The fiscal cliff has been billed as a battle between the GOP and the White House, but what’s really at stake is the initial move toward European-style austerity measures in the United States.
If Bush era tax cuts are not extended, workers will be shocked to discover in January that their take-home pay will be reduced and their tax bills at virtually every level of government will go up. Also, a lot of state and local agencies that depend on federal funding will see their grants slashed or eliminated.
To counter some of this, the Federal Reserve has been working hard to lower long-term interest rates and increase the amount of credit, as well as boost home and stock prices. Individuals have responded to the easier credit by buying more houses and cars and appliances, but this has had the effect of reducing their savings dramatically.
Unfortunately, savings are on track to fall further as government takes a larger portion of income. But people will only eat into their retirement funds so much. If the shock from higher taxes is great enough a new recession will follow as spending often drops slowly at first, and then abruptly.
More dangerous is the decline in capital investment by businesses, which had kept the economy rolling the past few years by growing in the double digits and is now shrinking.
That is despite record low interest rates. The decline reflects mounting fear that the impending setbacks to household incomes will halt or reverse the upward momentum in consumer spending, which is the chief source of business revenue.
The fear now is that as new revenues are raised from households in ways that compel consumers to cut borrowing and spending, businesses will reduce investment further. The result: total incomes grow more slowly or shrink. If the shrinkage in incomes and GDP is substantial, the federal budget deficits that we are trying to reduce may actually get larger.
It is fashionable now to be optimistic that an agreement will be reached and stocks will launch higher due to the increase in certainty. But is that really true? Both the GOP and White House are essentially seeking different types of austerity. The GOP wants the government to spend less and the White House wants households to have less. It’s possible a compromise that achieves both leads to a market sell-off.
Even a compromise that matched the Simpson-Bowles compromise for deficit reduction would limit U.S. GDP growth to around 1.5% for several years as consumer spending setbacks lead to more business investment setbacks. Business invests when the economy is expected to grow, not when it is condemned to austerity.
As a result, I am not too optimistic about growth stocks for 2013, and would prefer to look at well run consumer staples companies in the faster growing parts of the world. One of my favorites of these is Fomento Mexicano (NYSE:FMX), better known as Femsa, which is a big beverage maker and distributor in Mexico. It is one of my top stocks for 2013.
But on the short side, here are two that look overstretched in my system and should return to earth. If I see any confirmation of the thesis, I will play them as shorts and puts for my Trader’s Advantage subscribers.
Tenet Healthcare (NYSE:THC) is a hospital operator. Shares have risen $22 from the summer and in the past week have gone vertical. This one is coming back to earth, and I’m looking closely at January puts.
On the surface, Kellogg (NYSE:K) looks like a pleasant little uptrend that has been pulling back to its 13-day average. But come on now; this is not a semiconductor maker or a biotech. It sells cereal and granola bars. Sure, it’s a good company but it is likely to see a multi-week pullback very soon. I am considering January puts on K.
InvestorPlace advisor Jon Markman operates the investment firm Markman Capital Insight. He also writes a daily swing trading newsletter, Trader’s Advantage which aims to capture profits of 15% to 40% and often as much at 100% to 200% in less than 90 days.
Professional traders and hedge funds make huge profits off volatility. Now, Jon’s service CounterPoint Options levels the playing field with the first service geared towards helping individual traders make steady, consistent profits with the VIX. Get more information on Trader’s Advantage and CounterPoint Options today.