New Year Could See Immediate Recession At Worst, Slower Growth At Best

Includes: DIA, SPY
by: TrimTabs

By Charles Biderman

Here we are two weeks to year end. Before I can make any kind of prediction about the economy and the stock market in 2013 I need to know the results, if any, of the fiscal cliff battle that is going on in Washington. I do know enough to predict that whatever happens will, at worst, mean an immediate recession in 2013, or, at best, much slower growth. And that, to put it mildly, will not be good for the stock market.

If we do go off the cliff, taxes will go up by over $500 billion next year. To put that in context, take home for all who pay taxes grew about $300 billion this year to $6.6 trillion in aggregate. In other words, if we go off we will automatically be in a recession. A real world recession, ignoring GDP nonsense, is a year over year decline in after tax income.

My reading of the tea leaves, says the Obama Administration will settle for a $140 billion per year tax hike. If a deal gets done reducing incomes by $140 billion, and then adding about $50 billion in new Obama care taxes, overall taxes will go up by around $200 billion. That is two words of this year’s gain in after tax income. The best deal I can imagine the Obama folk agreeing to is at least a $100 billion tax hike. Add Obama care that would be a $150 billion hit to after tax income.

To recap, at best U.S. economic growth will slow by at least half the already current anemic pace and at worst, we go into recession. Unfortunately I see no way things better early next year.

Now let us look at what tax hikes will do the U.S. stock market, which is selling at 17 times trailing 12 months earnings. It is not pretty. Wall Street currently expects decent growth particularly during the second half of next year. However, with income growth at best slowing, how are sales and earnings going to grow anywhere near Wall Street’s fantasies. Yes, Sandy rebuilding is helping the economy currently and a big drop in mortgage rates has helped the real estate market. But both of those are one timers.

Not only will next year’s earnings estimates be downwardly revised, I think that so will the Price Earnings ratio itself. As I have said many before on this blog site, historically the average PE has been under 10 when real incomes are growing by less than 3% a year. Moreover, in the past, stocks have sold at 15 times earnings or more when income growth was over 5% a year.

In other words, the U.S. stock market is selling at a price hand in hand with a rapidly growing economy. And obviously the U.S. economy has not been growing rapidly. So why is there a disconnect, between lack of growth and today’s high stock prices? The disconnect is the result of global central banks not only cutting interest rates to zero, but providing unlimited amounts of newly printed money. That is the only reason stock prices are as high as they are.

Fed Chairman Bernanke, at yesterday’s press conference, said that the $85 billion of new monthly money creation is not really monetization, or money printing, because the Fed plans on selling off what it is creating at some point in the future. Really? To whom will the Fed be able to sell its $5 trillion balance of printed paper?

In two years, total U.S. government debt will be $23 trillion, $18 trillion Treasury and $5 trillion Fed. And that does not include one dime towards the $87 trillion in the present value of future Social Security, Medicare and government worker pensions. Compare all those obligations with at best, after tax income of $7+ trillion two years from now.

There is no way an economy generating $7 trillion in after tax income can support $23 trillion of government debt, let alone all future entitlements. All income subject to taxation would have to grow by 50% to just generate enough income taxes to pay current bills. Therefore, it is literally impossible for the U.S. to grow fast enough to not only pay its current bills but also pay off all U.S. government debt.

After the global government bond bubble bursts, how soon do you think it will take the financial media and analysts to claim they knew there was a bubble all along?