How The Fiscal Cliff Will Impact U.S. Industry

Includes: GLD, HTWR, OIL, UNG
by: Kyle Spencer

How much damage will going over the fiscal cliff inflict on the U.S. Economy? The National Association of Manufacturers (NAM) took up the subject in their new report, Fiscal Shock: America's Economic Crisis. The verdict:

A fiscal shock of this nature would, in essence, wipe away a generation's worth of labor and growth, turning back the clock on our economy.

NAM notes that according to recent surveys, 55 percent of manufacturers and other small business owners wouldn't start their business in today's climate. Companies make decisions a three-to five-year horizon, and business planning is disrupted by congressional failures to set clear policy at the federal level.

If the United States falls off the fiscal cliff, the effects will be far worse. The report displays the significant harm massive tax increases and sequestration cuts will have to the United States over the next three years.

The results include the following:

  • More than 6 million jobs lost
  • Unemployment rate of more than 11 percent
  • From 2012 to 2015, a cumulative 12.8 percent drop in GDP
  • 10 percent loss in household income
  • A recession in 2013 and dramatically slowed growth in 2014
  • Households will take a big hit. Real personal disposable income will drop almost 10 percent by 2015.
  • Manufacturers of consumer goods and defense contractors likely will see large and durable contractions in their industries

The long-term employability and productivity of workers will also be severely damaged: Workers simply can't afford to "take off" for 24-36 months in the hyper-competitive global manufacturing sector and expect to pick up where they left off.

In addition to defense industry executives, a variety of non-defense industry chief executives have decided to postpone hiring and investments . These companies range from electrical components and power systems to automotive parts manufacturers. America's manufacturing base functions is a leading indicator, the report warns. Next will come the American consumer.

Fig. 1: Long-run Contraction of Real Disposable Income

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(Source: National Association of Manufacturers)

In addition, there are conflicts of direction as confusion is transmitted down the chain of command, such as the Department of Labor's bewildering guidance that, despite the Worker Adjustment and Retraining Notification (WARN) Act, which requires employees be given notice at least 60 days before layoffs begin, employers do not have to warn employees of pending layoffs in anticipation of federal spending cuts.

However, the Department of Labor is not responsible for enforcing the WARN Act, thus leaving companies potentially exposed to lawsuits from pink slipped employees. In short, the DoL is telling companies "fire employees if you have to, don't worry about the 60-day notice", but won't be standing in court arm-in-arm with employers, should they decide to take this advice.

Impact Across Industries

The following estimates are given by the National Association of Manufacturers should be read by investors as a best case scenario of the effects on individual industry sectors should Sequestration go into effect without a Grand Bargain from Washington. The figures are conservative for two reasons: 1) The widespread impact of the likely resulting downgrade of U.S. debt is not taken into account, and 2) The fiscal multiplier in recessionary environments where the interest rate is near zero bound is > 1.

Fig 2. Long Term Economic Impact, Macro View

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(Source: National Association Of Manufacturers)

In other words: For every dollar taken out of an economy under the current conditions, more than a dollar is withdrawn from circulation, as too many consumers pull back at the same time, resulting in a deflationary spiral that feeds on itself in a race-to-the-bottom, which can't be countered by the Fed as banks will be loathe to lend and consumers equally disinclined to borrow.

Fig 3. Impact By Industry (Mining-Tobacco)

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Fig. 4: Impact By Industry (Textiles-Service Industry Machinery)

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Fig. 5: Impact By Industry (Elect. Industrial Dist-Sanitary Services)

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Fig. 6: Impact By Industry (Wholesale Trade-Government Industry)

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These projections illustrate both the downside risk to investors if the fiscal cliff is left unresolved. The industry sectors which stand to suffer the most over the next decade are the ones most closely aligned to disposable income: Television and stereo systems, followed by fashion/clothing, automobile services, publishing and dentistry. These sectors would scarcely be spared in any case, as any resolution of the fiscal cliff would still involve a lot of pain for the consumer. It should be noted that these results apply to individual industry sectors as a whole, and cannot be used as the only criteria for selecting individual stocks. Nevertheless, prudence would dictate avoiding these industry sectors if at all possible in favor of gold (NYSEARCA:GLD), natural gas (NYSEARCA:UNG) and oil (NYSEARCA:OIL) ETFs and ETNs, and medical instruments and supplies growth leaders such as Heartware International (NASDAQ:HTWR), which recently won approval from an FDA Advisory panel for the company's Ventricular Assist System.

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.