From Fiscal Cliff to Recession – Implications

Most everyone has weighed in on the “fiscal cliff” and what will happen if Congress allows it to occur. In a nutshell, the fiscal cliff is some legislation the Federal government passed a while ago that mandates some very severe across-the-board cuts of government spending and large tax increases if Congress, by year’s end, doesn’t pass a more sensible, less painful solution to reducing our nation’s debt. All the think tanks and economic analysts agree that such cuts will lead to (playing a funeral dirge would be appropriate at this point)……Recession!

The American public responds with a collective “Oh No!”  We have just been through THE “Great Recession”. The recovery has been anemic. Unemployment is still around the 8% level. The country can’t possibly bear another recession. Can it?

Let’s reduce the emotion, and step back to review the situation. First of all, it is helpful to note that historically, after 4 years of recovery, the window for recession reopens. Let’s see. The Great Recession was mostly in 2008. One year is 2009; 2010 is two years; 2011 is three years; and 2012 is (drum roll please) four years. Right on schedule.

I know it doesn’t feel like we have been out of recession for four years, what with unemployment just grinding down. But we have. From a business point of view, it has been a fine recovery. The reason recessions are an important part of the free market cycle is that periodically businesses need to improve productivity, clean up their balance sheets, and correct any excesses. From that standpoint, the recovery has been excellent. Productivity has increased wonderfully. Profits rose accordingly. Balance sheets were greatly strengthened.

In fact, the business community is sitting on piles of cash, and there’s the rub. They have not grown and expanded their businesses. They have not hired huge numbers of people. Why? They have been telling us throughout the post-recession period that they limit expansion when faced with uncertainty. Our government’s profligate spending results in much uncertainty. Everyone seems to realize that our government’s deficit spending cannot be sustained at the rate it is piling up. Except the politicians! That’s not true. They know. That’s why they passed the “fiscal cliff” legislation in the first place. And the business community awaits resolution. And employment stagnates. Note, however, that unemployment has some structural problems that need fixing. See our November 6^th article, “Politics is not the only factor in unemployment”.

If Congress does not correct the deficit spending problem and we go over the fiscal cliff, we will very likely indeed have a recession. However, most economists seem to agree that it will not be a very deep recession. Nothing like 2008. Just your run-of-the-mill recession. There are no huge imbalances/bubbles that need fixing. Recall that the 2008 recession was triggered by massive amounts of bad debt floating around that bedeviled banks and about destroyed the real estate industry. That is not the case now. The only big excess is government debt.

Personally, I am more afraid of Congress avoiding the fiscal cliff by “kicking the can down the road”. That means using a band-aid when major surgery is called for. If Congress does not come up with a meaningful schedule for reducing spending and increasing revenues, uncertainty will continue and the economy will limp along as businesses wait and see.

We need a whole herd of political sacred cows to be converted to hamburger (my apologies to vegetarian readers and Chick-fil-A).

The investment implications are pretty muted. If the politicians fail to generate a plan to restore fiscal integrity, as stated earlier, we will likely go into a mild recession. Investors will at some point over-react, presenting some good buying opportunities on the equity side. As progress on debt reduction occurs despite the recession, the stock market should pull out of its correction and sustain recovery as our nation’s balance sheet improves. If the politicians are able to structure a mid-term and long-term plan of action to reduce the debt, avoiding the fiscal cliff, equity investors might just become euphoric, presenting some profit-taking potential. No one can say for sure what will happen.

In times of such uncertainty, it is good to be well-diversified and globally invested. We are.