Last week the failure of the congressional “super committee” to find ways to reduce the U.S. budget deficit by at least $1.2 trillion resulted in a sharp correction in the stock market. In short, we were not surprised by either the committee’s failure or the resulting market reaction. Congress basically set the committee up to fail by including automatic spending cuts of $1.2 Trillion beginning in 2012 in the same budget agreement reached in August of this year that created the “super committee”. This was the perfect out for congress as all areas of government will be affected and congress can respond to angry constituents by saying that they never really agreed to any specific cuts. This is Washington politics at it very best (gutless and cynical). We are assuming that congress does not repeal the automatic cuts or alter the sequestration process that implements the cuts.
Our investment outlook for 2012 remains unchanged. Most economic analysis we have seen of the automatic spending cuts show that the cuts, while effective in reducing the deficit, would have little impact on economic growth. The cuts are simply not big enough to make more than about a 0.5% dent in real GDP growth. We still see a prolonged recovery marked by painfully slow growth and high unemployment accompanied by higher than usual volatility in the financial markets.
We are more concerned with 2013 when the Bush era tax cuts will expire. The higher rates for higher income taxpayers coupled with higher taxes on investment income and capital gains and higher payroll taxes could have a serious negative effect on consumer spending in 2013.
In conclusion, we do not believe that the” super committee’s” failure in itself was a significant blow to the economy because the automatic spending cuts already in place will likely do much the same thing the committee was supposed to do. A much more serious threat in the form of higher taxes may be on the horizon for 2013. The situation in Europe is also likely to deteriorate further and could impact economic growth in this country if timely and constructive steps are not taken by European political leaders and central banks. We are monitoring this situation carefully and at this point are still optimistic that the European debt crisis will result in a moderate recession and not deteriorate into a prolonged and severe period of economic struggle.
We also remain concerned as to investor’s fortitude while working through this difficult time. We have often said in this blog that it takes both courage and patience to be good investor. The coming few years will test both. As always, if you are concerned about market volatility call an independent, fee-only financial advisor and schedule an appointment to review your portfolio and make sure it is appropriate for your risk tolerance....