Weekly Market Commentary 8-13-12

Over the next six months, the dominant macroeconomic event we will deal with is the Fiscal Cliff. Now that the Republican candidate has picked his Vice President, the debate and potential outcomes are much clearer.

As a brief refresher, the Fiscal Cliff is what will occur this January because of Congress failing to act on a permanent solution to our growing debt crisis, in addition to the upcoming tax increases and spending cuts.

According to an analysis by JP Morgan’s economist Michael Feroli:

“In all, the tax increases and spending cuts make up about 3.5% of GDP.”

Below is a table breaking down all of the increases in taxes and cuts in spending, with the Bush tax cuts making up about half of that.

While I have a personal political judgment about all of this, the economic impact on growth is clearly negative if this all occurred in one year.

Before we discuss Romney’s Vice President nominee, Paul Ryan, I want to point out another trend to help focus the picture on this Fiscal Cliff. There are several Republican Senatorial Candidates that align with the Tea Party making significant headway on their elections.

• Todd Akin - Missouri
• Josh Mandel - Ohio
• Ted Cruz - Texas
• Richard Mourdock - Indiana
• Wisconsin has two in a tough primary battle election tomorrow

On top of these there are 61 current Members of the House of Representatives that align themselves with the fiscally conservative group.

Now to address Paul Ryan, according to his latest plan, he does not want to eliminate the Fiscal Cliff; he just wants to reshape the cliff. Buried on the last page of his plan in Appendix II, he shows how he would reshape the cuts being imposed on government through the sequestration in the Budget Control Act. Clearly, the future has cut's in it.

With the Ryan selection, this election just went from blaming the President about our current economic malaise to a much broader debate on the size and scope of government. (By the way with only 3% undecided, this election looks like a "ginning up the base" election).

If Obama keeps his job, the only bargaining tool Republicans will have will be the mandatory sequestration cuts including the cuts to Medicare and Medicaid. Certainly with 61 congressman and a few senators being elected as fiscal conservatives, anything less than a delay on everything other than cuts will not do.

If Romney and Ryan are elected, it's hard to see how they can propose anything other than cuts to current spending, and the Democrat's only real bargaining power will be in their holding onto the Senate. They will not go easily without tax increases and some of the Fiscal Cliff being implemented. Especially cuts to the defense budget.

The bottom line is it now looks likely some sequestration will likely occur. Perhaps a delay might be negotiated by Romney but certainly cuts will be in store for whoever is elected.

Keep in mind, it will only take about 150 billion in annual cuts to shrink GDP by 1%. Again, let me emphasize, I am making no political judgment, just simply a mathematical one. Short term pain looks likely and that will manifest itself in our equity markets with more volatility.

The fiscal cliff got a little closer in the window and to me looks more like an exclamation point than a question mark.

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

Tim Phillips, CEO – Phillips & Company