You’d be hard-pressed to find someone who argues that balance is a bad thing, but in this time of austerity versus growth and political us-versus-them, you’d be equally hard-pressed to find agreement on how to achieve balance. Right now the U.S. economy is teetering on the edge of the much-publicized so-called “fiscal cliff,” a one-two punch of automatic spending cuts and tax increases set to go into effect in 2013, and which threaten to tip the nation into recession. Will the U.S. speed off the cliff and into the abyss? Or will politicians pull together to prevent this economic Weeble from wobbling?
At Cliff’s Edge
Ed Perks, Sr. Vice President and Director of Portfolio Management for Franklin Equity Group®, has a thing or two to say on the question of balance and potential economic cliff-dives. Says Perks:
“If nothing were to be done, forecasters have projected a potential hit to GDP of about 3.5%, and that is very meaningful. Certainly we do have concerns about that, but when we really look at the issues that comprise parts of the fiscal cliff —whether it is the expiration of tax cuts or extension of unemployment benefits—many of these things can be dealt with over a number of years. Thus, the immediate impact on the economy could be much more muted. Ultimately, we do need to see some cooperation in Washington, which I know is hard to envision given the (politicians’) recent track record. Ultimately a government’s ability to live more within its means is very important long term.”
Achieving growth alongside austerity seems like a balancing act requiring the skills of a master yogi. In some European countries, attempts at fiscal balance via severe austerity have resulted in social and economic fallout. But Perks believes growth and austerity are possible to achieve in tandem, as long as politicians are willing to bend a bit.
“I’m in the camp that believes they (growth and austerity) aren’t mutually exclusive. I think you can have the government on a long-term path to sustainability and balancing budgets, and there will likely need to be some combination of revenue increases for government as well as spending reforms or spending cuts over the long-term. As we move to a more balanced or sustainable fiscal path in the U.S., it’s important that the private sector be in a position where it is supported with good underlying policy to generate employment growth. I think that could be a very important offset to any negative drag or fiscal drag from austerity measures and would enable a more balanced path as well as growth in the economy.”
Further, Perks notes that while many countries in Europe have gone down the austerity path, the U.S. must find its own best course.
“I think the situation in Europe is very different country by country, so extrapolating what’s happening and in, say, Greece today or Italy or Spain is a very different situation, and I would expect that the U.S. situation certainly will be very different. As we go down this (austerity) path in the U.S., I would not expect any specific European country’s model to necessarily be a perfect match for what we need to do.”
On Balance Sheets and Portfolios
As the market pendulum swings, rebalancing is often a part of the investment process. Perks is tasked with finding and adjusting a mix of stocks, bonds and convertible securities in his portfolios seeking current income and long-term capital appreciation potential. Many investors seeking the former in a yield-scarce environment have gravitated toward dividend-paying stocks, which are also part of Perks’ strategy. Just a few years ago, an income investor looking at the broader equity market in search of attractive dividend-paying stocks might have found the pickings rather slim. They were generally limited to fewer sectors—mainly utilities, pharmaceuticals and telecom services. Perks says these sectors are still important today, but there has been a fundamental broadening of the dividend-paying equity universe.
“Over the last several years, we saw companies come out of the financial crisis (in 2008 – 2009) and really focus on their balance sheets—deleveraging, extending debt maturities and reducing interest expense. But we think we have seen a fundamental shift in that much of that activity has been completed. And today, companies are more focused on deploying cash to equity owners. It might be dividend initiation, it might be a dividend increase and it might be a share buyback—and that’s something that I think is fundamentally positive for what we’re trying to do, which is find attractive opportunities for income. And it’s not just about the absolute level of dividend yields—it’s certainly important and we like high dividend yields—but we also like when the underlying company is on a nice path and has a real prospect for dividend growth over time.”
Baby Steps, Not Big Jumps
Fears about economic stability in Europe have caused some investors to shy away from the region, just as fears about volatility have driven many investors from equities just about everywhere in the past few years. These reactionary extremes don’t generally lead to balance, and as Perks points out, they can also mean that investors accidentally avoid opportunity as they attempt to avoid risk. In fact, in the equity market, Perks is finding opportunities today not only in dividend-paying companies, but in multinational names—even from some based in Europe.
“An example might be an issuer that might be based in Europe and has some business in Europe, but also participates in businesses around the world—different geographies—maybe a play on Latin America for example. These are really global multinational companies. So it’s really driven by our research, where we are following industries that have become truly more global, and in many instances that U.S.-based companies that are competing look very similar. We really want to find what we think is the best opportunity.”
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What are the Risks?
All investments involve risks, including possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in a portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. Floating-rate loans are lower-rated, higher-yielding instruments, which are subject to increased risk of default and can potentially result in loss of principal. These securities carry a greater degree of credit risk relative to investment-grade securities. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.