The fiscal cliff is now the ultimate cliffhanger and the best possible scenario for Wall Street is a called back deal that prevents across the board middle class tax hikes.
Tim Geithner had predicted in a CNBC interview that the White House is prepared to go over the fiscal cliff, a fiscal version of JFK’s “eyeball to eyeball” brinkmanship in the Cuban missile crisis. The Republican right in Congress have vetoed Boehner’s efforts to cut a bipartisan deal. This is the mathematics of Von Neumann’s Game Theory (Prisoners dilemma) where malign payoffs dictate the worst possible scenario. Add in Italian politics, fissures in the Spanish growth model (Catalonia, missed fiscal targets, Rajoy’s reluctance to accept the conditionality diktat implicit in OMT), Middle East politics and the ominous rise in the Volatility Index (VIX) above 20.
Implications for Wall Street? One, risk premia across asset classes would rise. Two, euro could fall from 1.32 down to 1.28 as the Old World slips into recession. Three, another $100 downside in gold. Four, a growth scare in the US, let alone a mini-recession, guts optimistic EPS and margin estimates. Five, West Texas Intermediate crude drops $10 and takes down oil and gas shares. Six, with the stock market near fair value, multiples cannot really expand. Seven, sector correlations once again begin to rise. Net net? A fasten your seat belt, hello darkness, my old friend moment in January as the index falls to 1340.
My faith in US money centre banks was vindicated with a vengeance last year. Despite myriad banking crises from Libor to the London Whale, Citigroup was up 42 per cent and the Bank of America doubled, the best performing Dow share. US homebuilder were another winning theme, as were Hong Kong property developers, Turkish banks, the Mexican peso/Bolsa and, since October, the spectacular money making opportunity shorting the Japanese yen at 78 and buying the Nikkei Dow at 8900. In the UAE, my recommendation to buy First Gulf Bank at Dh7 was profitable as did the late 2011 recommendation to go long the Thailand index fund, up 34 per cent for a dollar investor in 2012. The biggest loser trade? The recommendation to short the Aussie dollar at 1.02.
New ideas for 2013? Silicon Valley megacaps, from Cupertino/Palo Alto to Armonk (in New York, the seat of Big Blue, but the Valley is my metaphor for Big Tech, not just a geographical place) to Redmond. So Apple now trades at nine times 2013 earnings (seven times, ex cash) on the eve of the Apple TV and China. IBM, with 60 per cent recurrent revenues in its services/software model, makes a bid for analytics/cloud with its Pure Systems product offering. Big Pharma has a jewel in Pfizer, with its vast economies of scale, new pipeline, shareholder value obsessed CEO and 3.6 per cent dividend yields. In Europe, my recommendation to buy Daimler AG at €36 is well in the money with the owner of the Mercedes Benz brand now trading at 41. The recommendation to buy France’s BNP at €30 was also profitable, with the bank most exposed to Club Med sovereign debt now trading at 43 (Take profits).
US investment grade corporate debt was a huge winner in 2013 as Uncle Sam IOU (the ten-year US Treasury note) yield fell 20 basis points credit spreads compressed by 100 basis points and, coupon yields all combined to offer 10-12 per cent returns. This is mathematically impossible to replicate next year, though I still swoon over US money centre bank debt.