Interview With Sam Stovall: U.S. Likely To Fall Off Fiscal Cliff, But Recession Unlikely

Includes: DIA, QQQ, SPY
by: Harlan Levy

Sam Stovall is chief equity strategist at S & P Capital IQ as well as the author of The Seven Rules of Wall Street and the column Stovall's Sector Watch, a page on marketscope.

Harlan Levy: Is the post-election stock market slump the start of a prolonged downturn because of the looming fiscal cliff and the Republicans and Democrats still refusing to compromise?

Sam Stovall: Normally, the market rises about 4 percent in the two months after an incumbent has been reelected. Yet, I have a feeling that November 2012 could end up being a Dewey-Truman redux.

Back in 1948 the S&P 500 rose 8 percent in the 10 months leading up to the election, only to fall 10 percent in November after the unpopular Democratic president was reelected. This time around I don't think Wall Street should have been taken by surprise by the president's reelection, because market action ahead of the election seemed to telegraph the eventual winner.

Therefore, I think that the decline we are currently experiencing is a result of not only the worries surrounding the fiscal cliff, but also surrounding weaker than expected economic data emanating from Europe.

H.L.: Do you expect Congress to let the economy go over the cliff?

S.S.: I believe that most investors and business people would prefer that the fiscal cliff controversy be resolved in 2012 rather than allow the draconian cuts to occur. However, I worry that most politicians would prefer to be reactive rather than proactive.

Proactiveness frequently gets blamed for excessive prudence and sometimes results in the leaders' removal, whereas reactiveness makes the leader look like the cavalry coming over the hill. I think it would be more politically palatable for Congress to allow the end of the Bush-era tax cuts to kick in, because whatever changes Congress makes to the tax rates in 2013 could then be described as tax cuts.

Unfortunately, I think we will fall off the cliff. Yet, we will not fall off and stay off for all of 2013. As a result, the U.S. will not likely slip back into recession as a compromise will probably be made in the first quarter, and tax changes will be retroactive to the beginning of the year.

However, the damage to investor confidence and share prices will already have been done.

H.L.: Europe seems to be continuing to unravel, as you said. What's ahead there?

S.S.: The concern about Europe is that the recession there ends up deeper and longer than currently expected. We still are of the mind that European Gross Domestic Product will be flat to slightly higher in 2013, but we are unnerved by the recent weakness in German output and confidence.

Germany's leader Angela Merkel is not up for reelection until late 2013, but soon she will have to begin embracing a stance that will be acceptable to a majority of voters. The recent Greek vote to accept the required austerity budget in order to receive additional bailout funds from the European Union produced a sigh of relief from most investors. Unfortunately, this alternating worry and relief will become more than the norm rather than the exception, in my opinion.

H.L.: Looking at the most recent economic data and the uncertainty and fear currently in the air, what's ahead for the U.S. economy under Obama?

S.S.: Because of the status-quo reelection, meaning a Democratic president with a split Congress, we worry that not a lot will be getting done. As a result, we are maintaining our less than half-speed growth projection of 1.8 percent in 2013, versus 2.1 percent in 2012.

Unless we have meaningful tax reform that incentivizes investors and business owners to redeploy the horde of cash on the sidelines, we think the U.S. economy will continue to grow at a pace that is precariously close to the precipice of recession.

H.L.: Do you see any real progress on jobs?

S.S.: S&P Economics projects unemployment will average 8.1 percent in 2012 and 8.0 percent in 2013. As a result of a weak U.S. economic recovery, combined with a worse-than-expected European contraction, we think it will be hard to meaningfully reduce the jobless rate next year - if at all.

H.L.: Has the housing market hit bottom and begun to recover?

S.S.: Yes. From both an existing-home-sales perspective and a price perspective, according to the S&P Case-Shiller Home Price Index, it appears as if the housing market has finally turned the corner.

That area of the economy, which helped trigger the Great Recession, is now on the mend, if ever so slightly, which should be looked upon favorably by investors.

That said, there are other headwinds that appear to have taken housing's place - the fiscal cliff, the European recession, and the degree to which the Chinese economy slows.

H.L.: What would have happened to Federal Reserve police if Romney had won and what will happen under Obama?

S.S.: I think that had Romney been elected and had he put at the top of his list the replacement of Fed Chairman Bernanke it would have added to the already overloaded basket of uncertainty facing investors today.

Sometimes it's best not to try to unscramble an egg or to change horses in midstream. Pushing interest rates higher, as a result of the cessation of the Fed's easing efforts would have likely caused the U.S. debt to skyrocket, reversing what is needed to be done today.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.