Six for Six
As a relatively upbeat fourth quarter earnings season enters late innings, stocks have maintained their upward momentum and generated nearly a year’s worth of returns in the first six weeks. Investors received relatively few new data points to inform their view of the economy’s progression this week, but we believe that a 7 percent rise in gasoline prices so far this year and higher payroll taxes could begin to bite. Consumer spending remains the biggest part of the U.S. economy, and with workers just now beginning to feel a pinch on their discretionary income, the likelihood of slower consumption will likely be seen in first quarter GDP. While construction spending and post-Hurricane Sandy inventory rebuilds are likely to help the economy early this year, government spending appears set to decline. If Congress fails to enact another workaround, $85 billion of sequestered federal spending cuts are set to take effect March 1, representing roughly one-third of expected GDP growth for the year. Given the government’s penchant for kicking the fiscal can down the road, we doubt whether this down-payment on deficit reduction is being factored into consensus estimates calling for 2 percent economic growth this year.
The Congressional Budget Office (CBO) added fuel to fiscal debate fires this week when it projected continued federal budget deficits as far as the eye can see. While this forecast likely surprised few, what undoubtedly caused some to take notice is the fact that in the past five years, the country’s debt (excluding intra-agency holdings) as a percentage of GDP has doubled, from 36 percent of the economy before the financial crisis, to 72 percent currently. Financing the nation’s growing debt burden has arguably been eased by the Fed’s monetization of Treasury issuance, but with interest rates starting to rise, servicing the nation’s debt will become more costly. Investors are left to take heart in CBO estimates calling for the federal budget deficit of 2013 to fall below $1 trillion for the first time since fiscal 2008. Against this depressing backdrop, many on Capitol Hill are steeling themselves for sequestration, under the belief that federal spending needs to fall. With defense contractors set to suffer more than their proportionate share of the cuts, stocks such as General Dynamics, Lockheed Martin and Raytheon are underwater since year-end and notably underperforming a market (S&P 500) that is now up 6.5 percent year-to-date.
Paybacks are #?%!
Hewing to the theme of government actions and private sector reactions, McGraw-Hill shareholders felt the pain caused by a $5 billion Justice Department lawsuit leveled against it, claiming the company’s Standard & Poor’s unit fraudulently rated collateralized debt obligations in the go-go years before housing crashed. The stock fell every day this week and cratered by a cumulative 27 percent on the tail risk that success from this and a raft of other state lawsuits accompanying it could put the company out of business. While McGraw-Hill clearly did a poor job rating subprime CDOs and other mortgage-backed securities, investors might ask whether competitors Fitch and Moody’s did any better. After all, neither of these ratings firms were charged. All of which leads a person to question whether Eric Holder & Co. are intent to extract their pound of flesh for S&P’s decision in 2011 to strip U.S. Treasuries of their AAA credit rating. While acknowledging its admittedly poor job of analysis preceding the last credit meltdown, S&P is arguably loathe to miss the next one.
Our Takeaways from the Week
- Stocks have now delivered nearly a year’s worth of returns in six weeks
- Federal budget pressures present rising headwinds for the economy