For some inexplicable reason, the stock market seems to be ignoring the "sequester" that goes into effect tomorrow (March 1st), and we believe the economy will be significantly affected by it. The consensus is that if the Sequester goes into effect, GDP will drop by approximately .6% and there will be 750,000 to 1 million jobs lost. Even if we strike a "grand bargain" to avoid the "sequester," any significant rise of revenue by taxing, and spending cuts by the government, will negatively affect economic growth.
The consensus GDP estimates of nine economists interviewed by Steve Liesman from CNBC, range from 2.1% to 2.9% during the four quarters of 2013. The total GDP for 2011 was only 1.8%, 2012 was 2.2% and the fourth quarter was a positive 0.1%. Therefore, the consensus estimates from these nine economists is for a better economy this year than last year, and even this tepid forecast should be taken with a grain of salt, as the consensus has now erroneously predicted a better economy for the last three consecutive years.
We have explained in other comments and "special reports" this year that there are only 4 ways to increase or decrease GDP. The four ways are: 1. Consumption by individuals 2. Business investment. 3. Net trade balances and 4. Government spending. The effective raising of payroll and capital gains taxes in January, as well as sharp increases in gasoline prices, will have a significant effect on personal consumption. Furthermore, as businesses continue to buy back stock and hold large cash balances, there is little growth from business investment. While the US Trade Balance is improving somewhat, it is a negligible factor compared to the other forces at work. Finally, government spending will have to decrease even more as the debt ceiling debate in May, and Continuing Resolution (the funding of the government starting March 27th) will continually plague our policy makers in the most partisan government in US history.
It is clear that the equity markets are being held up by the Fed's manipulation of the long end of the interest rate curve. This week Fed Chairman Ben Bernanke testified before Congress and put up a spirited defense of Quantitative Easing (QE) in the face of some grumblings within the Fed itself. All of the explanations and assurances are only valid if QE will actually stimulate the economy.
If we continue to raise taxes, it will affect consumption negatively, and as we continue to cut government spending, it will subtract, dollar for dollar, from GDP. Therefore, since we have already cut $2.5 trillion (tn) from the budget so far, and could cut up to $4 tn, the affect on GDP will be significant. We were all able to see the effect of cutting back defense spending by 22% in the release of fourth quarter GDP, as it moved from positive to negative (and revised back to +0.1% today) . It would seem to us that the chance of a recession or even severe recession is greatly increased. Given the stock market's strong rise the first nine weeks of this year, we are wondering if we are the only ones that are concerned about the "sequester" or "grand bargain."
The economic impact of the latest fiscal deal will slow the economy by 1.5%. Sequestration will decrease GDP by approximately 0.6%. These headwinds could easily push the US economy that is growing at around 2% into a recession. The immediate economic impact of the sequence of artificial deadlines won't be a sudden disaster, but more like "a death by a thousand cuts."
In making these judgments, we are not expressing any opinion as to whether any given policy is right or wrong. We are only attempting to analyze their effects on the economy and the market. Clearly, there is an ongoing problem with excessive household debt and a long-term problem with excessive government debt. The dilemma is how to get the economy growing again at a rate high enough to bring down the unemployment rate while, at the same time, not letting government debt soar to unsustainable levels. It is the enormous difficulty of solving this problem that continues to keep us bearish on the market.