Stocks down again yesterday but interestingly bond yields up a tad, dollar down a tad, oil and metals up, and even long BMA ratios holding steady, etc.
The cliff isn’t nearly as large and threatening as the debt ceiling cliff would have been in 2011 if that thing hadn’t been extended, and we’d gone cold turkey into an immediate and forced balanced budget. But that event is the stock market’s ‘recent memory’ of stock market reaction functions.
And this time GDP is being supported by a private sector credit expansion/housing expansion, with private debt service ratios substantially lower due to cumulative federal deficits adding to nominal ‘savings’. And the federal deficit remains well above 5% of GDP, which historically has been more than enough to reverse a recession.
And then there’s the election factor. Post election I’m hearing (anecdotally) distraught Romney supporters thoroughly convinced the President is a ‘socialist’ bent on destroying capitalism, taxing the rich ‘job creators’ and giving it to what Romney called ‘the 47%’ dependent class, etc. etc. etc. Merits of this ‘belief’ aside, it looks to me it’s driving portfolios to shift out of equities. However, if not supported by an actual decline in earnings, which is how I see it, it’s all a case of ‘pushing on a spring’.
Yes, the euro zone is a problem, with Q3 GDP just reported at -.1%. But that’s an ‘improvement’ from q2′s -.2% as larger deficits are acting counter cyclically to cushion the austerity driven decline. And Rehn was just quoted on Spain favoring not adding to austerity measures, perhaps indicating a move to ‘let it be’ for a while, which will allow GDP to stabilize at modestly positive levels.
And China is no longer going backwards, so that negative has been reversed as well.
Back to the cliff, in fact letting tax rates go up for high income earners should have little effect on GDP, as the marginally propensity to spend for that segment is reasonably low. (of course that means there’s no point in taxing that income in the first place, but that’s another story). Nor does it mean investment or employment will suffer since investment is driven by sales prospects. And with higher tax rates, and business expense tax deductible, the after tax cost of investment goes down with higher tax rates. For example, in the 70′s, when my tax rate was around 70%, I clearly recall making very high risk investments figuring it was better than giving 70% to the govt. Point is, taxing income and savings that isn’t going to be spent is about social engineering, and not ‘funding the deficit’ or altering aggregate demand, and is intellectually honestly framed as such. So point here is, I score the effect of raising the highest tax rates at 0 regarding aggregate demand.
This all supports my take that the stock market has over discounted the cliff, partly for ideological reasons, partly due to the recent memory of what stocks did during the debt ceiling debacle, and partly from fear of what’s going on in the rest of the world.
So as we get through it all with modest top line and earnings growth continuing, I’m looking for valuations to quickly return to at least where they were before the election.