"No oppression is so heavy or lasting as that which is inflicted by the perversion and exorbitance of legal authority" - Joseph Addison
As we put the Thanksgiving holiday behind us and hopefully have had time to get back to our pre-Turkey Day weight, it is time to turn our attention to 2013; specifically what it may bring for the market and investors. Market direction and prices are primarily driven by overall earnings discounted at a chosen interest rate called the discount rate. This will be first of a five part series that I will be publishing over the next few weeks. Each of the pieces will cover a particular aspect of both the factors driving market direction and price (Earnings and discount rate). In the opening article, I will discuss the increasing government and regulatory headwinds companies should encounter in 2013. The second article will discuss the prospects for company margins which is a direct input to earnings. The third submission will talk about where worldwide demand is heading and thus prospects for revenue growth. In the fourth article, I will speculate on where the discount rate will head given what I see for the yields government debt investors will demand in 2013. Finally, I will provide a synopsis from the first four articles and make some market calls for 2013.
So let's get started with a discussion on the overhang the government will be placing on business in 2013 which can be placed in four Categories:
Fiscal Cliff: Obviously the first obstacle the politicians need to get over for investors is the "Fiscal Cliff". Initial statements by both parties were encouraging and ignited a large market rally. Republicans also seem ready to concede additional tax revenue via capping deductions. Tim Geithner has been appointed to lead negotiations for the administration. Although a better choice than Lew as speculated, I would have been more encouraged by the appointment of Erskine Bowles signaling true entitlement reform would be on the table. At least the Treasury secretary knows something about avoiding taxes. Hopefully the president can avoid denigrating the other side on the campaign trail this week and concentrate on negotiating behind closed doors to reach deal all sides can accept. Regardless of the outcome, some combination of tax increases and spending reductions will occur. Although good for the long term health of the government balance sheet, they are likely to provide a headwind to growth in 2013, albeit less than going over the fiscal cliff.
Obamacare: Unless negotiations derail and we go off the fiscal cliff for an extended time, Obamacare is likely to be the biggest headwind from government for business in 2013 as the Affordable Care Act gets implemented. The CBO estimates this legislation will mean 800,000 job losses. I think that estimate will come in on the low side as companies slow or curtail job growth to deal with the extra costs of this legislation. Small firms that are close to the 50 employees that trigger the penalties will be particularly impacted as will companies that operate low margin business with a large number of currently uninsured employees. Costs will also come in higher than expected for the government as companies opt to pay the $2K per employee fines and dump their employees with minimal existing coverage on this new entitlement program.
Restaurants will be one of the biggest losers with this legislation as it drives costs significantly higher on this low margin business. Already major restaurant chains like Darden (DRI) are experimenting with solutions that use more temporary and less than 30 hour workers to reduce the costs of this act. Restaurants should also face higher food input costs as QE efforts continue to drive agricultural commodities higher. They also face billions of dollars of signage costs to post calorie counts on every item in their menu so consumers know that a pizza is fattening. I am avoiding the sector completely and have a short position in Panera Bread (PNRA) due to these government imposed headwinds.
Unions: Companies will encounter more pressure from unions in 2013 as the administration rewards one of its core constituencies that drove its successful re-election campaign. We can already see this new militancy in the protests at Wal-Mart (WMT) during Black Friday after the slow response from the National Labor Relations Board (NLRB) to curtail these actions. It is one of myriad reasons I would avoid the stock of the world's largest retailer in 2013. In addition, new rules allowing easier union organization already are in process as well.
Regulations: The administration curtailed new regulations that had more than $100mm of impact down to Clinton and Bush levels leading up to the election after being very active earlier in the first term. Huge backlogs of recommended new regulations were formulated during this moratorium and are ready to be unfurled on industry. The market will also have the new regulations of Dodd-Frank to digest early in the president's second term. Particularly vulnerable is the coal industry which was already severely impacted in the first term. Look for new and existing coal plants to be made non-viable in the second term. Ironically, given there are 1200 new coal plants being planned worldwide; so this will do nothing towards the goal of reducing global greenhouse gases.
Bottom Line: Given my outlook, I am avoiding domestic low margin businesses which have employees not already covered with insurance that meets new government mandates. I would also avoid firms that have a high degree of unionization and/or potential for union actions. To me, Apple (AAPL) is the perfect stock for this environment. It has high margins and does the vast majority of its manufacturing overseas. Its domestic workforce has solid health insurance and the tech sector faces less potential for new regulatory actions than mining, manufacturing, banking or retail. I also think the shares put in a bottom on November 16th as I predicted in this article.