Weekly Update: Two more months until the kicked-can rolls upon its next cliff
A reliable mantra for stock investors historically has been: “Don’t fight the Fed.” Now it appears to be, “Don’t fight Big Government.” This week’s fiscal cliff deal would raise an estimated $600 billion of revenue over 10 years, while the Congressional Budget Office estimates spending will increase $10 trillion over the same period. The CBO estimates there are $10 in tax increases for every $1 in spending cuts in the bill. (How does this compare with the ‘balanced’ approach President Obama promised?) Although the issue of taxes appears to have been settled, there are still the items of sequestered defense and health-care spending, the debt ceiling and entitlement reform for the next Congress to deal with—and soon. The debt ceiling already has been breached, with temporary moves by Treasury putting off an actual default until late February-early March. Without adult supervision, the markets will be forced to be the disciplinarians, setting the stage for increased market volatility and greater uncertainty for what could be months. But ISI notes that, historically, politically contentious issues tend to not weigh upon capital markets until the final days. Over the last 30 years, the debt-ceiling debate has been taken to the brink five times. Each time, the markets did not move until just a week or two before the “drop-dead” date.
While projections put the hit of going over the cliff at 4% to 5% of GDP, the compromise to avoid it will still lead to a fiscal tightening of around $250 billion, or 1.5% of GDP, according to ISI. It estimates we could get another 1% hit to growth in the debt-ceiling fight, putting the final drag well above what the Fed has likely factored in (which may explain why policymakers, in December minutes released this week, disagreed on when to end QE bond-buying—more below). The question is how will the economy perform under more self-induced uncertainty? While employment, manufacturing and housing appear to be modestly improving (more below), growth is still weak and subpar. Inflation hawks also are sounding the alarm, suggesting the biggest risk for 2013 could be a surge in oil prices. Already, U.S. gasoline futures have increased 20 cents to $2.80, putting retail prices on track for $3.50, up from $3.30 currently. Of course, inflation hawks have been crying wolf for some time, even as CPI inflation over the past year has been up 1.8%, core CPI has been up 1.9% and core PCE inflation, which the Fed watches, has been below 1.5%—a full percentage point under the Fed target for beginning to let off the throttle.
The broadening of the tape is encouraging. The Russell 2000 and the S&P MidCap 400 Index made new all-time highs this week and the VIX lost 35% over two days, the largest two-day drop in its 22-year history. Moreover, 2013’s first day of trading saw the S&P 500 rise 2.5%—the fifth-strongest post-New Year’s Day rally since 1928, only behind 1988, 1931, 2003 and 2009. With the exception of 1931, when the market fell 47% on the year, the other three years saw returns of 12% to 26%, and Deutsche Bank observes that at 1.73%, January historically has had the best monthly returns since 1928. Still, the Wall Street Journal notes that, on average, the market’s return the year after an incumbent has been reelected has been -0.3%. I’ve always said the market didn’t want a grand bargain. That will include nasty spending cuts and more tax increases—we’ve just scratched the surface on this one. No, the market wants to kick the can down the road, and that is what we have done—although the can can only roll down two blocks, if blocks can be measured in months. When the grand bargain does make itself clear, it likely will include tax increases and entitlement cuts, neither of which are pro growth. So, the piper will have to be paid, but we would like to pay it s-l-o-w-l-y. In the meantime, we all want to get paid. And dividend-oriented investors know how to get paid.
Positives
All roads lead to jobs Upward revisions to November made this morning’s in-line 155,000 increase in nonfarm payrolls better than expected. Increases in weekly wages and hours worked also were encouraging (though it appears companies accelerated December pay to avoid potential 2013 tax hikes. The month’s 0.7% increase in aggregate income growth capped the strongest two-month performance since May 2010, likely on some pulling forward of income distribution to avoid higher tax rates). Elsewhere, ADP private payrolls rose the most in nine months, the December ISM’s employment component rose the most in three years, the Rasmussen Employment Index surged by a record in December to a 5-year high, online help-wanted ads rose by the most in six months, Challenger layoff announcements slowed in December and fell 13.6% on the year to a 15-year low, and the four-week average of initial jobless claims dipped to their lowest level since March 2008. Jobs are growing at 1.4% year-over-year in the establishment survey, below the long-term average of 1.7% but strong enough to keep a recession at bay.
Growth in services accelerates Employment drove December’s significantly stronger-than-expected increase in the nonmanufacturing ISM to 10-month high of 56.1. The manufacturing ISM also reentered expansion territory, rising to an above-consensus 50.7 on improving employment and supplier deliveries. Higher supplier deliveries imply demand is so brisk that factories require more time to ship product out the door. ISI’s composite of various regional and national manufacturing indexes, including the Empire, Philly, Richmond, Chicago and Markit, also continued to move up last month, offsetting worries about November factory orders, which were modestly softer than forecast.
Auto sales shift into higher gear 2012 was the industry’s best year in five years, aided by a strong boost in sales in December. Sales totaled 14.5 million for the year, up 13% from 2011. Easier credit and improving household balance sheets are helping fuel the increase, as the ratio of consumer financial obligations to disposable personal income hit a 29-year low of 15.7% in 2012. Its peak in 2007 of 19.0% was a very bad omen. In contrast, low readings in 1981 and 1984, both around 15.7%, set the stage for significant economic expansions.
Negatives
Fed up? December’s FOMC minutes suggested a slightly less accommodative path of balance sheet policy than markets had anticipated, with most voters currently expecting asset purchases to end in the second half of 2013. But this view is contingent upon a rebound in growth, and Fed growth forecasts have been over-optimistic in recent years. Additionally, 2013’s voting members are likely to be more dovish than last year’s. ISI believes if the Fed stops buying around June or September, it will be because the economy is getting stronger. That would be a bullish, not a bearish, development.
Construction spending disappoints It declined in November, the first monthly decline since March, as public projects continued to slide on reduced government spending for infrastructure and related building. However, private residential construction exceeded nonresidential for the first time since February 2011, reflecting the turn in housing. While still well below its long-term average, residential spending as a share of total construction spending rose above 34% to its highest level since April 2008—another sign that housing has gone from a drag to a catalyst.
Consumers are still deleveraging 78% of the recovery in GDP post-crisis has been achieved through price markups and only 22% via unit growth, according to MacroMavens. In the realm of retail sales, units are still below where they were before the crisis of 2008. This was reflected in December, with sales coming in generally below expectations. The Discover U.S. Spending Monitor dropped in December by the most in six months on lower post-holiday spending intentions, deteriorating personal finances and economic uncertainties.
What else
Cliff notes The Senate received the 154-page bill only three minutes before voting on it, which may explain why $77 billion in various tax breaks were added, including: subsidies to Hollywood movie studios that make films in the U.S.; accelerated depreciation for NASCAR racetrack construction; and tax-exempt financing used by developers to fund construction of luxury apartments and Goldman Sachs headquarters in lower Manhattan … It’s remarkable that the Democrats led passage of this week's bill, which makes almost all of the Bush-era income tax cuts permanent, when you recall how Democrats have vilified Bush for advancing those cuts. This bill will raise almost all of its new income tax revenue from 0.7% of U.S. households.
I’m sorry. I couldn’t help it “Fiscal cliff” heads the list of the dozen words and phrases in the 38th annual List of Words to Be Banished from the Queen’s English for Misuse. Second on the list, which is compiled by northern Michigan’s Lake Superior State University, is “kick the can down the road.”
As a very frequent flier, I appreciate this On the non-economic side of life, murders in New York last year dropped to their lowest level on record. And global air travel last year was the safest since the dawn of the jet age. The U.S. hasn’t had a fatal accident since 2009.
