Devastating. Unthinkable. Shameful. Brutal. Disastrous. Those are just some of the adjectives Reuters used to describe politicians’ inability to reach a compromise on the upcoming sequester deadline. If Congress and the President fail to reach a deal by this Friday, March 1, Congress’ self-imposed sequester will automatically chop $85 billion in the final seven months of this fiscal year and by $1.2 trillion over the next nine years. Bloomberg. Although most view the sequester as painful and imprudent – cutting with an axe instead of a scalpel – compromise before Friday seems unlikely. Assuming no compromise is reached and with the caveat that the future remains uncertain, let’s consider how the latest game of political brinkmanship might affect our economy, the markets and your portfolio.
Triple Threat. As we noted in our January webinar, Friday’s deadline is just one of three looming on the horizon. Soon after the March 1 sequester deadline, we face the March 27 government federal funding deadline and then the May 18 debt ceiling limit. Once again, the principal actors in this fiscal soap opera are political leaders whose actions or lack thereof potentially could derail the economy and depress the upbeat markets. Moreover, the U.S. credit rating could hang in the balance. Already, two top rating agencies, Moody’s and Fitch, have warned that the U.S. needs to get its federal finances on a more sustainable trajectory. Bloomberg. If Congress merely extends the deadline on spending cuts and the debt ceiling and/or fails to pass a rational budget, America’s once-stellar credit rating could be at risk.
How might these events affect the economy? We believe that while the combined impact of the sequester and the recent tax hike could create a temporary drag on the U.S. economy, a severe recession is unlikely. The cost of long-term deficit control is short-term economic pain. We recognize that jobs may be lost in some areas and that the pain will not be shared equally by all Americans. We are frustrated that the spending cuts are focused on discretionary spending while entitlements, the key component of spending, remain unscathed by these Draconian cuts. Our confidence is buoyed by evidence of ongoing positive economic trends that could offset some of the negative effects from the sequester and preserve our economy’s momentum:
- the continued improvement in the housing sector;
- the ongoing boom in energy production;
- the uptick in U.S. manufacturing jobs;
- reasonable levels of corporate profits; and
- still-accommodative banking policies.
We believe Congress will again sidestep the next imminent drama – the need to raise the debt ceiling for the 108th time since 1917. We do not pretend that highly artificial solutions and bad politics are viable long term, but even a hapless resolution can keep the show on the road for a long time. That said, we believe that our government is making progress – albeit at a snail’s pace – toward a workable resolution. We sincerely hope the actions of our lawmakers will lead to increased tax clarity and economic stabilization by the second half of 2013.
How might these events affect the markets? We believe any market corrections resulting from sequester or another fiscal showdown also likely will be temporary. No one can be certain how the markets will react. It is not unconceivable that the markets may rally if the sequester’s mandatory cuts actually occur; investors could view it as a positive sign that the government was being forced to live within its means. We understand that short-term corrections can be unsettling, but market volatility often creates attractive opportunities for investors with longer time horizons.