With President Obama in office for another four years, here are two takes from  on what investors should be prepared for.

The Equities view:

Joanna Shatney, Head of US Large Cap Equities: Does Obama have the same political capital as when he entered his first term?

Obama’s victory in the election came as a landslide of major swing states fell to the incumbent President. However, this was the not the victory we saw in 2008. Obama does not have same political capital as when he entered his first term.

The biggest difference is that the Republicans have retained control of the House of Representatives. When Obama won in 2008 it was Democrat controlled (the Republicans won it back in 2010). This will be the focus of controversy in the next few weeks as everyone waits to see what will happen in terms of dealing with the fiscal cliff.

We believe that there will be a compromise reached before year end (although January is possible) to push the deadlines out on the $600 billion of tightening which is currently scheduled for the new year. There does seem to be some agreement on extending Bush’s tax cuts (which represent a significant portion of the fiscal cliff) for the short term until greater tax overhaul is discussed (we hope in 2013).

Overall, though, just getting the election out of the way is probably a positive for the equity market. The presidential campaign has only served to show the state of the economy in a bad light – and this has taken its toll on consumer confidence.

We expect a positive year for the equity market in 2013, although gains are likely to slow from 2012. Equity valuations remain very attractive – particularly compared to US bonds. High yield, high risk bonds are more expensive than equities. The question is when will we see the catalyst which makes investors take advantage of this value? While we saw strong outperformance from equities in the third quarter, I think this would need to persist for a good deal longer: there is always something of a herd mentality about moving from one asset class to another.

In terms of the economy, we know we are not going to see a rapid turnaround, but we are optimistic that GDP can continue its slow pace of  about 2% next year. We are a bit worried about the beginning of 2013 given fiscal uncertainties and a tough 1Q12 comparison which was boosted by an exceptionally mild winter. However, the housing sector is picking up – and we believe this will have a positive effect on the consumer; we are finding a number of good opportunities in consumer discretionary stocks which should benefit from the confidence this brings.  We also expect it to be positive for financials.

What is most encouraging about market conditions today is that it is now stockpicker’s market – the correlation that dominated stock performance a year ago has completely reversed – and this has been very positive for our portfolios given our bottom-up approach.  

The Fixed Income view:

David Harris, Head of US Multi-Sector Fixed Income: Victorious Obama could face fiscal gridlock

Although President Obama’s victory reduces the level of market uncertainty, the considerable challenge of negotiating an agreement on fiscal policy remains.

Indeed, the status quo of an Obama presidency combined with a Democratic-controlled Senate and Republican-controlled House of Representatives presents a worst-case scenario for reaching a near-term fiscal agreement and continues the gridlock that failed to produce an agreement in 2011.

A nearly equal split of the popular vote means there is not a clear mandate for Obama, despite the larger-than-expected margin of victory in the electoral vote.  The loss of several moderate figures from the House and Senate arguably polarizes government even more.

While Obama’s post-election speech was reconciliatory, it will be difficult to achieve an agreement that includes higher taxes.  Increasing taxes in any form is a virtual death sentence for Republicans seeking future re-election.  Higher tax rates may be possible in the future but only with an income threshold above the currently proposed $250,000 level and with substantial offsets that will take time to negotiate.

Regarding the approaching fiscal cliff, the best possible scenario in the near-term is for an agreement to temporarily delay the expiration of tax cuts and spending cuts until later in 2013 in order to build a consensus on a sustainable policy. The cumulative impact of both the expiration of tax cuts and sequestration is roughly 4% of US GDP, so an incentive to find an interim compromise (in other words, a delay) is high.

In the longer term, however, a grand bargain is required rather than simply avoiding the fiscal cliff.

Addressing fiscal imbalances would improve business confidence and increase US competitiveness. Such a plan would need to be credible (bi-partisan) and realistic, requiring some sacrifice from nearly all interested parties – both regarding revenue (taxes) and spending (entitlements).

The initial bond market reaction to the heightened economic risks is that the 10-year treasury yield moved 10bps lower. Meanwhile, risk premiums for corporate bonds moved slightly higher; 0-5 basis points for high quality industrials and 5-10bps for banks. The risk premium on mortgage backed securities (MBS) has so far remained unchanged.

Investment conclusions

Fiscal uncertainty and monetary status quo appear to be the key themes following the election result.

Federal Reserve policy is likely to remain highly accommodative with a continuation of zero interest rate policy and large scale asset purchases (QE).

Looking ahead to the first half of 2013, the economic risks are skewed to the downside. Private sector GDP growth of 2%-2.5% is at risk of being offset by at least a portion of the fiscal cliff taking hold, or a delay that will prolong policy uncertainty.

Economic uncertainties will keep downward pressure on interest rates and limit gains on some corporate bonds. However, a continuation of QE from the Fed will be supportive for MBS, and its zero-rate policy will be supportive for high-quality alternatives to low-yielding treasuries.

Disclaimer

The views and opinions contained herein are those of Joanna Shatney, Head of US Large Cap Equities, and David Harris, Head of US Multi-Sector Fixed Income, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.