Sequestration 2013: Don't Expect It to Hurt the Bullish Stock Market

The sequester has arrived, dealing the U.S. economy arguably strike three in its attempt at recovery for 2013.

From a purely fundamental analysis, 2013 began following a disappointing year of GDP growth. Three declining quarters in four was strike one against the 2013 economy pulling a turn around this year. 

As the U.S. Bureau of Economic Analysis chart proves, America’s recovery has been marginal at best over the past several years, with few components showing consistent recovery quarter-to-quarter. It is very difficult to add jobs when business activity is uncertain. U.S. unemployment has continued to hover around the 8% level +/- a few tenths of a percent providing little stimulus for growth for several quarters.

Strike two thrown at economic improvement for the U.S came with the avoidance of the fiscal cliff early in 2013 . While a return to the tax rates of the Clinton administration was largely prevented, several other economic stimulative measures ended.

 

CBO joined multiple private sector economic analysts agreeing the combination of ending the ARRA programs and upper-income Bush-era tax rates were likely to cause a 1%-1.6% reduction in 2013 American GDP.

Strike three knocking out hopes for real growth in GDP arrived with the onset of the Sequester. The Bi-partisan Policy Center (BPC) predicted the following:

“We estimate that the Sequester will reduce 2013 gross domestic product (GDP) growth by half a percentage point, and would cost the economy approximately one million jobs over the next two years.”

CBO and Macroeconomic Advisors in recent reports have roughly confirmed these projections.

While the economic outlook isn’t promising, the U.S. economy won’t collapse with the sequester. Even the left-leaning Washington Post has featured articles by a few economists who note the sequester could eventually help the economy grow faster than it would have otherwise. Yet few economists refute 2013 unemployment rates will probably increase and growth will grind to a halt.

So what are we on Main Street missing that Wall Street continues to see as a reason to push equities near record highs, perhaps it is simply that investors see no viable alternative.

In general, bonds returns have dropped to new lows. Treasury debt isn’t keeping up with inflation. High Quality Corporate debt is returning an inflation adjusted rate of 1%+. Junk Bonds interest rates today are in the range of what only preferred rated corporation could borrow at six years ago.

One of America’s best kept secrets is, the total value of U.S. equities is roughly $16 trillion. To put that in perspective through 2012 the total value of U.S. mortgages was basically $16 trillion with roughly 83% of that amount guaranteed by federal government agencies. United States Treasuries combined with state government and municipal bonds actually represent an equally significant body of debt instruments.

While equity market prices earn the majority of the headlines, bonds remain a market over twice their size. In the truly “big picture” the U.S. equity markets rise and fall basically in reverse to the yield in the bond market not as a reflection in future economic growth.

Nominal 2012 economic growth combined with increased tax burdens and now the impact of the sequester will impact the U.S. economy, possibly causing actual negative GDP. But that impact is unlikely to substantially interrupt the bull run on Wall Street, who sees little alternative of return for their assets.