Is there a real method to the madness in Washington?
I had the opportunity to spend the last two days in Washington, DC, as a representative of the Miami Jewish Community to meet with a number of lawmakers from both parties…US Senators, Congressmen, their chief staffers, and White House staff. The fiscal issues we face dominated the discussions as the next rounds of deadlines are fast approaching. The year-end deadline resulted in final resolution of the Bush tax cuts, and in the last week both the House and the Senate have passed legislation to extend the debt limit into August. So some meaningful progress has been achieved, but much harder negotiations are facing lawmakers this month. What looms is the $1 trillion cut in discretionary spending, including defense, which is known as, “The Sequester.” This will take effect on March 1 if Congress does not act.1 Then there is also the March 27 expiration of the current “CR” or continuing resolution which authorizes all general spending by the federal government.2
The Sequester is scary, and a great sense of anxiety was felt in all the discussions I participated in. An indiscriminate whacking of the federal budget may feel just given the frustration many rightly feel with the way our legislative and executive branches have failed to effectively cooperate in recent years. But, then consider the impact on our citizens and the military. The charities who participated on our trip are terribly concerned about whose early childhood programs may get terminated or which elderly citizens no longer qualify for home-delivered meals. There were also discussions of international issues in our sessions. With all kinds of threats brewing in the world that could impact both national and homeland security, how wise is it halt production of new military programs?
Sadly, it seems our legislators can only figure out a way forward under the threat that their inaction would cause calamitous results. It creates such unnecessary anxiety across society. Will they act or won’t they? How many more times does the public deserve to be taken out to the edge of the abyss, only to be saved at the very last moment? While revolting to endure, this approach seems to actually be somewhat effective. Shock therapy appears to be the appropriate treatment for our dysfunctional government.
The markets are accepting this crazy reality, with the S&P 500 rising over 5% for the month of January– its best start to a year since 1997.3 Underlying private sector economic activity continues to make slow but decent progress, and corporate earnings season is coming in better than expected. Through January 30, 223 companies in the S&P 500 had reported earnings, and 66.4% of them beat expectations.4 Overall, earnings have improved in the fourth quarter by 2.5% as compared to a 2.2% decline in the third quarter of 2012.5
The concern is that the markets have become too complacent with this approach of going down to the 11th hour and 59th minute before finding agreement. What if this time around we go over the proverbial cliff? At least equity valuations are generally not on the high side historically speaking, so there is some cushion built in if the shock therapy fails in the weeks ahead. But if the treatment continues to work, we very well might be somewhat further down the path towards greater fiscal health, which could unleash great forces of confidence to invest and spend by consumers and businesses alike. With the combination of more certainty in the tax rates, appropriate restraint in government spending and reasonable private sector economic growth, the likelihood of continued shrinkage in the deficit could significantly increase. Hang on for more down-to-the-wire antics in Washington. The markets for now at least are signaling potentially positive resolutions. Let’s hope the markets have it right.