Ever since the Presidential election was decided, the focus on the "Fiscal Cliff" has increased. The concern is that President Obama and Congress will again fail to find a compromise to address the debt issues and need for spending cuts. In 2011, this failure led to the first downgrade to the credit rating for the United States. If no deal is found, automatic -- and perhaps drastic -- budget cuts will be implemented across the board, which could damage certain sectors of the economy and trigger another credit rating downgrade.
It's easy to find analysts and investors who are certain that a deal will be reached, or at least that the can will be kicked down the road to buy more time. It's also easy to find more pessimistic views that are based on the lack of cooperation in the past, and a deeply polarized country and political system. However, I think many are missing the point, which is that the United States is likely to face a recession and market correction in 2013, regardless of whether or not a compromise is reached over the Fiscal Cliff. A belief that everything is going to be fine as soon as clarity on a deal takes place appears to be false hope, because that won't change the fact that austerity is coming to America. I believe Obama refused to make a deal on the fiscal cliff last year (which resulted in a credit downgrade of the U.S.) for strategic reasons. If Obama had made a deal a year ago, the negative impact of government spending cuts would have already hit the economy by now and made it worse. Now that he's successfully secured a second term, he can stop trying to postpone reality to American voters about taxes, budget cuts and the truly weak economy. A real economy that has hit bottom would not need to have tough budget decisions postponed or constant QE interventions by the Federal Reserve.
Whether a "Grand Bargain" is reached (which is clearly preferable), or whether automatic budget cuts take place in the event that no deal is reached, one thing is clear: taxes are going up and government spending will be reduced. Just consider how weak the U.S. economy is right now, even after nearly $1 trillion of borrowed money was spent by the U.S. Government in order to provide economic stimulus and "shovel-ready" jobs. Also, consider that the "Bush tax cuts" have continued to relieve businesses and consumers of higher tax rates. These two factors have given a huge boost to the economy for the past couple of years, and without them, the economy would have been much worse. That is the big problem.
Deal or no deal on the Fiscal Cliff, taxes are going higher, and the level of U.S. Government spending is going to dwindle because the nearly $1 trillion Obama stimulus package is done, and current levels of spending on defense, entitlements and other areas are also not sustainable and are poised for budget cuts. We will soon see the economic support that the Bush tax cuts, heavy government spending and the massive Obama stimulus plan provided as they evaporate and are replaced with higher tax rates and budget cuts. To get a sampling of what the combined impact of higher taxes and reduced government spending might feel like in 2013, all we have to do is take a look at Europe. Italy, Spain, Portugal and Greece have all raised taxes and cut government spending in the past couple of years, and the resulting effects have been quite devastating. It did not take long for unemployment to spike and economic weakness to set in as consumers and businesses also cut spending. We are already seeing signs of this in the United States in advance of a potential Fiscal Cliff deal as corporations become more cautious, horde cash and reduce hiring. It also looks like U.S. consumers are becoming more cautious as even companies like McDonald's (NYSE:MCD) see same store sales drop for the first time in 9 years. Industrial companies like Caterpillar (NYSE:CAT) have also been signaling a slowdown as it recently reduced earnings guidance for the next couple of years.
The stock market is starting to reflect the realities facing the United States. The Standard & Poor's 500 Index (NYSEARCA:SPY) which trades for about 14 times earnings, has begun to trade lower and currently is just slightly above the 200-day moving average. I expect it to break below that key support level in the coming weeks and months which is likely to spur additional selling pressure. This country and its economy have been driven largely by borrowed money for many years, and that party is coming to an end. While the Obama stimulus plan and postponement of budget cuts has masked and delayed the real weakness in the economy for the past couple of years, that bandage is coming off soon and investors should consider getting very defensive in advance of 2013, when the effects of rising taxes and budget cuts will bear down hard on the economy. It's time to raise cash and avoid industrial stocks like Caterpillar and General Electric (NYSE:GE), which are highly sensitive to the economic cycles.
A recession and stock market correction in 2013 seems almost inescapable based on common sense. The United States has a massive debt problem, which now stands at about $16 trillion and is expected to grow by about $1 trillion annually in Obama's second term. The average American seems to be in the dark or in denial about this debt, just as many Spaniards and Greeks were a couple of years ago. If we continue to vote in politicians who will promise to give us more and not take away what we have now, the debts will grow and eventually spiral out of control. We need an adult to tell us we can't have any more candy, but we are not electing "adult leaders" that tell us what we don't want to hear. Until true reforms and solutions are found to cut the debt and bring solvency to essentially bankrupt programs like Social Security, Medicare, student loans, and even the post office, there is little chance for a robust and secular economic rebound in this country.
In summary, this economy has been held together by unsustainable government spending and Federal Reserve manipulation. If a true bottom had been reached in this economy, the Federal Reserve would not need to be intervening again and again. While some hopeful signs have emerged in housing and in other areas due to the stimulus and QE3 programs, that is likely to unravel in 2013. The real Obama economy (not the one that has been artificially propped up to win an election) and austerity is coming to America, whether it is induced by politicians or by the markets. Excessive exposure to stocks makes little sense at this time. When and if true reforms are passed, and the debt is reduced to manageable and responsible levels, it will be time to get fully invested. However, raising cash and mostly limiting stock exposure to short-term trading opportunities is the smartest way to enter 2013. When trading those short-term opportunities, it makes sense to stick with cash-rich companies that can continue to grow in a weak economy. That includes stocks like Apple (NASDAQ:AAPL), which have already taken a major hit and are now at oversold levels. Apple stock now appears well-positioned for a holiday rally, and I can see a rebound once analysts realize that the new mini iPad will be one of hottest gifts of the season. Another short-term trading strategy will be to buy stocks near the end of the year that have been depressed by tax-loss selling, and then selling them in a January rally when the end of tax selling and short covering allows the stocks to rebound.
Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.