Washington passed a fiscal cliff deal that honors the most famous cliff diver in history - Wile E. Coyote. Just as Mr. Coyote obtained complex and ludicrous devised plans from a mail-order company Congress cobbled together yet another bill that pretends to have answers but leaves lots of questions and more frustration.
Just as the template for the Road Runner cartoon saw contraptions used by Wile E. Coyote "invariably fail in improbable and spectacular ways" each issue that gets resolved in Washington these days is doomed to failure. Part of the reason failure is inevitable is because core problems are not only not addressed, but often they are worse after would-be cures have been applied. The thing is, the United States economy is as durable as Mr. Coyote - we can take a lot of hits and stay in the game...until we can't anymore.
That being said, you have to be in the market making changes to exposure but not panicking. Picking the point of implosion is next to impossible and I will tell you now the global economy is going to rebound this week and that will carry a lot of American-based companies. There is a disconnect masked by the notion the stock market is a report card on the US economy. It used to be that way, but over the last fifteen years it's changed dramatically. Add in the fact Wall Street loves all the money-printing of the Fed and we have ample reasons for a much higher stock market even as, like Mr. Coyote, our economy will end up "burnt to a crisp, squashed flat or at the bottom of a canyon."
While saying the fiscal cliff deal is a further step in clarifying the medium-term deficit and debt trajectory it "does not, however, provide a basis for a meaningful improvement in the government's debt ratios over the medium term." Moody's ratings agency put the onus on upcoming battles as last chances to lower future budget deficits. If the problem isn't addressed (read fixed with real decreases in spending) in upcoming battles the agency is likely to lower America's credit rating. I'm not sure how the Street will react to this warning but hopefully it influences Washington.
Rich and Connected Win Again
I find it fascinating how the rich and well-connected continue to reap rewards no matter what party is in office and no matter the mood of the general public. While President Obama didn't lift a finger to stop more than 100 million working Americans from having to pay more taxes his buddies in Silicon Valley and Hollywood get gigantic economic gifts from the fiscal cliff deal. I wrote about the R&D benefits mostly helping Silicon Valley yesterday but there are other friends of Obama cashing in big time.
$9.0 billion extension of active financing exception for manufacturing and banks (helps to offshore jobs)
$1.2 billion for renting in Liberty Zone around WTC (Goldman says thanks a lot - no wonder Blankfein loves the deal)
$430 million Hollywood deal that began years ago to help small struggling filmmakers; now individual television episodes can get up to a $20 million break
$331 million railroad maintenance
$222 million excise tax on rum returned to Puerto Rico and Virgin Islands
$70 million NASCAR accelerated write offs
$4 million electric motorcycles
$1.0 million treats coal on Indian land as alternative fuel
Small Business Still Short End of Stick
While Silicon Valley, Hollywood and Wall Street firms with huge pockets and sweet profit margins made out in the fiscal cliff deal small businesses took a hit and that means American job creation will take a hit as well. You see, when the White House says only a few small businesses will be hit it never mentions these are the businesses that are hiring.
What we're going to see is a firing phase as higher taxes from the fiscal cliff and Obamacare pressure these small businesses. According to Sageworks/Forbes these small businesses enjoy the highest profit margins:
Ambulatory centers 15.0%
Tax Preparation 14.7%
Self Financing 13.3%
Portfolio Managers 12.2%
Oil & Gas Drillers 12.0%
So, Where to Now?
Just as it would seem inevitable the economy craters under the weight of $20.0 trillion+ in debt, sluggish growth, aging population, low birth rates and deteriorating educational standards it would seem the bond market has to be pricked. The experts and I are talking to people that trade billions in the bond market, have been calling for or bracing for a crash for at least two years. Some like Bill Gross of Pimco understand investors' willingness to chase performance in the bond fund having declared a year ago the "cult of equities is dead."
He was right that investors have completely lost faith in stocks and somehow think even after their extraordinary rally bonds are a safer bet.
It doesn't hurt that the Federal Reserve's printing press, coupled with no real competition, has kept bonds moving onward - higher and higher. Consequentially, investors poured $9.84 billion into bond funds over the last five weeks ($8.09 in taxable) while taking out $24.56 billion from equity funds ($22.6 billion in domestic). This combination of blind faith in bonds and unmitigated disdain toward stocks is a contrarian dream come true. Moreover, individuals are so under-exposed to equities there has to be a natural rebalancing at some point.
Older Americans are severely under-exposed to equities, even taking into account traditional risk formulas that suggest subtracting one's age from 100 to find stock market exposure. Considering how much longer Americans are living and how little yield there is in bonds, the only thing that needs to happen is a stock market breakout to shift from a cautious stance to one driven more by greed.
When all of this happens I'm not sure but it will be stealthy, even on days when the Dow is up 300 points it will not register as a sign to move away from bonds. Instead most investors will be caught flatfooted, hence the need to overcompensate via stocks - particularly high growth stocks that afford outsized valuations.
I can't give you an exact timing on this although it feels like it's already happening.
This morning's ADP report was rather encouraging, giving some hope for a stronger than expected result this Friday when the government's numbers are delivered. According to ADP, 225,000 private sector jobs were gain during December, above the Street's consensus estimate calling for a gain of 140,000 jobs and significantly above the 148,000 added jobs in the prior month, which itself was revised higher from 118,000. At the moment, economists are predicting for this Friday that private sector businesses will have added 165,000 jobs in December, and the unemployment rate will likely remain flat at 7.7 percent.