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Posted: April 02, 2013

Focus on fiscal fundamentals

It's clear things are looking up

KC Mathews

As I spend time researching the economy and markets, I find more and more information related to politics and the fiscal cliff, both of which are important variables that influence markets. In 2012 the presidential election held investors at bay, and immediately following, the focus was on the looming fiscal cliff. Unfortunately, the fiscal cliff, or ruminates of it, will be dealt with throughout 2013.

We now know that  the revenue side of the fiscal cliff equation will result in a tax increase for 77 percent  of U.S. households. The spending side of the equation was kicked down the road, only to be dealt with at the end of February. Now, as Congress wrestles with spending cuts, they must consider raising the debt ceiling or perhaps face a government shutdown  or even a default on U.S. debt.

These issues are important, but they are not the drivers of long-term asset prices. Over time, they become market noise — a distraction from what is truly important: the fundamentals.


First, from an economic standpoint, presidential elections don’t really matter that much. The elections themselves create some uncertainty which cause market volatility and opportunity. But, in general, the markets are bipartisan in nature and don’t “care” who wins or which party is in control. In studying past election results and market performance since 1900, the market prefers a Democratic president, and the results improve with a Democratic president and a split Congress, the current political power status.

Table 1: Market Performance, March 4, 1901 – March 4, 2013

Political power status


% of Time

Democratic President



Republican President



Democratic Congress



Republican Congress



Congress Split



Democratic President, Democratic Congress



Democratic President, Congress Split



Democratic President, Republican Congress



Republican President, Republican Congress



Republican President, Congress Split



Republican President, Democratic Congress



Second, as mentioned earlier, 77 percent of U.S. households will see an increase in taxes this year. Yet historical data tells us that taxes don’t have a major impact on market performance. When taxes go up, be it income tax rates or capital gain rates or taxes on dividends, markets can still produce attractive returns. For example, in 1993 income taxes and taxes on dividends increased substantially; however, using the S&P 500 as a market proxy, the market posted a return of 10 percent.

Table 2: S&P 500 Total Return Index, January 1, 1928 – December 31, 2012

Top Federal Income Tax Rate is …


% of Time




Not hiking



Third, the consternation over the debt ceiling, in absolute terms, is exaggerated because the overall amount of debt will (and should) continue to increase as our economy grows. The debt ceiling has been raised 79 times since it was established in 1917, and it will continue to be expanded when needed. As our economy grows we should naturally take on additional debt, as long as it is manageable and fiscally effective.

While it is debatable whether the current situation is manageable, we can all agree that the debt ceiling should be constrained to a rational level in terms of debt as a percentage of GDP. An example would be for the U.S. to constrain the debt-to-GDP ratio at 80 percent. So in simplistic terms, as the economy grows to $20 trillion, the debt would increase; however, it would be constrained to $16 trillion or 80 percent of GDP.

It’s unfortunate that the decision to extend the debt ceiling, which should be a simple function within our normal management of the balance sheet, has become an explosive instrument of political leverage because of previous fiscal recklessness and ongoing divisiveness in Washington. Perhaps the way it’s being handled will force Congress to come up with a rational, long-term solution. Then we can move forward knowing there will be some required discipline guiding the future extensions of the ceiling.

What really matters?


I grew up in Wisconsin, so naturally I am a Green Bay Packers football fan. In 1959, Vince Lombardi became the head coach of the Packers; unfortunately he inherited a dysfunctional team. After assessing the team, he stood before them holding out the ball and spoke arguably the most famous quote in football history: “Gentlemen,
this is a football!” He made the decision to start with the basics and fundamentals as he rebuilt the team. In 1960 the Packers played in the NFL Championship game, and even though they lost, Lombardi went on to be a great coach with an impressive track record. The stock market isn’t much different— fundamentals matter.

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KC Mathews, CFA is executive vice president and chief investment officer of UMB Bank.

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