What the "State of the Union" Address Means for Investors
by Mitch Zacks, Senior Portfolio Manager
The President’s recent State of the Union address gave us much to think about. As an investor, I always strive to not spend too much time deciding if I agree or disagree with any political decisions. Rather, I focus on how decisions and policies out of Washington will affect stocks and my clients’ portfolios.
With that in mind, I believe that there are three key elements to the address that will have an effect on the stock market.
The Labor Markets
The administration stated a desire to raise the minimum wage from $7.25 an hour to $9.00 an hour nationwide by 2015.
Allen Krueger, a labor economist from Princeton, is one of the President’s primary economic advisors. Not long ago, he wrote a widely read paper that showed that in New Jersey, based solely on fast food restaurants, a rise in the minimum wage did not change the level of employment. Although Krueger’s research is well respected by academics, common sense seems to indicate that raising the minimum wage will result in fewer minimum wage workers.
However, Krueger does show that there is likely not a lot of elasticity to hiring with respect to hourly wages. In a layperson’s words, if the minimum wage goes up, you are stuck with paying the higher wage when you need to hire hourly people.
If the minimum wage increases, then there would essentially be a transfer of earnings from companies that employ minimum wage workers to the minimum wage labor force in the form of higher income. The increase could result in an annual $3,000 in fresh income per hourly worker. With 20 million of these types of workers, this would essentially mean a $60 billion stimulus, as this new income is likely to be immediately spent.
The net result could potentially be positive for businesses that sell to minimum wage people, but it will definitely be negative to businesses that have minimum wage employees.
Luxury retail could be hurt, as well as auto and manufacturing companies, as these companies face tough cost pressures from higher hourly wages.
Overall, we think the rise in minimum wages should be positive for GDP growth, but negative for corporate earnings. If we have rising incomes, then you can get discretionary spending, education, and healthcare spending all up. It is possible the rise in GDP growth could offset the negative effect of declining earnings, but we think it is unlikely. Ultimately, an increase in the minimum wage is negative for the stock market.
Fiscal Issues
The Federal government is going to have an $845 billion deficit in 2013.
Additionally, there must be $2.4 trillion more in budgetary cuts over the next ten years.
The administration offered an olive branch to Republicans in the form of agreeing to the $340 billion in Simpson-Bowles health and entitlement cuts, and spoke about getting 30,000 troops out of Afghanistan. This is part of an overall attempt to get the U.S. deficit down towards a $600 billion annual number.
In addition to the Simpson-Bowles cuts, we think we have to see perhaps $100 billion more in cost reductions. Decreasing government spending is positive over the long-term, but could cause a pullback in GDP in the short-term. Additionally, cost reductions will likely not bode well for Aerospace and Defense companies.
European Free Trade
An improving Europe is important for our stock market and therefore, our economy. The administration has made helping them a priority.
Remember, a stabilizing Europe is a large reason for our rising stock market and corresponding wealth effect. European financial issues have become more stable, but their economies are still not growing. GDP growth can improve with lower tariffs and less red tape. If we are a net buyer of European goods, then this becomes a stimulus to them. Free trade of this type gets high wage jobs up, and service demand rises in both economies.
Banks and other financial institutions will likely benefit from more free trade. Furthermore, any company with protected intellectual property, such as technology companies, will also benefit.
At the end of the day, if Europe continues to stabilize it is a benefit to the U.S. stock market.
Putting It All Together
Overall, the policies that the administration laid out will not have a dramatic impact on the stock market. Corporate earnings and Federal Reserve policy are both far more important. We therefore remain focused on fundamental data to identify stocks to invest in.
No matter what your opinion is of the administration’s policies, market valuations and low interest rates alone provide sufficient reasons to believe the U.S. market strength will continue.
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