Weekly Update: If this is a circus, what are the odds we'll go over the cliff?
Back in 1974, American stocks traded at 6 times P/E multiples with a 5%-6% dividend yield. Watergate literally froze the government for months as the investigations unfolded, hearings began and the Nixon team spent much if not all of its time defending itself or, one by one, being picked off. Watergate became a circus, which fixated the nation’s attention for months during a time we needed to be addressing severe economic/monetary problems. Little to nothing was done in 1973 because government ceased to function during that national crisis. The Petraeus/Broadwell story seems to be becoming a circus, too. Broadwell has reportedly hired the prominent Washington criminal attorney who dealt with the fallout of the Watergate scandal to represent her. And the FBI removed an agent from the Broadwell case because he sent shirtless photos to Jill Kelley, the woman who spawned the probe after complaining about harassing emails. The agent also is the FBI whistleblower who informed U.S Rep. Reichert about the matter; Reichert then informed House Majority Leader Eric Cantor. What a circus!
In the lame-duck session following the 2010 election, Congress did not enact legislation to extend the expiring Bush tax cuts until Dec. 17. Last year, Congress dithered all the way until Dec. 23 before finally enacting a payroll tax-cut extension. Because of the Thanksgiving break, compromise on income taxes, defense spending cuts, and entitlement spending will have to be negotiated during a compressed 4-week period ending Dec. 21. According to the Pew Research Center, 51% of Americans think our leaders will fail to reach an agreement over this fiscal cliff. And if no deal is reached, 53% (vs. 29%) are inclined to blame Republicans rather than Obama. I have been reporting to my readers for months that very few retail clients I have met knew what the fiscal cliff is. On Wednesday, when I spoke to a group in Buffalo and asked who is familiar with the term “fiscal cliff,” I got lots of hands up and laughter. They know now. A Google search finds 850 stories on the subject in the week since Obama’s reelection.
I spent the end of the workweek in London. While there, I became a baroness … Baroness Linda D. M’m, m’m, m’m. At least, I was dubbed such by someone who says he has the authority to do so. Our friends across the pond like to joke about the U.S. Brits are very funny. But I spent a lot of time on defense. Our market took a turn after the election gave us status quo and nervousness set in over the fiscal cliff. The S&P 500, Dow and Nasdaq are at four-month lows and well below their 200-day moving averages, making technical traders more bearish and suggesting all three are likely to test their long-term trend lines in coming weeks (for the S&P, that’s 1,275). It didn’t help that the White House’s opening position called for $1.6 trillion in tax hikes and much less in spending cuts—that would appear far from realistic. The Mister asked me, “Why is the market going down when you said it was pricing in the status quo and that’s what we got?’’ The answer is because now we are focusing on the fiscal cliff. That’s the way the market is. It can only focus on one thing at a time. Today, whether business or politics, the media can’t go five minutes without saying, “fiscal cliff.’’ We are hearing about fiscal cliff ad nauseam, and as I’ve said before, ad nauseam is at least partially priced into the markets. We’ll know more in weeks, but if a deal gets cut—even a temporary one—the pain trade likely will be to the upside.
Positives
Inflation not yet a problem Contrary to expectations for a gain, October producer prices fell at both the headline and core levels, in part because of falling energy prices and because of declining auto prices linked to the model-year switchover. Headline consumer prices also came in below expectations on falling energy prices, while core CPI rose an in-line 0.2%. What remains to be seen is whether Sandy’s hit on refineries and production may cause energy prices to spike back up this month, wiping out October’s improvement.
Fed still all-in The October FOMC minutes showed a number of Fed officials supported additional asset purchases in 2013 after Operation Twist concludes at year’s end—that may be announced at the mid-December meeting. There also was broad agreement to consider modifications to the forward guidance language, but less agreement on what to do. The minutes showed only minor changes in policymakers' collective assessment of economic conditions. There was little concern over inflation pressures, and there were indications that many favor moving from a calendar-date target for a Fed policy exit to “data thresholds,” i.e., setting a target for unemployment and inflation under which the Fed would begin to remove accommodation.
Small business sentiment marginally improves The NFIB index rose modestly in October, with earnings and sales trends continuing to improve gradually. But the index still remained at recession levels and reflected limited momentum, as uncertainty over the election left the percentage of small business owners who were uncertain about business conditions six months from now at an all-time high of 23%. Net hiring plans also remained unchanged.
Negatives
Sandy throws a wrench in the economy October retail sales were weaker than expected, with much of the decline likely due to special factors including Hurricane Sandy’s virtual shutdown of the populous East Coast and payback from the initial spurt in iPhone 5 sales. The latest weekly jobless claims also shot above 400,000, the Philly Fed gauge of manufacturing unexpectedly contracted, as did October industrial production—negatives analysts largely dismissed as one-off effects from Sandy’s devastation. Nonetheless, the near-term hit to the economy is a negative for fourth-quarter GDP.
Holding back housing Fed Chairman Ben Bernanke joined the chorus complaining that banks are harming housing and the overall economy’s recovery through overly strict mortgage lending standards. Empirical Research says even though housing prices have turned, credit standards also must loosen to bring more first-time borrowers back into the market. This year, 3/4 of the loans being guaranteed by Fannie Mae and Freddie Mac are for borrowers who have credit scores of 740 or higher—an extremely high threshold by historical standards.
Don’t look to Europe or Japan for help While there are increasing signs that China’s economy is ready to reaccelerate, much of the rest of the world is struggling. Japan's real GDP shrank 3.5% in the third quarter, while the 17-country eurozone economy shrank 0.1% on top of the second-quarter’s 0.2% contraction. Also, euro-area industrial production fell a worse-than-expected 2.5% in September. Every component of the index showed a contraction in production, with durable consumer goods production falling the most, down 4.3%.
What else
Brits love their health care and one-payment system Londoners that I talked with during my visit this week were effusive about their socialized medicine, calling it “phenomenal.” And even though the country’s highest marginal tax rate is 50% (but will drop to 45% next year), one gentleman I talked with said the tax system is bearable because they pay to just one government, while in the United States, we have federal, state and local taxes. He also noted the UK has only one police force, while we have many police forces—local, state, the FBI, the CIA, etc …. He thinks we are suffering from the weight of complexity we have given ourselves.
Middle class may be in for a rude surprise In a Pew survey on the fiscal cliff, Republicans were more likely than Democrats to say that the impact of the cliff will have a “major effect” on their own personal finances. In the survey, 47% of Americans thought the cliff would have a minor effect or no effect at all. But according to the Tax Policy Center, the average change in tax liability for a household in the middle income quintile can run from $700 to $2,000. It appears that consumers have the most scope to be surprised on the downside, particularly next year as fiscal tightening begins to set in.
The Mister goes back for seconds, so this doesn’t apply to us The cost of a classic Thanksgiving dinner for 10 this year is $49.48, up only 28 cents, or 0.6%, over last year, according to the American Farm Bureau Foundation, which has been tracking this stat since 1986. (We are hosting this year; our cost will likely be higher, as I will probably burn the first pies.) Price increases vs. last year were found in turkey, coffee, eggs, sugar, flour and butter, while price decreases were found in whipping cream, stuffing (my favorite), sweet potatoes (how do you suppose they made them orange, I asked my husband as a newlywed), milk, cranberries, peas and pumpkin pie mix.
