Why A Fiscal Cliff Deal Will Bring Austerity And A Recession To America In 2013

Includes: AAPL, GD, MSFT, RTN
by: Trade In Mexico

Finally, some members of the media and analysts are starting to use the word "Austerity" to describe the United States, not just Europe. For the past couple of years, we have heard about austerity in Europe but few Americans seem to realize that austerity is coming sooner or later to our shores. Amazingly, it appears that few Americans even knew what the Fiscal Cliff was about until it became more widely discussed in the Presidential debates.

A recent Fortune article summarizes that Fiscal Cliff concerns are finally catching up with the average American and it states:

"Meanwhile, the rest of America either wasn't paying attention or didn't really care. Consumer confidence in November spiked to more than a four-year high. Since the presidential election, though, there's been a marked shift, Duke says, referring to polls that Wal-Mart (NYSE:WMT) -- the biggest retailer in the U.S. and the world - conducts on its shoppers. Whereas only 25% of Wal-Mart's core U.S. shoppers said they knew what "fiscal cliff" meant before the election, that number rose to 75% after it. He added that 15% of those who knew about the cliff said it would affect their holiday spending."

Many Americans are being led to believe by the media and government officials that all will be well and that we could even see a big rally if a deal is reached on the Fiscal Cliff by Congress and President Obama. But that appears to be a fantasy since a deal is likely to entail tax increases and some government spending cuts which could put a major dent into an already weak economy. Countries like Spain, Portugal, and Greece which have cut government spending and raised taxes (otherwise known as austerity), have subsequently seen a sharp drop in economic activity and an increase in unemployment. It now seems that more investors and analysts are willing to acknowledge that a Fiscal Cliff deal is likely to involve austerity. CNBC's Bob Pisani's "Trader Talk" article recently stated:

"Though the Republicans and President Barack Obama seem far apart, we can already see the elements of the deal: modest tax raises and some spending cuts. The bad news: The era of American Austerity is about to begin. The good news: It will be a fairly gentle austerity, at least in the beginning."

The CEO of Goldman Sachs (NYSE:GS), Lloyd Blankfein also seems to recognize that austerity is coming and that it will pose challenges to the economy as a recent CNN Money article states:

"The next 12 months will be tricky," warned Blankfein, speaking at a conference Wednesday hosted by The New York Times' Dealbook. "Any compromise will involve some dose of austerity -- a deflationary policy."

The markets have been in rally mode (ever since the post-election sell-off the S&P 500 Index (NYSEARCA:SPY) has jumped from about 1350 to around 1421, although it has become a bit jittery in recent days) and investors seem to be taking a "what, me worry" approach to the potential risks of going off the Fiscal Cliff as well as what ensuing austerity could do to the American economy in 2013. If a deal is reached in which major spending cuts and tax hikes are implemented, austerity is coming. Just take a look at stocks in the defense sector which could be hit hardest by going off the Fiscal Cliff and you can see that shares of General Dynamics (NYSE:GD) and Raytheon (NYSE:RTN) are trading near the high end of the recent trading range. (General Dynamics has jumped from about $62 in mid-November to over $67 and Raytheon has surged from about $54 to over $57 in the same time period.) By looking at those stocks, you would not even know that multi-billion dollar defense spending cuts were looming. The abundance of optimism that a Fiscal Cliff deal will be reached and the fact that the markets have been rallying should concern investors, along with the fact that if a deal is reached, austerity will start to impact the U.S. economy in 2013. It seems that most investors are betting on a Fiscal Cliff deal and are bidding up defense stocks and judging by how slow most Americans were to understand and acknowledge the Fiscal Cliff, it is not surprising that they would not yet be grasping the potential impact of austerity in 2013. Once and if a Fiscal Cliff deal is made, the media is likely to start assessing the toll budget cuts and tax hikes will take on our economy and that is when more investors might re-position their portfolios. But for now, the stock market does not appear to have priced-in either a going off the Fiscal Cliff scenario or the austerity that is coming. That means a significant sell-off is possible in the near future, as is a recession in 2013, which could be driven by austerity.

Investors who want to stay one step ahead of the average American should consider raising cash now and prepare for what could be a much better buying opportunity in the stock market once we either go off the Fiscal Cliff or once investors fully realize that a deal is likely to bring the same austerity countries in Europe have experienced, when governments cut spending and raise taxes. Investors should consider selling the recently rally in defense stocks and other sectors. Cash should be on-hand for better buying opportunities in companies like Apple (NASDAQ:AAPL) which has growth potential even in a weak economy and a cash-rich balance sheet. Companies and countries that have a strong financial position will be poised to take advantage of opportunities that could come with a recession, while companies with significant debt levels and heavy exposure to economic downturns are likely to be more challenged. Earlier this year it was reported that Apple had more cash on hand than the United States Treasury, and with the recent decline in the share price over "growth concerns", it sure seems like a better stock to be buying on dips especially compared to defense stocks (as if those companies are going to see strong growth in the coming years). As of the latest quarter, Apple has about $121 billion on the balance sheet and in contrast to many stocks in the market, Apple shares have already priced-in slower growth which seems likely for most companies in 2013. The recent market run does not make sense, and as the reality of austerity comes into play sooner or later, investors who are well-prepared might be able to buy into high-quality stocks in cash-rich companies at what might be lower levels. Microsoft (NASDAQ:MSFT) comes to mind as it has a relatively stable revenue stream from its Windows operating system and like Apple, it has a fortress-like balance sheet with about $66 billion in cash and just around $12.37 billion in debt. Microsoft shares have also dropped (like Apple) from about $29 in early November to below $27 today, in what seems to be a case where the market is pricing in slower growth expectations for Windows 8. Cash-rich companies whose stocks have already price in lower growth expectations are likely to outperform stocks that have been bid up recently on (possibly false or misguided) optimism over a Fiscal Cliff deal.

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.