Jim McCaughan: Stick With Stocks Because Congress Will Resolve ‘Fiscal Cliff’

Wednesday, 18 Jul 2012 01:29 PM

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Congress will likely steer the country away from a “fiscal cliff” after elections, which will open the door to attractive buying opportunities in the stock market, said Jim McCaughan, CEO of Principal Global Investors.

At the end of the year, tax breaks expire while automatic cuts to government spending kick in, a combination known as a fiscal cliff that could siphon over $500 billion out of the economy next year by some estimates and send the country back into recession.

Congress must work to steer the country away from the cliff, and despite political unwillingness to change tax and spending policies in an election year, lawmakers will find a compromise to avoid seeing a sharp fiscal retrenchment that could derail recovery.

Editor's Note: The Final Turning Predicted for America. See Proof.

Expect fear between now and then to push stocks down, but hold onto equities, as when compromise is reached, they'll gain, McCaughan said.

"What I believe is likely to happen is that after the election in the lame duck session and this depends very much on the results of the elections both in terms of the administration and Congress, but on almost any outturn that's likely you will get some compromise on the fiscal cliff," McCaughan told CNBC.

Democrats and Republicans are currently at odds right now over the Bush-era tax breaks, which expire at the end of the year.

Democrats want to extend them for everyone save households bringing in over $250,000 a year, while Republicans want them extended for everyone regardless of income.

Even if that issues remains unresolved, compromise on the spending cuts may result.

Either way, lawmakers are aware of the political and economic ramifications of letting the fiscal cliff arrive unchecked and will agree to some sort of measure to avoid disaster, even if on a stop-gap basis.

"Although the cliff will get close, I do believe that it will ultimately get punted and neither side will see it's in their interest to provoke a recession next year by really just basically inept public policy," McCaughan said.

"It's going to look dangerous and really part of my thesis here is that there may be some pretty good buying opportunities between now and December. But you shouldn't lose faith in U.S. business, which continues to do pretty well."

Sectors to consider include technology, capital goods, transportation equipment and related areas.

Turning to monetary policy, McCaughan said the Federal Reserve has done all it can via interest-rate cuts and bond buybacks from banks.

The Fed has twice injected liquidity into the economy by buying Treasury bonds and mortgage-backed securities held by banks, a monetary policy tool known as quantitative easing (QE).

Market talk is building that a third round (QE3) is on the way to prevent deflationary decline and any further weakening in the job market, though harmful side effects may follow.

"It's treating the wrong disease. The problem is fiscal," McCaughan said.

"If QE3 were done, I believe that the excess liquidity would simply push the U.S. dollar down unnecessarily just because the quantity is available and that the liquidity would tend to go to relatively unproductive places like commodity investing, which if the oil price went up, it would raise input costs for U.S. business."

"So I'm of the view that QE3 right now would be a pretty serious policy mistake."

Other experts agree that quantitative easing could damage the economy, especially if Congress avoids tackling the fiscal cliff, which could keep growth at bay.

"Having exhausted long ago the effectiveness of traditional monetary policy tools, the Fed has no choice but to consider another mix of unconventional measures – specifically, additional purchases of securities, a lower interest rate on excess reserves, an even more aggressive communication policy, and enhanced access to the discount window," Mohamed El-Erian, CEO of Pimco, the world's largest bond fund, wrote in a Financial Times OpEd.

"But, more of the same will not have a durable beneficial impact, especially if other policymakers remain missing in action," El-Erian added.

"Indeed, the advantages of another round of unusual Fed activism are declining while the risk of both collateral damage and unintended consequences is material and growing."

Editor's Note: The Final Turning Predicted for America. See Proof.



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