9/18/2013 4:45 PM ET|
Caution: Budget fight dead ahead
With the Federal Reserve's decision to keep stimulus going, stocks are moving on up. But the looming fight over the federal budget, taxes and spending could end the party for all of us.
The Fed has finally made its decision: The much dreaded "taper" of its $85 billion-a-month bond purchase program will wait. Most likely until December at the earliest.
And with that, investors move on to another worrisome catalyst that threatens to rattle investors' confidence and sting the market: the renewed federal budget brouhaha.
On matters of the federal budget, a sense of relative calm has prevailed since the fiscal cliff deal came together at the beginning of the year and the budget sequester kicked in March 1. Despite dire warnings about its limited cuts, the latter has largely been a nonevent.
But here we go again: Washington needs to pass a new budget deal by Oct. 1 to keep the government running, and then raise the Treasury's debt ceiling by roughly the end of October.
Failure to do either could hit hard at the market and hurt all our portfolios. Inaction could bring a repeat of the August 2011 market spasm, which took the S&P 500 index ($INX) down about 13%, lead to additional downgrades of America's credit rating and short-circuit the improvements underway in the global economy.
Here's how the battle is shaping up, and how to get ready:
How bad is it?
Reviewing the federal budget situation is about as exciting as watching paint dry. But investors need to pay attention because the outcome of this fight between Republicans in Congress, the Democratic-led Senate and President Obama's White House will no doubt be the primary factor determining how stocks perform through the end of the year.
On Tuesday, the Congressional Budget Office released its updated long-term budget outlook. It's not pretty:
- Despite all the budget cutting done to date, a lack of reform on long-term entitlement programs (Medicare, Medicaid and Social Security) means that the federal debt held by the public is set to swell from 73% of Gross Domestic Product (GDP) now -- which is already double the level of 2007 -- to at least 100% of GDP in 2038. That's larger, relative to the economy, than it's ever been except for 1945 and 1946 as the country was recovering from World War II.
- This number doesn't factor in the consequences of a high and rising debt load. These include the crowding out of private borrowers looking to invest and grow business; larger and larger interest payments on the national debt; less flexibility to use the budget to respond to wars and disasters; and an increased risk of financial crisis.
- Looking out further, federal debt held by the public as a percentage of GDP reaches 150% in 2059, 200% in 2076, and nearly 250% by 2088.
The Committee for a Responsible Federal Budget (CRFB) notes that these estimates, as bad as they are, may be too optimistic. The estimates assume Congress doesn't enact yearly "Doc fixes" to bolster physical payments under Medicare, doesn't extend various tax breaks and allows taxes to swell indefinitely as a share of the economy.
The chart above illustrates just how unsustainable the current trajectory is -- despite all the deficit cutting to date, including the budget sequester, the end of the payroll tax cuts and the tax hikes on the wealthy enacted at the beginning of the year. Overall, total deficit reduction measures since 2011 are set to total nearly $4 trillion over the next 10 years.
The problem is, while the deficit has indeed improved recently, big and unresolved problems lurk just over the horizon.
The simple fact is that we've got a lot more budget cutting to do if we're going to cut our way to a sustainable level.
The CRFB estimates that, assuming the across-the-board sequester spending cuts (worth about $1 trillion over 10 years) stay in place, we'll need another $1.6 trillion in deficit reduction to stabilize the national debt and put it on a clear downward path.
This may come as a surprise to many who assumed that the combination of the budget sequester, tax hikes and an improving economy eliminated the need for more cuts. But that's wrong, as the numbers above illustrate.
The best of all worlds would see the sequester -- which is too front-loaded, ends in 2021 and is too focused on the discretionary spending side of the federal budget -- replaced with a more gradual plan that targets the real driver of long-term budget deficits: Social entitlement programs.
After all, discretionary federal spending is expected to grow by about 25% through 2023 vs. the 75% growth expected for Social Security, Medicare and Medicaid. Long-time readers know that the real threat to the country's solvency is in these areas, due to an overpriced and inefficient health care system and a rapidly aging population.
The Moment of Truth Project has tried to put together a plan to accomplish this, dubbed, somewhat inelegantly, "A Bipartisan Path Forward to Securing America's Future." The plan would dump the sequester, but it calls for $2.5 trillion in total deficit reduction over 10 years by cutting entitlements and reforming the tax code by reducing deductions. (It uses some of those proceeds to cut tax rates and the rest to pay down the deficit.)
At its core, it's a plan to both raise taxes and cut spending in a way that minimizes the pain as much as possible. We need both if we're going to get out of this mess.
(The project, by the way, is run by former Sen. Alan Simpson and former White House chief of staff Erskine Bowles, who headed the president's Commission on Fiscal Responsibility and Reform. When the commission split, they released their own report and have been pushing its recommendations ever since.)
This "Path Forward" would reduce, according to their estimates, 70% of the negative short-term drag the sequester is having on the economy while still ensuring the national debt is on a clear downward path.
The really exciting thing is that the plan tries to rise above the stimulus vs. austerity political mud fight that's hampered efforts to put budget problems behind us once and for all. That's because it gives a little something to both Republican deficit hawks and Democrats worried about the legion of unemployed. It results in fiscal stability, but also promises to boost the economy by 0.2% or 0.3% of GDP over the next two years.
That's a win-win in my book.
Economy can't take the hit
Without getting into the politics, it's probably a little naïve to assume any other budget deal will get past both the Senate and the House without a confidence-rattling showdown over spending, taxes, Obamacare and a possible government shutdown.
But let's hope it does --because another fiscal showdown will rattle the economy just as it's trying to build some upward momentum.
While the manufacturing sector is putting together its best turnaround since early 2011, according to Deutsche Bank economists the factory sector alone isn't strong enough to lift the economy. For real GDP growth to rise back towards a more normal 3% annual rate vs. an average of just 1.2% over the last three quarters -- which is what we need to really reignite the jobs market -- consumer confidence and consumer spending must improve.
Recent data suggests shoppers are clamming up after braving a $225 billion hit to income from the tax hikes and sequester cuts earlier this year. Thus, consumption growth fell to a 1.8% annualized rate last quarter. Consumer sentiment dropped hard as well. This isn't good enough.
If Washington can get its act together and enact thoughtful policies without the dramatics, consumer confidence should rebound and the stock market will be off to the races again.
If not, we could be looking at another late 2011 scenario where political drama mixed with a reduction in cheap money stimulus (the Fed was ending the stimulus program known as "QE2" back then) cause a major disruption to the economy and the financial markets. Already, the Republicans are showing signs of making a tough fight even tougher by throwing the defunding of Obamacare into the mix.
Mark your calendars. October is going to be exciting.
How investors should play it
In the wake of the Fed's "no taper" decision today, Sept. 18, interest-rate sensitive areas such as home builders, mortgage REITs and precious metals are jumping. Steelmakers were on the move again, too, and the market rose on the expectation of cheap money for the foreseeable future.
It's a move worth chasing for at least a couple of weeks. But keep your finger on the sell button as the Washington debate heats up.
At the time of publication, Anthony Mirhaydari did not own shares of any of the stocks mentioned in this column. He has recommended REM, MTL, KBH, and DHI to his clients.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at firstname.lastname@example.org and followed on Twitter at @EdgeLetter. You can view his current stock picks here.
VIDEO ON MSN MONEY
The real truth is that many of us older Americans have sent a lot of money to Washington to provide for medicare and social security. Our politicians over the years have "found" other uses for that money. The time is now coming where we are seniors and we expect our retirement benefits we have paid for. If you can't figure out where to get the money to support those promises, then give back what you took along with interest. Anything less is a clear indication that you are a thief. To our legislators: If you can afford to live nicely on your own money, we should stop your federal pension (means test federal pensions!!
The only Real Battle ahead, do actual workers want to take back their country, the one they built with their blood, sweat, and tears.
The policies of the past 12 years say it all when the top1% now control almost a quarter of the nations wealth and the middle and working classes are much worse off due to declining wages. It's not trickle down economics anymore they super wealthy having hoarded every dollar they were given under Bush now want even more and probably refer to it trickle up as they cut wages and fight tooth and nail to stop any attempt to make them pay a living wage for their workers!!!
Once upon a time in America our national debt was at 120% of GDP, we raised taxes on the super wealthy who own 90% of Americas riches and we supported workers and union membership. The result was the national debt fell by 90% of GDP, the middleclass thrived and all American enjoyed the fruits of prosperity. In 1981 this trend was reversed, the super wealthy who earned 9% of wealth each year in 1981, now earn 23%, and the American middleclass has declined.
We know what we need to do to correct the situation, but do we have the balls to do it.
Stop supporting the party of the super rich, stop the coddling the rich and return America to our former greatness.
No fight... We will just CUT up Obama's credit card. We will DEFUND Obamacare, and we MUST cut government spending. We know the President, being irresponsible will want to SPEND More, TAX more, BORROW more and of course PRINT more...
His supporters are idiots and traitors.
"Folks should also be disturbed that Corporations will go out and borrow massive amounts of Money just to do stock buybacks and increase the Dividends. Folks should also be disturbed that's it the boneheaded actions of Uncle Ben that is allowing for these short sighted actions."
Just so everyone understands... say a publicly traded corporation will buy back $1 billion in stock. The stock it will buy back first is the shares given internally- to themselves. Typically they were part of the compensation package (so... free). The FACT exists that the share price is based entirely on Bernanke's bond-bought fiat money NOT actual tangible activity developed from enterprise. The $1 billion in funds used to make purchase will be borrowed-- the lender will use a derivative formulation to fund it... maybe $1 million from itself (generally an internally-concocted derivative) and seek the rest of it from others (generally externally-concocted and perhaps dark pool monies like from drug cartels). So... 100% of those monies are predicated on the future being better than it is today in a financial way. BUT... with every fiat dollar printed, the actual dollar dilutes (shrinks in value) so the possibility of the derivative formula working as represented is-- ZERO. It forces more bond-buying and more fiat money printing! There are $630 TRILLION... YES TRILLIONS in derivatives in the world right now... NONE have ever been reconciled. IF WE DO INDEED RECAPTURE DC AND FORCE RECONCILIATION OF THE FED AND ALL FINANCIAL INSTRUMENTS... they will be no different than a wart on the big toe of the globe that can be burned off and destroyed without any adverse effect on the rest of us. OF NOTE- a derivative contract liquidates BEFORE all stocks and other liens against the assets of the corporation. They sold the factories, they import the product, they are nothing more than a few paper and button pushers in leased office space, churning stock based on fake money into cash-in-pocket, then taken offshore or invested in hard assets. YOUR stock is worthless. THEY will rule the world soon. YOU will owe the interest on Ben's Bonds which will net you less than 50% of your paycheck in a diluted currency value economy. WAKE UP YOU IDIOTS!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
This joker still has a column?? Good for him cuz his personal portfolio has to be in shambles lol
Let's all get one more deep lung filling huff of the stimulus paint can before the idiot parade of the budget battle knocks some reality back into the market.
Denial isn't just a river in Africa, it's overflowing on the home front too.
Got portfolio? I do, even if it is just funny money.
The GOP increased spending an average of 7.7% per year for 8 straight years, an increase in spending of 61%.
Obama has averaged spending increases of just 1.5%, a 12% 8 year projection.
Please explain why you want the party that grows government 5 times faster to be in power. You claim to want smaller government, but you back the USSR.
United States Socialist Republicans, clearly your a communist at heart.
One common way to measure federal spending is to compare it to the size of the overall U.S. economy. That at least puts the level into context, helping account for population growth, inflation and other factors that affect spending. Here’s what the White House’s show about spending as a percentage of the U.S. economy above(gross domestic product):
2008: 20.8 percent
2009: 25.2 percent
2010: 24.1 percent
2011: 24.1 percent
2012: 24.3 percent
2013: 23.3 percent
WITH AN AVERAGE 2.1% INCREASE IN GDP OBAMA IS A FREE SPENDER WITH MONEY WE DON'T HAVE
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