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This is normally the time of year when the stock market has its strongest seasonal upside move as the end of tax loss selling and optimism about the next year pushes stocks higher in the mid-November to mid-February level more than any other 3-month period in the year. But confidence in this seasonal move is fading quickly as investors start to realize that the politicians in the U.S. need to put partisan positioning aside for a while and come together with a new tax and spending package to replace the ‘fiscal cliff’ that will otherwise occur on December 31st as the Bush tax cuts expire and a series of automatic spending cuts are enacted. The impact to the U.S. economy of these measures is the equivalent of cutting US$600 billion from annual output, a substantial hit just as the world’s largest economy is just starting to show some sustained growth. Listening to the ‘posturing’ by the senior politicians of both the Democratic and Republican parties is giving investors very little comfort that these folks are actually intent on getting an agreement in place before the end of the year. So while the traditional ‘Santa Claus rally’ looked to be getting started two weeks ago, the political wrangling that we have witnessed since then looks like it could snuff out the traditional ‘holiday cheer’ that stock markets have given at this time of year.
The ‘Fiscal Cliff’ is basically THE issue holding back stock markets. It’s really not the economic risk in general as much as it was, particularly in the U.S., the world’s largest economy. Over the past year, job growth has picked up south of the border and unemployment has fallen by the largest amounts during the entire recovery. Consumer confidence, after waffling during much of the recovery, recently hit a four-year high. Bank lending has reversed its decline and household net worth is now just 7% below its all-time high after being down some 25% in 2009. Housing starts and home prices are finally ascending. State tax collections recently hit a record high. Meanwhile, low interest rates have helped drive down household debt from a record high 19% of disposable income in 2007 to a near-record low of 16%. The chart below shows the ISI Surveys that we have followed for years and provide a very good indicator of overall growth trends. While the pace of recovery has not matched that of prior cycles, the numbers show an economy that continues to expand at a moderate pace, despite the recent pullback due to weaker data following the impact of Hurricane Sandy.
Overseas economies are also on the mend. China seems to be reviving from its recent slowdown. Data released over the weekend gave more evidence that China’s manufacturing and services sectors both picked up in November, providing a positive driver for regional and global growth. The rest of Asia’s manufacturing sector also appears to be on the mend while inflation remains tame, giving policy makers room to take action to stimulate their economies if global conditions deteriorate.
We are even starting to see some positive developments in Europe as recent data show a reversal in some key indicators such as the ISM surveys, even though they remain in recession mode. But this improvement should move the euro zone from a severe risk to global economic growth to a mere chronic problem.
But the most important data point supporting continued U.S. growth, in our view, is the long-awaited recovery in the housing sector. Moving annual starts from an annual rate of under 500,000 homes to a current level of almost 900,000 homes has not only lead to a recovery in the related industries such as construction, building products and retail but also increased consumer confidence as the value of their largest asset stops deteriorating.