By Joseph Morrison
On February 12, 2013, President Obama stood in the halls of Congress to give the customary State of the Union address. The economic backdrop is an interesting one. The Dow Jones Industrial Average (DIA) has gone above the 14,000 milestone, the S&P 500 (SPY) has been trading above the 1,500 milestone comfortably, and the NASDQAQ (QQQ) has been trading near 2007 highs. All of this is in the face of a fourth quarter in which unemployment increased from 7.7% to 7.9% and the United States GDP shrank by 0.1%, in addition to other macroeconomic headwinds.
The State of the Union may be viewed as close to a corporate conference call as it comes. The CEO, in this case the President, lays out the strategic agenda for the upcoming year to the shareholders, in this case the citizenry, as well as reflecting on the year that has just passed. There is no doubt about the link between politics and economics, especially given the looming sequester fight, as well as the debt ceiling debate, which will be held this upcoming year once again. Therefore, iIt is important to parse what the Executive branch of the government has in store for 2013 to get a feel for the macroeconomic landscape.
President Obama did speak of the progress that has been made during his tenure, such as 6.1 million new private sector jobs, an increase in U.S. manufactured automobile purchases, and a decreased reliance on foreign oil. He also spoke about the rebounding housing market and the stock market trading at highs of his administration. He wrapped up this segment by stating that the state of the Union is "strong."
The President then began to set his agenda by stating that while corporate profits were at highs, household income was at lows, and that the private sector was not hiring enough, since there are "too many people who cannot find full time employment. " He spoke in grand terms about needing to get the middle class thriving again.
President Obama began his address with a somewhat conciliatory tone, quoting late President JFK that the Constitution makes us, "partners for progress." That was perhaps the last conciliatory message he had for the Republicans in the legislature. He began provoking the rival party early by stating that the American people expect the politicians to put the "Nation's interests before party." This was the first shot across the bow, particularly at the Tea party caucus. He then addressed the sequester as a "really bad idea" and dismissed some possible resolutions to this issue, such as preventing the defense spending cuts with greater cuts to domestic programs. Where this should being to worry investors is that the President did not lay out any proposals of his own to avoid the $1.5 trillion sequester.
The President then went on to discuss his campaign talking point of deficit reduction through a balanced approach of closing tax loopholes mixed with spending cuts, particularly through the proposals set forth by the Simpson-Bowles plan. This is a proposal that does not sit well with both sides of the aisle, as the plan raises taxes and cuts out most loopholes, as well as makes structural reforms and cuts to domestic programs. This plan has been the outline of bargain talks before, but that did not make it out of the House of Representatives. As the nation careens towards the sequester and the debt ceiling debate, investors should worry if this is again to be the foundation for a grand bargain, as it has already been attempted and failed.
President Obama then used harsher language to prod the House Republicans by stating that America cannot keep "drifting from one manufactured crisis to the next," which was aimed specifically at the debt ceiling talks. He reiterated his dedication to not allowing America to default on its debt. This confrontational language should give investors pause, as this points to a more entrenched position in the Executive branch as the negotiations on the debt ceiling ramp up around the May 1st deadline.
The address to the nation then focused on increasing government investment in projects to add jobs. President Obama urged Congress to invest in manufacturing, energy, infrastructure, housing, and education. All of these proposals are sure to be non-starters with fiscal hawks in the Legislative branch.
The President then took on employment in his address. Perhaps the most debatable portion of the address in regards to unemployment is raising the federal minimum wage from $7.25 to $9.00 per hour. The topic of the minimum wage has been unpalatable to conservatives and some economists for some time, and its passage is dubious. The President also proposed tax credits to hire employees who have been experiencing protracted unemployment.
Afterwards, Senator Marco Rubio of Florida gave the Republican response. If the response is, in fact, a sample of the Republican sentiment, President Obama's proposals will be fought at every turn. Perhaps the quote from Senator Rubio that best defines the hard-line that will be taken against the President by the Republican Legislature is, "So Mr. President, I don't oppose your plans because I want to protect the rich. I oppose your plans because I want to protect my neighbors." Senator Rubio struck at the President for the economic contraction during the fourth quarter in 2012, and cited that economic growth will be the key to helping the middle class thrive.
The key for investors in these addresses is to gauge the prospects for resolution for both the sequester and the debt ceiling in a way that will not rattle the markets. Judging from Senator Rubio's response, this will not occur. In regards to the sequester, which is a debate that has been tied to a budget that gets the United States on the path to fiscal stability, Senator Rubio reiterated the Republican stance on requiring a balanced budget amendment, something President Obama has opposed, as well as reiterating the Republican stance on lowering, not raising taxes. Concerning the debt ceiling, Senator Rubio revealed the entrenched Republican position by stating, "But we won't be able to sustain a vibrant middle class unless we solve our debt problem. Every dollar our government borrows is money that isn't being invested to create jobs. And the uncertainty created by the debt is one reason why many businesses aren't hiring."
The tone of the debate is shaping up to be just as contentious as prior debates. History has shown that tumult surrounding either of these two issues, the debt ceiling and the sequester, has been bad for the markets. Therefore, I look for these issues to take center stage in the consciousness of the market from March to May, and look for the market to pullback on these issues. As a result, it is my opinion to sell on these market highs. Then, as the markets trade lower and the deadline nears, redeploy back into equities, as I do expect there will be a resolution or at least a deadline extension, and the markets will then retrace back to the current highs. There is no reason to sit through the pain when one could turn the tumult into a profitable situation.