Crying Wolf? or Meet me in the (foggy) Bottom

**Crying Wolf?  or  Meet me in the (Foggy) Bottom

The Sequester is here.  The sky has not fallen – in fact, the DJIA has hit a new all-time high.  Has the President been crying wolf?  The quick and dirty answer is this:  1) people have tired of DC drama and have tuned out; 2) businesses and households continue their gradual recovery with housing, construction, and new orders picking up; and 3) a potentially more significant showdown looms later this month.

Let’s look at all three briefly.  People have tuned out the noise from Washington, and perhaps rightly so, since we’ve had a series of fiscal showdowns ever since the summer of 2011.  Despite the headlines and tales of woe surrounding the Sequester – (translation: automatic government spending cuts to take place over 10 years — starting with $85 billion by Sept. 30), it’s been a non-event.  (Info on the Sequester HERE). The President may have overdramatized the immediate impact of these across the board cuts, but all sides agree this is a very crude solution – there’s no shortage of good ideas to trim spending and increase efficiency in the US Federal government [click HERE for policy ideas; and HERE for ideas on defense spending].  Comparing budget cutbacks to a crash diet, if you’ve got to drop weight fast, I’d go for liposuction over a machete.

Many people also wonder why they should care, if Wall Street doesn’t. The Dow Jones Industrial Average has traded above 14,000 for several sessions, back to levels last seen in 2007. Broader indices such as the S&P 500 have also recovered, up 125% from lows seen in 2009.  Wall Street has chosen to skip the hyperbole and figures some ‘patch’ will be found. Instead they are focus on the private sector, which continues to improve. Yes, consumers have parted back spending after the payroll tax holiday expired in January, but unemployment claims continue to decline and hiring has notched higher, car and home sales have rebounded, and values of major assets – from homes to retirement portfolios – are rising. Some are betting the slow progress will continue in spite of Washington, others prefer the US to even weaker outlooks in Japan or Europe, and some think the market is overdone but figure they can get out before the music stops.  Indeed, analysts have voiced concerns that the bull market in equities is near a peak, noting that trading volumes have fallen even though prices are rising, and a few contrarian investors have retreated to US Government bonds.

But wait, there’s more. A big reason why no one is paying Washington much mind is because the Federal Government is still open for business. The problem is that the Continuing Resolution that funds the US Government (since Congress can’t agree to an actual budget) will run out on March the 27th – which happens to be the full moon. While the impact of the Sequester will take some time to be felt, a total US Government shut-down would prove more far-reaching and dramatic (here’s a primer on the 1995-1996 shutdowns). Pundits have the usual three scenarios about what might happen – another extension of the Continuing Resolution (being considered by Congress as we write), a long term agreement which would truly enable the economy to take off (we can only hope), or a total shut-down which could potentially undo the progress beginning to take root. If you’ve missed the rally and are itchy to get in – you may wish to wait a bit longer to see how this works out. If you’re in and concerned, ask your advisor about whether it makes sense to take some profits – particularly if the February employment report (due out on March 8) provides a positive surprise.

Assuming that most of the budget cuts under the sequester take place, analysts estimate this would reduce US growth by 0.6% in 2013 – basically wiping out the pickup that economists forecasted for the year, keeping us locked in the 2% range seen since 2011.  A government shut down could be worse, though the impact would depend on how long it lasted. Talk about a race to the bottom. If Washington keeps fumbling, we won’t be worried about whether the politicians were crying wolf – we’ll be too busy howling at the moon.

** We pay homage to legendary bluesman Howlin’ Wolf’s classic, Meet me in the Bottom.
Lisa Kaess

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