Expectations Meet Reality
Research for Online Investors

by John Dalt

10/26/10

Elections in the U.S. are one week away.  Expectations are that conservatives (Republicans?) will gain control of the House of Representatives and come close in the Senate.  Taking control of the House from the democrats (socialists?) will provide a small check on the administration.  The exciting thing is that ALL SPENDING ORIGINATES IN THE HOUSE.

This should mean the end to stimulus packages.  It should mean attempts will be made to repeal or change the national health care bill.  It may mean a return of all monies to the treasury of stimulus and TARP funds that are not spent.  It could mean a reduction in funding for a few of the most egregious regulatory agencies such as EPA, Education, Labor, Housing and Energy Departments.  It could mean an end to funding for public broadcasting.

The big challenge that must be addressed is entitlements.  Social Security and Medicare need to be adjusted to bring their costs down.  The defense budget may be reduced as the Iraq war winds down and Afghanistan the same in 2011.

The popular perception is the conservatives intend to stop the growth of government, and then begin to shrink it.  Good luck.  Will they vote to extend unemployment benefits for the voters that have been unemployed for 99 weeks?  Will they reduce food stamps that are now collected by over 42 million people? (Associated Press)

Our future is being played right now in Europe.  Last June British Chancellor George Osborne urged British citizens to prepare for sacrifice.  He said “The truth is that this country was living beyond its means when the recession came, and if we don’t tackle pay and pensions, more jobs will be lost.”

Last week, Britain’s conservative government, in coalition with the Labour party, unveiled their budget plan.  The plan cuts spending across the board 19% for most departments.  These are the biggest cuts in over 60 years.  Social services take a hard hit, with an increase in retirement age.

National debt is expected to reach $1.4 trillion.  The British government’s plan is to eliminate the $245 billion annual deficit and begin paying back debt in the next five years.  The budget plan includes $45 billion in tax hikes and $125 billion in spending cuts.

Finally, a country led by politicians that realize you can’t get out of debt by spending more money!  There are and will be protests.  There will be tough times to work through.  There will even be higher unemployment, as direct and indirect government workers get laid off.

Housing prices may fall further and consumer confidence is dropping, according to Kitty Ussher, a former minister of the previous Labour government.  Economist Martin Wolf said that the British had been “shocked into sobriety” by the European credit crisis while noting the U.S. still has not cut government spending.  Economist Joseph Stiglitz wrote in the Guardian to warn “the world cannot afford not to have another stimulus.”  His second point, “Austerity in the midst of a downturn lowers GDP and increases unemployment.”

We agree with Mr. Stiglitz’s second point.  Unemployment may go up; GDP may go down…Until business activity builds because of low taxes, confidence in government and low interest rates.

An interesting note, as GDP stalls and unemployment increases you can imagine the pressure that will build to “do something.”  ArcelorMittal Steel (MT) turned in disappointing third quarter results.  Financial Times reports that the company’s Chairman Lakshmi Mittal called for ‘more government stimulus measures to speed up growth..’

The government trough may run out of slop!

What does it mean to investors in U.S. equities?  The feeding at government’s trough may be about to close.  As investors realize the result of the elections, the stock market may go into “Sell the News” mode.  We only have to look over the ‘pond.’  European markets were down this morning.

Just another reason to be prepared for a wild ride.

To the mailbag:
If they lower the tax rates to say 10% and Google still gets to keep their off shore havens while retaining a 2% effective tax rate, why would they bring more back to the US?  I must be missing something here. —paid up subscriber J.P.

John’s reply: The tax is only paid on the profits, after all deductions.  The goal would be to make the tax rate low enough that all the hassle of setting up overseas units is not worth the effort time and expense.  Just pay the tax in the U.S. and do business.  Ireland has rolled out the red carpet with low rates and has the 2,000 employees we would have in this country if our taxes were lower.

Very interesting, great column again.--- paid up subscriber D.E.

Quote:
The early bird may get the worm, but the second mouse gets the cheese in the trap.---Larry the Cable Guy

Editor’s note:  This applies to investors, don’t be in a hurry.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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