Will sequestration hurt the stock and bond markets? Not this month, when the budget cuts are scheduled to take effect. What about the economy? Probably not that much either, according to prognosticators.
The sequestration cuts themselves are actually quite tiny. Total federal spending in 2012 was $3.53 trillion. President Obama’s budget request for 2013 was $3.59 trillion. Under sequestration, total federal spending in 2013 would be $3.55 trillion, an increase of only $25 billion, a little less than 1 percent, according to the Congressional Budget Office (CBO).
Did you catch that?
“Under sequestration, total federal spending goes up, just by less than it would have gone up without sequestration,” says Peter Klein, a University of Missouri economics professor, who also co-writes a blog called Organizations and Markets (www.OrganizationsAndMarkets.com).
The White House and Congress have worried everyone that the sequester will have a terrible effect on the economy, when in fact the economy is humming along just fine.
So far, the stock market has continued to hit record levels in the face of sequestration. And bond-market investors also seem to like the headlines about “debt reduction,” even though with sequestration, there is no real debt reduction.
Instead, there will be a reduction in the rate at which U.S. government debt increases. Even with sequestration, there is a projected budget deficit – the government will spend more than it takes in – every year until 2023.
And the American public likes sequestration, given the feeling the government needs to stop spending as much, just as citizens are spending less.
“Some actually believe this small measure of austerity, and the world not falling apart, is a good thing,” says Michael Galantino, managing director at Boenning & Scattergood Inc., in West Conshohocken.
The CBO estimates that a fully implemented sequester would result in GDP growth of 1.5 percent – below the pace that would otherwise be expected, adds Brad Sorensen, director of market and sector analysis at the Schwab Center for Financial Research.
Given many analysts’ estimates of 2 percent annual growth, that doesn’t leave a lot of cushion. However, the CBO forecasts don’t take into account potential changes that could result from a given action.
“It’s possible that reduced federal spending and fewer debt concerns could increase business confidence and stimulate hiring, which could help to offset at least some of the [GDP] losses [in the longer term],” Sorensen says.
“The economic impact of the sequester will probably be smaller than the CBO’s forecast, and U.S. growth will remain modestly positive,” Sorensen predicts. “The cuts will be implemented gradually, rather than all at once, which should give the economy time to adjust.”
The U.S. bull market in stocks has vaulted over some impressive hurdles, including last week’s fears of a banking run in Cyprus. And Galantino says the main focus for his clients remains “trying to find yield in a low-yield environment.”
Interestingly, many of his retail clients “are slowly putting more money to work as the confidence returns, and they just can’t take the pain of being out of the market any longer,” Galantino said.
And that typically is not a good sign – more a signal of a short-term plateau in the market.