It is a terrible situation when Washington DC is the primary issue driving the markets, but that’s what’s been happening, and I expect the politicians to continue having an unfavorable impact on the economy. Even though Washington dealt with the revenue side of the fiscal cliff issue there’s another battle looming over the spending problem. Don’t be surprised when the issues get stoked into another major media narrative, painstakingly and deliberately bombarding the public with excruciating and mostly irrelevant, hazy details.
The markets don’t respond well to uncertainty, and during this next political saga, expect the markets to vacillate, at least a bit. But these problems, like the fiscal cliff debate, are in my opinion, little more than day-to-day drivel. What is important for investors focused on the long run are the underlying strength of the economy and the companies in which we’re invested.
So let’s take a look at the four essentials of the economy: growth, jobs, inflation and profits.
Gross Domestic Product (GDP) should maintain the tepid growth we’ve seen over the past few years, although it is likely that the first part of 2013 will see a slowing as consumers get accustomed to their increased payroll taxes. We never really got very far out of the recession of 2008; consequently, there is still a lot of “pent-up” demand for major items like cars and houses. And consumers’ debt situations are in the best shape since the FED began tracking the household debt service ratio in 1980. Likewise, corporate balance sheets show that companies could bring capital goods investment back up to a normal level, without significant borrowing.
Employment numbers continue to slowly improve. Civilian unemployment has been below 8% every month since last September’s report. The actual number of unemployed remains over 12 million, as people who quit looking for work are coming back into the labor pool. But it will take a long time to get the country back to full employment, especially in the face of all the new regulations being rolled out.
The most recent inflation numbers indicate a very moderate increase in prices as compiled in the Consumer Price Index, and it isn’t much different for “core inflation” or the broader full index that includes energy and food prices. Both numbers peg inflation for the past year at less than 2%, a very comfortable pace. One key element that should continue to help keep prices in check is the country’s dramatic improvement in energy sources. In the past seven years, we’ve reduced our dependence on foreign energy from 30% to less than 15% of our total consumption.
However, in the next few years the FED faces some tough choices as they will have to eventually “unwind” their extensive positions in US Treasuries. I believe that the FED will have no choice but to capitulate on inflation, unless the government allows business to expand untethered by the current regulatory and tax environment.
It is corporate earnings season, and the numbers for the fourth quarter are being reported as this essay is under construction. Most experts expect earnings to remain way above the historic average of 6.2% of GDP. The third quarter of last year, the most recently completed earnings season, saw the ratio at 9.6%, more than 50% above the historic average. Make no mistake about it, companies are making money and will continue doing so for the foreseeable future.
The current expansion continues to be hampered by the “Uncertainty Tax” created by our dysfunctional leadership in Washington. I believe that the economy’s fundamentals are stable and strong enough to survive the onslaught and any likely outcome from the next ridiculous spectacle of political brinksmanship.
Sources: Wall Street Journal; JP Morgan Asset Management; Economy for iPad by Cascade Software Corporation
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