Here’s the Result of Politics-Driven Economics

Mike Larson, Money and Markets columnist and editor of the Safe Money Report, is out today. Don Lucek, who oversees The Weiss Million-Dollar Ratings Portfolio, is filling in …

MARKET ROUNDUP
Dow	+5.71 to 16,851.84
S&P 500	+3.74 to 1,960.96
Nasdaq	+18.884 to 4,397.930
10-YR Yield	+.004 to 2.533%
Gold	+1.60 to 1,317.70
Crude Oil	-0.10 to 105.74

All ideologies aside, when politics drive changes in an established economic system, unintended consequences can and should be expected. How we as investors react to them is key.

Take this week’s revision to first-quarter GDP. Many were surprised by the drop in consumer health-care spending, which weighed on GDP growth to the tune of -0.16 percentage point. Most forecasters — including myself — were expecting the opposite — a GDP-supportive result in this measure. Some economists estimated that health-care spending would add 1 percent to overall growth.

This unexpected aberration in health-care spending helped lead to a GDP decline of 2.9 percent, worse than most forecasters’ average prediction of negative 1.8 percent. I think there is probably a catch to this data, and that it has to do with implementation of a politically motivated change to the U.S. economic structure — the Affordable Care Act (ACA, aka Obamacare).

I’m not making a judgment here about the merits of the new system from a political standpoint; I’m just pointing out that we should anticipate those unintended consequences. I think the U.S. health-care continuum is in for more shocks to its previous operational order that may create new winners and losers from a financial perspective in the near future.

Exports declined by 8.9 percent in the first quarter, which showed a weakness in the GDP.

As the drop in first-quarter revenue shows, there appears to be some glitch in the system that needs to be identified and corrected for the sector to continue its growth influence on the U.S. economy. I don’t think fewer people got sick over the first quarter than normal. A technical hurdle preventing good reporting of revenue numbers could very well be at the root of this decline, though. This unexpected weakness in GDP could potentially ripple through the rest of the economy if it is not indeed a data glitch, so its bears close watching over the near term.

As members of my service know, and as I’ve exposed on these pages before, Weiss Ratings (the guiding principle behind my service) for health-care stocks have been on the decline for some time, only recently forming what looks like a bottoming pattern. All the while, health-care sector stocks have been the third-best performers in the market this year (behind energy and utilities). That makes it difficult to avoid a sector that so many investors believe in for the near term. But I’ll stick to my prescribed discipline and await an expected mean-reversion move in stock prices before getting more bullish on the sector in general (we do hold some health-care names in the WRP, but in lower allocation than the market as a current tactic).

“Don’t let your personal political views get in the way of the smartest investment choices.”

However, we cannot just focus on one potentially dangerous sector and totally ignore other real economic declines that weighed on GDP growth in the first quarter — exports declined by 8.9 percent, for example. And we need to recognize (without judging the merits of either side of the debate) how political changes on the horizon could potentially change the profit-maximizing game.

Case in point, from a non-consumer corner of the economy, is the renewed drive within the U.S. Congress to end reauthorization of the Export-Import Bank this September (deadline for the government to reauthorize). This federal agency was created in 1934 to assist U.S. exporters sell abroad — to customers to whom normal banks would not extend loan guarantees or extend any sort of credit insurance. It’s a common-type body extant in most of the world’s economies, with some governments using them as just the type of “corporate welfare” that opponents of the agency in this country use as the main reason to dissolve ours.

I don’t want to take any particular stand on whether I think our private (non-governmental) banking and insurance systems can eventually privatize both risks and rewards associated with export assistance. But I would point out that just letting the agency “blink out” in the very near term (remember, it’s an election year here in the States) would be likely to unleash unintended consequences on firms that do provide high-paying jobs still in this maturing U.S. economy.

Final word (for now): regardless of the pro free-market arguments I feel are at the basis of this idea to force non-government entities (i.e. publicly or privately held banks and insurers) to lend and cover the risks currently absorbed by the Ex-Im Bank, I think that an abrupt change in the system would likely have negative unintended consequences in the short term.

I don’t know what will happen in this case, and I’ll keep my own political views (my “rooting for my side” ) to myself on this issue. All I’m really concerned about is judging how likely it is that change will indeed take place. And then I will try to better forecast what unintended consequences could crop up if the current system does change.

But it is imperative that we, as investors, take a close look at the short-term financial consequences of an abrupt change. It may, as in the case of healthcare, cause stocks affected by the change (like global industrials, but also smaller start-ups in tech) to run up in defiance of weakening fundamentals. However, it is more likely that the good will be thrown out with the bad if this Ex-Im Bank change takes place. And that outcome would show itself both in the Weiss Ratings results (fundamental improvement) combined with presumably weak stock price action.

Bottom line: Don’t let your personal political views get in the way of the smartest investment choices. Take it as it comes, but try to handicap it in advance if possible.

OTHER DEVELOPMENTS OF THE DAY

 A lot of Americans are rooting for Team USA to beat Belgium and advance further in the 2014 World Cup soccer tournament. But one winner already appears to be Nike Inc. (NKE). The athletic apparel company’s shares rose today after it reported fourth-quarter earnings that beat expectations, helped by returns from its heavy investment in World Cup-related marketing. Nike is helping to outfit 10 teams in the tournament, including the U.S., according to a Reuters report. After the market closed Thursday, it reported that soccer revenue was up 21 percent for the year, hitting $2.3 billion.

 Shareholders of BNP Paribas SA (BNP) are feeling more pain after the French banking giant ran afoul of U.S. authorities, according to a report in the Wall Street Journal. The newspaper, citing people familiar with the report, says that the BNP plans to cut its dividend and sell billions of euros of bonds next week as it settles the U.S. probe into its alleged violations of U.S. sanctions. BNP had paid a dividend of about $2.04 a share for 2013. It had previously said it planned to increase that dividend for this year.

 Consumer prices in Japan increased at an annual rate of 3.4 percent in May, representing the fastest pace in 32 years as the country continues its years-long battle against deflation. That rise follows a 3.2 percent gain in April. Analysts cite a rise in the sales tax rate from 5 percent to 8 percent in April for aiding the drive to intentionally ignite price inflation. The BBC reports that authorities in Japan hope that once prices begin to increase, consumers and business will be encouraged to start spending now and not hold back on purchases, with the idea that they might have to pay higher prices later. Still, policymakers could see a backlash to their planning, as price inflation could, in fact, put consumers in a bind and see them hold off on spending at all.

U.S. consumer confidence rose in June, helped by solid job growth and apparently not hit by data indicating weak overall performance of the economy. The University of Michigan’s index of consumer sentiment edged up to 82.5 in June from 81.9 in May. The survey came after the government said the economy had shrunk 1 percent in the first quarter. However, it came after the revised estimate of a 2.9 percent decline was made public and analysts will be awaiting the next month’s index to see if that hurt sentiment.

Don’t forget, you can let us know what you think by putting your comments here.

Mike Larson’s afternoon Money and Markets commentary will resume on Monday. My column will return to its regular Wednesday afternoon spot next week.

Best,

Don Lucek