Across the Board Cuts to GDP

As of this writing on Sunday, the Joint Select Committee on Deficit Reduction, i.e. the Supercommittee, is poised to admit defeat. Once again, Washington is gridlocked and if the markets react like they did during the summer’s debt extension debate there’s potential for another round of market volatility.

Even though “across the board cuts” won’t start until 2013, I have concerns today with how our macro-economy and GDP will be affected if our debt problems balloon to an impasse like those of Europe and Greece.

For example, if our GDP grows at an annualized rate of 2% each year from 2011, then the first round of cuts in 2013 would amount to 0.44% of GDP.

These year-over-year spending cuts would have a significant impact on GDP particularly since we are already experiencing anemic growth. To make matters worse, if you include the 0.25% hit to GPD from our import/export relationship with the European Union, then our economy could face close to a 0.75% hit to GDP in 2013.

The markets care about this a great deal. Right now, there seems to be a tremendous focus on companies that receive substantial government funding like healthcare and defense spending. Looking at healthcare and more specifically the home healthcare and assisted living sectors, anticipated cuts to Medicare appear to have already been priced as seen in the YTD performance of the following healthcare companies:

Smaller defense and aerospace companies whose revenue relies greatly on significant government contracts could also come under pressure if these “across the board” cuts actually happen. While the S&P 500 is only down 4.80% since August 2nd (when Obama signed the Budget Control Act of 2011), there is potential for more negative markets.

With all this doom and gloom, let’s look at the bright side for a moment. It is likely many market participants have already discounted what they always knew: that partisan politicians can never get anything done and provide us a tremendous buying opportunity in light of expected GDP growth.

Let's see who shows up for the big announcement and who really cares. We certainly do.

Have a happy and joyous Thanks giving!

If you have questions or comments please let us know as we always appreciate all your feedback. You can get in touch with us via Twitter, Facebook, or you can Email me directly.

Tim Phillips, CEO – Phillips & Company