Text published in L’Echo (Belgium) on 1 December 2012 and an abridged version of this text appeared earlier in the French newspaper Les Echos.  

Recently, just before turning in for the night, I checked the Bloomberg website where I read that Wall Street had rebounded on the back of positive noises in Washington DC about the fiscal talks. The next evening, the same ritual, but this time the commentary was that the stock exchange was suffering from the lack of progress in the talks. The third evening I did not bother to look at the website…because the pattern will no doubt repeat itself in the coming weeks. The closer we get to the year-end deadline, the more fears will grow that the unthinkable might actually happen after all, with the failure of the Democrats and Republicans to reach an agreement triggering automatic spending cuts and tax increases.  These measures were set out in the deal that was struck in 2011 a few hours after the deadline and was signed by President Obama on 2 August 2011 (which, just for good measure, also raised the US debt ceiling). The experiences of 2011 show that the fiscal cliff may well end up as a fiscal cliff-hanger (excuse the word play), even though everyone realises that no agreement is not an option – not in 2011 because this would bring the public sector machinery to a grinding halt, and not in 2012 because of the ensuing recession in 2013.

No matter how hard people try to approach this problem rationally, fear will rapidly take hold as soon as the unthinkable becomes a little less unthinkable. Equity prices will undoubtedly move lower. Another factor that will play a role in December is the imminent rise in capital gains taxes, which will prompt investors to cash in profits now and start the new year with a clean slate.

For dynamic investors, this moment of stock exchange weakness may be a good opportunity to buy. This may seem rather daring, but it could be a risk worth taking (hence the title of this article). Here are no less than eight reasons for buying now:

1)      The price/earnings ratio is not too expensive.

2)      The US economy is abundant with Fed-created liquidity.

3)      The Fed is even considering to continue buying USD 45bn of government bonds every month (in the context of operation twist it is selling the same amount of short-dated paper from its portfolio), even though operation twist is due to expire at the end of this year. Add to this the purchase of USD 40bn of mortgage-backed securities under QE3, and USD 85bn is being pumped into the system every month.

4)      Corporate bonds are expensive compared to equities. Including the effect of share repurchase programmes, dividend yields exceed high-grade corporate bond yields.

5)      Government bonds are extremely expensive compared to equities.

6)      US investors who sell now for tax reasons will return in the new year.

7)      The January effect that often happens in the new year, partly because of the previous point and partly because professional investors start with a clean slate: the performance for the new year must still be realised; unless they are really bearish, they will therefore be inclined to buy shares. If the results are disappointing, they can always sell to limit their losses. If their cash position is too large at the start of the new year, they will find themselves obliged to chase after the rising prices, knowing that their expected return for the rest of the year will then be lower because the prices have already moved higher (‘the richest pickings have already been taken’).

8)      The US economic data are improving, so the macro picture is starting to look less uncertain. 

All in all, there are plenty of reasons for dynamic investors to take the plunge when the markets are suffering from the horse-trading in Washington. But I emphasise the word dynamic, i.e. investors with an investment horizon of several weeks. Beyond that horizon other factors will come into play.

 

William De Vijlder

Chief Investment Officer, Strategy and Partners

BNP Paribas Investment Partners