Why stocks will keep rising despite budget cuts
Large companies may not feel the impact of the sequester for a few months, if at all.
By Douglas A. McIntyre
After reaching nearly all-time highs Thursday, the stock market is supposed to fall because of the $85 billion in budget cuts that are to begin Friday. While this is what is expected to happen, the cuts will not move the stock market down, at least not for months. In effect, the earnings of too few big companies will be hurt because of Washington's lack of resolve to solve the country's budget issue. And earnings remain at the core of share values.
Granted, defense companies will carry the brunt of many of the expense reductions. Some other large departments of the federal government also will need to cut spending and may have to lay off workers to hit those goals.
But much of what the funds the government puts into the consumer economy will not change. Social Security and Medicare will stay intact. Without them, whatever money retired Americans spend would decline. But that spending can go on uninterrupted.
A review of America's largest companies, which make up a tremendous part of the S&P 500 ($INX) and Dow Jones Industrial Average ($INDU), shows how modest the effects of spending cuts will be. Large banks, like J.P. Morgan Chase (JPM), that serve consumers and corporations alike will not face a drop in revenue. Investors see it that way. J.P. Morgan shares trade just below their 52-week high.
The biggest energy companies should weather budget cuts, at least in the short term. Demand for petrochemicals, oil, heating oil and gasoline should not be undermined. Each is too essential to manufacturing and consumer needs.
Auto sales should continue at a pace that will put the annual figures close to the highs of 2005 and 2006. The cost to finance a car loan is low. Many Americans have driven their current cars for years and now have to replace them. And the car industry has cut production and personnel costs to improve margins. The real threat to auto manufacturing stock values is the trouble they have with sales in Europe. That is unlikely to change, and it has been factored into the price of these shares.
The largest telecom companies should not be hurt by federal budget cuts. Phones are too essential to people, and the upgrade cycle to new phones likely will continue. The cost of an iPhone or Samsung product is not high enough to damage that cycle, and there is proof of that in the demand for new models.
The stocks that have collapsed have, for the most part, not been hurt by drops in consumer confidence. Old-line retailers such as Sears Holding (SHLD) and J.C. Penney (JCP) suffer from self-inflicted wounds. Wal-Mart Stores (WMT) probably has suffered from supply chain glitches as much as a drop in demand. Many other large retailers, such as Costco Wholesale (COST) have not reported related problems. And the company at the top of the retail food chain -- Amazon.com (AMZN) -- has given no indication that its growth has abated.
The consumers will continue to fall back on optimism based on the improving value of their homes and the very modest improvement in the employment situation. And the consumers who have stocks can afford to consume more as their net worths rise with the market. In many cases, that consumption includes the purchase of more equity or equity-related investments. No one wants to miss out on the party, and this continues to be good for the markets.
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