Comstock Partners, Inc.November 15, 2012
It's Not All About The Fiscal Cliff
While the fiscal cliff problem has absorbed almost all of the financial media comment since the election, there's a lot more to the stock market decline that has virtually gotten lost in the discussion. The market actually topped on September 14th and has trended down ever since. Most importantly, the U.S. economy was a lot weaker than the consensus believes before Hurricane Sandy became a factor. In addition Fed policy is becoming increasingly ineffectual, earnings forecasts are coming down, Europe is officially in recession and China, as well as the other BRIC nations, is slowing down.
Although nobody knows the outcome of the fiscal cliff situation, it is likely to be settled, if not before year-end, then in the first part of 2013. However, even if this happens, the solution will probably entail some combination of lower government spending and increased revenues----in other words, a tightening of fiscal policy. While a solution is surely better than a continuation of confrontation, a tightening of fiscal policy creates further headwinds for the economy in the shorter term. Moreover, an agreement on the fiscal cliff does not solve all of the other serious problems facing the economy and the market.
Most serious of these problems is the U.S. economy itself. Although it may be doing better than most other countries, that is damning it with faint praise. Specifically, the highly-touted consumer recovery, when examined closely, is built on quicksand. Yes, after lagging earlier in the year, real consumer expenditures have jumped by 0.9% over the last three months. However, during that period real disposable income actually declined by 0.2%. Therefore, it can easily be seen that this decline was more than overcome by a drop in the consumer savings rate from 4.4% in June to 3.3% in September. In fact, while expenditures climbed $83.9 billion in the three-month period, savings decreased $130 billion, clearly an unsustainable situation. While Hurricane Sandy will muddy the statistical waters for the next month or two, the strength in consumer spending is almost sure to diminish beyond that point.
In addition, the outlook for capital expenditures is lackluster as well. New orders for durable goods ex-transportation and defense, a leading indicator of future capital spending, have declined 9.1% since year-end and 7.7% since May. This is likely to lead to softness in industrial production too. With consumer spending and capital spending accounting for the vast majority of the economy, overall growth is likely to falter in the period ahead.
With the economy likely to soften at a time when fiscal policy is about to tighten, corporate earnings estimates coming down and Fed policy increasingly ineffectual, the factors that have sparked the stock market in the last few years have come to an end. In our view, this is readily apparent in the change in trend since the peak on September 14th. We think that date will turn out to be the top for some time to come.