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Farr: Elections, Fiscal Cliff and Austerity

Barack Obama and Mitt Romney
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Barack Obama and Mitt Romney

I can't remember a client meeting, speech, or conference this year when folks didn't ask which candidate would be better for the markets.

While it is impossible to know, it is easy to recognize that the economic and political challenges, both domestic and abroad, will present significant headwinds for whoever occupies the Oval Office.

The passion of those on both the left and right has been intense. It's hard to recall an election where each side was so entirely convinced not only that their candidate was best but that the other candidate was awful. Either has a ton of work ahead of him, and chief on the docket will be repairing and leading a dysfunctional, divisive and partisan Congress through some of the most difficult and vital fiscal work in more than a generation. Their decisions will indeed affect the lives and wellbeing of several generations to come.

The Fiscal Cliff describes our day of financial reckoning.

After years of government spending that well outpaced government receipts, our gross National Debt (inclusive of borrowings from the Social Security trust) has reached a level equal to our Gross Domestic Product. Remember the famous Reinhardt and Rogoff study that warns of anytime an economy allows debt to reach 90% of GDP. Been there, done that. So, good news: the problematic imbalance will be addressed. But the tough news is there will be spending cuts and tax increases. We believe this will be true of both candidates. Less spending by government means there will be less money flowing into the economy, and higher taxes mean less money flowing into the economy. It is hard to conclude that robust economic conditions will blossom from these seeds.

(Read More: CEO to Workers: You'll Likely Be Fired If Obama Is Re-Elected)

The dither-and-delay Congress has, as a part of its dither-and-delay strategy, set strict consequences for itself to thwart additional dithering. This is sort of like the dieter who allows himself a malted milkshake today in exchange for his self-promise of eating only celery for the next five days. It may only mean that they won't be able to delay for much longer, but some form of austerity will be underway by this time next year. The clocks are ticking, and the bell will toll.

So notwithstanding the positive recent news on housing and the ongoing march higher in stocks, there are still considerable concerns supporting our continued defensive posture.

Perhaps most importantly, stocks and the economy at large are still far too dependent on massive central bank intervention. At some point, the Fed will have to extricate itself from its central role in the recovery. Second, several so-called "tail risks" remain which have the potential to derail the progress we have made. Most important among these obstacles are the aforementioned "fiscal cliff", the European debt crisis, and the economic slowdown in China. And last, our strong suspicion is that investors have become too complacent about the potential for corporate earnings disappointments in the year ahead. While unfounded so far, our nagging worry about high profit margins may prove justified in 2013 as companies struggle to hit the earnings targets that have been set for them.

(Read More: ‘Fiscal Cliff’ May Be Felt Gradually, Analysts Say)

And so, yet again, we repeat our mantra that investors should neither rejoice nor despair. Our problems are formidable, but so is our collective capacity to address these problems.

Michael K. Farr is President and majority owner of Farr, Miller & Washington, LLC. He is Chairman of the Investment Committee and is responsible for overseeing the day to day activities of the firm. Prior to starting FM&W, he was a Principal with Alex Brown & Sons.

Mr. Farr is a paid Contributor for CNBC television and has appeared on numerous broadcasts and has been quoted in global publications. He is a member of the Economic Club of Washington, DC, National Association for Business Economics, The World Presidents’ Organization, and The Washington Association of Money Managers. He is the author of "A Million Is Not Enough," and "The Arrogance Cycle."

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