How supercommittee gridlock could hurt you

If the congressional panel doesn’t reach a deal, automatic cuts could hit your stocks and the budget deadlock could shake the market. The deadline is Nov. 23, and hopes for agreement are not high.

By MSN Money Partner Nov 9, 2011 1:39PM

By Robert Powell for MarketWatch

 

The world is focused on Greece and Europe, but there’s another crisis brewing that we ought not overlook.

 

Can the supercommittee in the U.S. deliver on its marching orders to recommend a set of proposed spending cuts and revenue increases totaling $1.2 trillion over the next 10 years?

 

The consensus seems to be that the supercommittee — the 12-member congressional committee that began work six weeks ago — may not be able to agree on anything, and won't be able to come up with a proposal acceptable to members from both sides of the aisle. Marketwatch.com

 

If so, that gridlock won’t be without repercussions, said Vahan Janjigian, chief investment officer at Greenwich Wealth Management.

 

“One consequence of that failure would be drastic cuts to defense spending, which would have dire consequences for the nation's security,” said Janjigian, who is also author of “Even Buffett Isn't Perfect: What You Can and Can't Learn from the World's Greatest Investor.”

 

“That's a result that even the most partisan politician won't tolerate. I'm hoping we will soon see some compromise,” he said.

 

Market fundamentals are positive

The supercommittee -- whose members are split evenly between Democrats and Republicans in the House and Senate -- is supposed to provide its recommendations by Nov. 23, just two short weeks from now.

 

That has many folks fretting. “If the supercommittee is unable to make progress with regards to cuts and revenue, I believe that the equity market will react negatively, as sentiment will become increasingly gloomy,” said Robert Johnson, a Charlottesville, Va.-based financial consultant and CFA charterholder.

 

“If that is the case, investors will exit risky assets and U.S. Treasurys will rally. This is what is so ironic, and as a former college professor, I find so interesting. In the short term at least, investors will flee to the very assets -- U.S. Treasurys -- that have recently been downgraded.”

 

Conventional wisdom, said Johnson, is that U.S. debt was downgraded due to brinksmanship on the debt ceiling. But the downgrade was really the result of unsustainable government spending. “That is what makes the work of the supercommittee so important,” Johnson said.

 

If the supercommittee is able to make progress with regard to cuts and revenue, Johnson said he expects market sentiment will improve dramatically and that the equity markets will rally significantly.

 

Market fundamentals, Johnson said, are quite positive. For one, company balance sheets are strong and cash balances are quite high. Two, price-earnings ratios are on the low side historically. Three, insiders have been strong buyers. And, four, dividend yields are attractive relative to bond yields.

 

“Certainly what is keeping the equity markets depressed are the budget problems and the lack of progress toward any type of solution,” Johnson said. “The U.S. markets would be depressed even if the eurozone problems weren't hanging over the markets.”

 

For his part, Janjigian is of the opinion that if the supercommittee reaches a deal, there could be a rally in defense-related stocks, which have been depressed lately. His favorites include dividend-paying companies like Raytheon (RTN) and ManTech International (MANT) . Of note, ManTech International began paying semi-annual dividends only recently, he said.

 

There are two ETFs that allow investors to play whatever recovery there might be among defense-related companies. IShares Dow Jones U.S. Aerospace & Defense (ITA) , which holds 32 aerospace and defense firms, is down 9% since July 1. PowerShares Aerospace & Defense (PPA) , which tracks a modified market-cap-weighted index of 51 aerospace and defense firms, is down 12% over the same time period.

 

The election effect

Others, meanwhile, aren’t speculating so much about what the supercommittee’s recommendations, or gridlock, will mean for the markets. They’re focused instead on what effect the supercommittee will have on the election.

 

“The political currents that have led to the supercommittee are not at all favorable,” said Luke Imperatore, a CFA charterholder and managing director at Pulse Capital Partners LLC. “They are likely to lead to much greater voter unrest than we have seen for quite some time, the consequences of which will be greater than most are anticipating.”

 

Robert Powell is editor of Retirement Weekly, published by MarketWatch.

 

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