Weekly Market Commentary 4-11-1

Political Drama – Enter Stage Left & Right

Tim Phillips, CEO – Phillips and Company

In, The General Theory of Employment, Interest and Money, John Maynard Keynes laid out six objective factors that influence the propensity to consume. I would like to take a moment to focus on two of them that are pretty straight forward:

1. A change in the difference between income and net income: The amount of consumption depends on net income rather than on income, since it is, by definition, his net income that a man has primarily in mind when he is deciding his scale of consumption. (emphasis added)

2. Changes in fiscal policy: In so far as the inducement to the individual to save depends on the future return which he expects, it clearly depends not only on the rate of interest but on the fiscal policy of the Government. Income taxes, especially when they discriminate against “unearned” income, taxes on capital-profits, death-duties and the like are as relevant as the rate of interest (emphasis added).

keynes theory of employment, interest, and money

People consume net income and not their gross since their net income is dependent on expectations for interest rates and fiscal policy.

Since fiscal policy directly impacts our consumption (which is approximately 70% of our GDP), it’s rather interesting that despite the fact we went into the weekend with no clear agreement on the government budget and a real possibility of a government shutdown, the S&P 500 was only down about 4 points (-.32%).

s&p in early april

Since that debate has been decided, I suspect that the markets will turn their attention back to fundamentals with earnings season set to kick off today after the close. However, the fiscal drama is far from over for the year as the political theater turns their eyes to the debt ceiling and the 2012 Budget for their next act.

If we learned anything from last week’s political theater, it’s that both sides benefitted from brinksmanship (the practice of pushing dangerous events to the verge of disaster in order to achieve the most advantageous outcome) and it will most likely be utilized by both sides again in the next act with the debt limit debate and 2012 budget set to debut over the next several months.

While this may be beneficial to the two political parties, it unfortunately could be detrimental as increased uncertainty in fiscal policy (i.e. Medicare and social security) and our net income (i.e. personal and corporate tax rates, and personal deductions) could cause a decrease in our propensity to consume and significantly threaten corporate earnings and our GDP.

In fact we have already seen some GDP forecasts revised lower over the last month. The mean GDP forecast for the US is now 2.97%, which is down from the highs in February of 3.20% (per Bloomberg).

My most likely scenarios (based upon a healthy dose of skepticism and lack of trust for the political class) are:

  • If the 2012 budget is to truly address entitlement spending then it could rage on throughout fall and could in fact continue on through the 2012 political season.
  • The 2012 budget will likely drop any entitlement spending reform and that debate will be delayed for the following act, The 2012 Elections.
  • The debt limit will be raised and those practicing brinksmanship (playing chicken) will find some way to save face.

Overall, market reaction will probably be muted (similar to last week) as most of the investor class has grown weary of the political drama. However, we could see increased volatility as the two political parties play chicken. This volatility could provide additional dips and buying opportunities for the investors who prefer to take a dynamic approach to investing as we go through economic cycles.

Below is a chart of the S&P 500 with the dates of the last three times we raised the debt limit circled in green:

s&p during 2009 and 2010

Thoughts and comments are always welcome and I look forward to them throughout the week. Please send them to:


Tim Phillips, CEO – Phillips and Company