam, look attractive. While South America, and Eastern Europe also provide opportunities. On the commodity side, Wells Fargo suggests splitting investments into three buckets: agricultural and energy (which will be the first two to recover), and industrial metals.
Wells Fargo is cautious. Political uncertainty and risk in the U.S. is high, and flying under the radar, Florance said. While he expects Washington to fix the two major issues (“they are stubborn but not stupid”), he does warn investors to keep an eye out for what could be an escalation of rhetoric going into the presidential election. Asked if President Obama would win, Florance said it all depends on the employment outlook. Position investments internationally, with exposure to high growth countries, and watch duration risk closely.