Notwithstanding the ugly GDP growth headline number, there are couple of ominous storm clouds forming on the market's horizon. Here are some possible catalysts that could create some volatility for equities in the days to come.
Is the consumer faltering?
Firstly, the Conference Board Consumer Confidence Index unexpectedly plunged from 66.7 in December to 58.6 in January, the second month of decline in the index. I had written about the Credit Suisse analysis (via FT Alphaville) showing that the elimination of the tax cut has virtually undone all of the gains that the typical American household had last year:
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While the January reading is only a single data point, the fall in consumer confidence in light of the change in payroll tax is disconcerting, to say the least. The Conference Board press release echoed my concerns in a way that is eerily familiar after reading the Credit Suisse analysis [emphasis added]:
Says Lynn Franco, Director of Economic Indicators at The Conference Board: "Consumer Confidence posted another sharp decline in January, erasing all of the gains made through 2012. Consumers are more pessimistic about the economic outlook and, in particular, their financial situation. The increase in the payroll tax has undoubtedly dampened consumers' spirits and it may take a while for confidence to rebound and consumers to recover from their initial paycheck shock."
Additionally, a recent Gallup survey indicated that food and energy prices to financially hurt the consumer the most:
Americans are most likely to say the price of energy, the price of food, taxes, and healthcare costs are hurting their family's finances a lot or a little, out of a list of nine economic issues. Americans appear relatively unaffected by the availability of credit or immigration policies.
I am watching closely the rally in commodity prices. Should food and energy prices continue to rise and the payroll tax increase starts to really squeeze the American family's pocketbook, we could be in for a nasty surprise in consumer spending.
If the American consumer were to falter, then what happens to the economy?
Fiscal cliff anxiety, back from the dead
My second concern has to do with the possibility of the effects of sequestration. Remember all the anxiety over the fiscal cliff and how they disappeared with a last minute deal? Well, the sequestration threat hasn't gone away, and the Washington Post reports that Deep spending cuts are likely, lawmakers say, with no deal on sequester in sight:
Less than a month after averting one fiscal crisis, Washington began bracing Tuesday for another, as lawmakers in both parties predicted that deep, across-the-board spending cuts would probably hit the Pentagon and other federal agencies on March 1.
An array of proposals are in the works to delay or replace the cuts. But party leaders say they see no clear path to compromise, particularly given a growing sentiment among Republicans to pocket the cuts and move on to larger battles over health and retirement spending.
The prospect of any deal appears dim and participants are resigned to across the board cuts:
Adding to the sense of inevitability is the belief that the cuts, known as the sequester, would improve the government's bottom line without devastating the broader economy. Though the cuts would hamper economic growth, especially in the Washington region, the forecast is far less dire than with other recent fiscal deadlines, and financial markets are not pressing Washington to act.
Cuts to the military and the defense industry remain politically problematic. But Tuesday, even some of the Pentagon's most fervent champions seemed resigned to the likelihood that the cuts would be permitted to kick in, at least temporarily.
A few months ago, the markets were highly anxious over the prospect of the sequester, which would make deep cuts to government budgets that were abhorrent to both sides. Now, Mr. Market seems to be relatively complacent about the prospect of impending government cutbacks, which would be highly contractionary. Put it another way: the sequester is just another form of forced austerity - and we know how well that worked out for Spain, don't we?
The stock market is highly complacent right now and doesn't seem to be bothered by the prospect of going over a fiscal cliff, but when will the anxiety that was evident in Q4 2012 reappear? With the markets overbought and sentiment at a crowded long reading (see my previous posts Is the whole world bullish? and More overbought warnings from BoAML), these concerns that I raised makes me think that the stock market is cruisin' for a bruisin'.
Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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