The UBS Global Asset Management Cyclical Market Forum, held quarterly to discuss three plausible economic scenarios and their potential implications for investments over the next 12 months, found its Q3 Forum dominated by discussion of the US “fiscal cliff”—the impending spending cuts and tax increases that will automatically be enacted next year, unless specific political action is taken prior occur to January 2, 2013. Three market scenarios are proposed at each Cyclical Market Forum and debated by UBS Global Asset Management investment teams with combined assets under management of more than USD599 billion.
UBS Cyclical Market Forum Q3 Economic Scenarios Under Consideration
- Scenario 1, “Cliff-hanger”: A last-minute deal is struck that preserves many, but not all, of the mandatory cuts and tax increases, leading to anemic 2013 growth, but no recession.
- Scenario 2, “Temporary step back”: Washington decides to delay the pain by continuing most tax breaks and not reducing spending in 2013, pushing the fiscal problems into the future.
- Scenario 3, “Free-falling”: With no agreement between feuding political parties, the US falls off the fiscal cliff, leading to a government shutdown, widespread uncertainty and a likely recession.
Each scenario was intensely scrutinized with rigorous debate about both the probabilities of “falling off” the fiscal cliff, as well as the potential impacts of that outcome. Most Cyclical Market Forum participants voted Scenario 1 as the most likely. The discussion focused on how much 2013 GDP would be affected by next year’s prospective spending cuts and tax increases, and how different asset classes would be rewarded or punished depending on the political brinkmanship in Washington. The consensus view was that this issue would not be decided until after the presidential election, although the market effects of uncertainty may have already started.
While previous Cyclical Market Forums have focused heavily on the eurozone, all three of this quarter’s scenarios presumed that the situation in Europe would remain in a fragile status quo for the near future, although that could change depending on events in the eurozone. The participants nonetheless viewed the eurozone debt crisis as a key factor in coming months.
Curt Custard, Head of Global Investment Solutions, Chairman of the Cyclical Market Forum (Chicago), “There is almost no doubt that the fiscal cliff—no matter how it’s resolved—will lead to a drag on GDP growth next year. The question is how much, and if there is political will either to move toward fiscal responsibility with lower growth, or to push for growth at the expense of a continuing, unsustainable long-term fiscal position.”
Joshua McCallum, Senior Fixed Income Economist (London), “Regardless of the outcome, the uncertainty caused by the fiscal cliff problem is likely to lead to heightened levels of volatility in the markets. Paradoxically, the VIX—the traditional predictor of volatility—has been at historically low levels, and it has been very cheap to hedge against tail risk.”
Bruno Bertocci, Global Equity Strategist (Chicago), “As markets are pricing in the ‘end of the world,’ there are plenty of opportunities to make money in equities without a market-wide rise. We believe the long-term recovery of the US housing market will have more impact than the potential political artifice surrounding the fiscal cliff.”
Mark Rider, Global Investment Solutions Strategist (Sydney, Australia), “Commodity prices would certainly be affected by a longer-term slowdown in global growth, but other factors also play a significant role in valuations. For instance, the impact of last summer’s drought in the US will likely lead to an extended period of elevated prices for agricultural commodities next year, no matter what happens in Washington.”
Dave Roberts, Global Real Estate Economist (London), “As an asset class, real estate’s income potential, inflation hedging and higher yields should continue to be attractive, especially in times when investors have a profound fear of equity downside and bonds are paying such low yields. Nevertheless, real estate could suffer a short-term hit if the US does indeed plunge off the fiscal cliff.”