My guess is that there is only one positive outcome all Americans can agree on as a result of last night’s election: no more political ads…until the next time anyway. Now that all the theatrics are over it is time to get back to reality.
I was surprised last night not to hear any exit polling on whether voters are aware of the looming fiscal cliff. I am not suggesting that awareness would have necessarily changed anything, I am just curious – after all, I am an analyst at heart. I hope voters are aware, because it is serious and it must be dealt with immediately.
It may come as a surprise for Americans to wake up today and realize that there have been things happening in the world during the last few weeks other than storms and elections. GDP growth came in at 2 percent, which was better than expected. Unfortunately when one digs into the numbers you see that 0.72 percent of that growth was due to increased government spending, mostly a 13 percent jump in military spending, which looks to me like stockpiling ahead of the draconian cuts coming from the fiscal cliff. That leaves real GDP growth at approximately 1.3 percent, which is still better than we expected but extremely weak, and if I am correct will mean a drop in future military spending as this stockpile of supplies is drawn down even if the fiscal cliff is avoided.
Yesterday the pharmaceutical benefit company Express Scripts reported earnings. They beat expectations but cautioned analysts that next year’s earnings estimates are too aggressive, citing the weak economy when pressed for rationale. Analysts seemed legitimately surprised, and the stock got hammered. What seems strange to me is that sense of surprise; we get the same data as everyone else, and I don’t understand how people do not recognize the lack of economic activity.
Perhaps it is the housing data, which is the one true bright spot in the economy. However, some are behaving as though housing is going to now return to 2005 levels, and that is not going to happen.
Consumers are also more optimistic, although consumer sentiment is almost always a backward-looking indicator: consumers are usually the happiest when the economy has peaked, meaning that things have been relatively good but are about to get much worse. Likewise they are the saddest when the economy bottoms, meaning things have been bad but are actually about to improve. In other words, consumers are almost always wrong. Today I believe that is doubly true, because it is hard to understand optimism in the face of an enormous tax increase. My guess is that most Americans simply have not realized that their take-home pay is about to get significantly reduced come January 1 if nothing is done to avert the fiscal cliff. Either that or they are very optimistic that our leaders will reach a compromise by year-end.
Don’t get me wrong, I hope that optimism is well-placed. However, in my business it pays to hope for the best but plan for the worst. Investing is about making decisions today about the future, which is by definition unknowable. As a result we must deal in the world of probabilities. There must be some probability that no compromise is to be had and that we will indeed go over the cliff. This brings us to last night. The irony is that after billions of dollars spent on ads we are all glad to never see again, we have sent basically the exact same split government back to Washington. The guys who could not agree on anything for two years are now the ones we trust to avoid fiscal disaster. I fear the probability of going over the cliff has been greatly increased.
Beyond the fiscal cliff there is hope. Long-term valuations are reasonable and that is ultimately what drives results, but we must get over this cliff. Caution remains in order.
Chuck Osborne, CFA
Managing Director
