The likelihood of the American economy slipping into economic recession increases with each passing day. Contrary to popular understanding, the risk of the fiscal cliff will not all be realized upon our falling off of it on January 1st, when taxes are slated to increase. No, rather, because of the stifling situation brought about by Congressional gridlock, businesses have frozen discretionary capital spending plans today that should be supporting the economy now. In the absence or decrease of such spending, economic growth is hampered every single day heading into and before January 1st. As a result, we get closer to realizing recession with each passing day.
This article is not measuring the impact of falling off the fiscal cliff, which many experts say could drive the economy into recession and most agree will significantly hamper economic growth. Rather, I want to point out that the stifling impact on business plans is affecting the economy today and every single day in which this situation is not mitigated.
Now, let's not ignore the philosophical differences of opinion with regard to taxes and economic drivers. Republicans and Democrats are not simply protecting constituents, at least not for the most part. They are also seeking to employ economic tactics which they believe will spur economic growth and help balance the budget at the same time. Opinions vary, and the philosophical divide is vast. Where should the threshold dividing the rich and the poor be marked, and at what point or income level does taxation stifle economic growth? What is fair and consistent with the ethos of American capitalism? These are important questions at the root of the argument and so the debate and discussion is at least somewhat just. Still, compromise is the key for our leaders to keep philosophical divide from damaging us all in their efforts to save America.
It is clear by the actions of the stock market that this fiscal cliff issue is important for tomorrow but also for today. This goes for the economy and also for the securities markets. The SPDR S&P 500 (SPY) is down 7.4% since its September peak, and I expect it will continue downward without resolution to the fiscal cliff issue. The industrials are lower as well, with the SPDR Dow Jones Industrial Average (DIA) down 7.1% since its fall peak, and the PowerShares QQQ (QQQ) is lower 11% from its top mark.
The drivers have been multi-fold, beginning with the realization that corporate earnings season would not support the valuations achieved by stocks on central bank fluffing. The second hit came with the reelection of President Obama, which was apparently a let down to the investment community, based on the immediate direction of stocks following the election. And now it is the lock-on focus of investors and businessmen on the critical economic change in store for the close of the year, the fiscal cliff.
Small businessmen were reported to be more optimistic lately, but that was based on a survey taken before the election and likely on the expectation of a different result. Now small businessmen are focused on the same status quo in Washington that led Standard & Poor's to downgrade the U.S. last year, and with another momentous decision just weeks away.
Consumers, less sophisticated and sensitive to economic warnings, will however react to higher taxes and deteriorated economic conditions should they dawn in 2013. The Consumer Discretionary Select Sector SPDR (XLY) is only off its high for the year (trailing 52 weeks) by 5.6%, but retailers are bearing the cost of long-lasting soft economic conditions and tighter competition for fewer dollars. The SPDR S&P Retail (XRT) is off by 7.1%, and there is a clear shift in spending accelerating toward discounters like Wal-Mart (WMT) and Amazon.com (AMZN) away from the traditional stores and marketplaces. As this fiscal issue increasingly dominates headlines, it may even impact consumer spending before the turn of the year, and that would be an economic disaster in the all-important holiday shopping season.
In times past, we could look overseas for support to American exports for companies like Caterpillar (CAT) and bellwethers like General Electric (GE), but Europe is actually deteriorating, not improving. China's growth is volatile due to its ties to the west, and its data is questionable due to corruption and inadequate reporting. The last thing we need today is a severe disruption to domestic business activity, since we have little other support. So some sort of compromise is even more important and must be accomplished.
In addition, I believe that any support to balance the budget garnered from revenue generation (taxes) should be cautiously undertaken, limited in reach and focused to avoid damage. It's not yet time to put broad belts across the waist of the economy, but rather to cure inefficiencies in capital distribution toward economic growth initiatives. Unless this economic focal point is mitigated, investors would do well to hedge risk through investments in contra plays like the ProShares S&P 500 (SH) or the ProShares Short Dow 30 (DOG) and the ProShares Short QQQ (PSQ). I have some other ideas I favor as well which I would like to retain today for a later focused report, so stay tuned.