March, lamb or lion?

Perhaps you know the saying, ‘if March comes in like a lion, it will go out as a lamb.’ As the Washington tragedy continues with its latest act entitled ‘Sequestration’, the audience seems increasingly disinterested by the day. Stocks are up and life goes on as usual.

All the while, political and ideological differences have become so entrenched and divisive that the traditional give and take of the budgetary process has been reduced by sequestration to the indiscriminate lopping of government services, regardless of merit, while the true culprit of fiscal destruction – entitlement lumbers irresponsibly along.

SequesterJust how bad the sequester will hurt the US economy and real people remains to be seen. But if congressional leaders and the president cannot reach an agreement to avert the cuts today, which is not expected, the president will be forced by law to  issue orders to governmental departments to begin cutting $85 billion from their budgets this fiscal year.

The cuts will occur in the remaining seven months of this fiscal year which ends September 30th. They are not likely to be as dramatic as described by the White House in recent days, rather they will be more of a “slow-rolling deal,” as more recently described by David Axelrod, a former top White House adviser and Obama campaign strategist.

In addition to being indiscriminate, the cuts are also notorious by their failure to address the real problem. As you can see in the graphic below, by far the largest component of the government’s annual $3.4 trillion budget is “Mandatory” entitlements.

Share of CutsA disproportionate share of the cuts are directed toward “Discretionary” programs including Defense and Domestic programs. To be sure there is waste in these programs, but sequestration is aimed at removing some splinters while the patient bleeds to death from the bleeding wounds known as Social Security, Medicare, Medicaid and interest.

The government spent $1.793 trillion on Medicare, Social Security, Medicaid, and interest on federal debt in 2012, which represents 50.7% of the federal budget.

Given a number of short-term deadlines looming, one wonders when or if the Administration and the Congress will focus the big long-term issues of entitlements. On March 27th, funding for some federal programs and agencies expires. If an agreement isn’t reached, a partial government shutdown could ensue. The debt ceiling debate will crescendo on May 19th, as Congress just passed legislation kicking that can a little further down the road.

Those opposed to cutting federal spending argue that budget deficits are coming down as the economy recovers. This year’s deficit is projected to shrink to $845 billion this year from $1.4 trillion in 2009. The Congressional Budget Office predicts it will fall even more in the next few years because of spending cuts and an improving economy that generates more tax revenue and restrains government safety-net spending, according to the Wall Street Journal.

These improvements salve and mask the bigger problems. The Social Security disability trust fund is projected to exhaust its reserves by 2016. The Medicare fund that pays hospital bills will burn through its reserves by 2024. Roughly 46 million Americans received Social Security retirement benefits in 2012, a figure forecast to grow 40% by 2023, with a similar increase for Medicare, according to WSJ. Hopefully, a real solution will emerge from the political mire in time to address both coming train wrecks.

Economy Slowing

Another big news item this week came yesterday with the government’s release of its second estimate of US gross domestic product for the fourth quarter of last year. It was revised up to plus 0.1% form a negative 0.1%, coming off a 3.1% third quarter. Forecasters were looking for a revision of plus 0.5%.

Also in the report inflation was 0.9% annualized versus an initial estimate of 0.6% and 2.7% in the third quarter. When excluding food and energy, inflation was revised to 1.2% from 1.1% percent and 1.3% percent in the third quarter.

In a couple of speeches this week Fed Chairman Ben Bernanke indicated that quantitative easing was still required to sustain the recovery and that the benefits outweighed the risks of inflation. He was more forceful than usual, according to Econoday, when he stated that the impact of sequester could be significant, taking into account that economic growth is only moderate. He expects that quantitative easing will continue until there is substantial improvement in the labor market, noting that easing has specifically helped boost the housing market and motor vehicle sales.

Housing is indeed doing quite well. New home sales in January surged a monthly 15.6% to an annualized 437 thousand from an upwardly revised 378 thousand for December, according to Econoday. According to the Case-Shiller index, home prices increased a strong 0.9% in 20 monitored US cities in December. The adjusted year-on-year rate for December is plus 6.9%, which is the highest since the giant housing bubble back in 2006.

Manufacturing, jobs, consumer confidence, and other indicators were relatively constructive in a busy week of economic data, but there’s fog ahead and it impacts the biggest part of our economy – the consumer. Consumer spending has been looking up in the past few months, but that trend could be in trouble.

Today, the Commerce Department announced that incomes fell the most in two decades in January as higher tax rates kicked in. Personal incomes dropped 3.6% in January. This drop was the mirror opposite of December’s big gains from accelerated payouts of dividends and bonuses ahead of January tax increases. It is not a given that reduced income will slow economic growth, but combined with sequester, higher fuel and food prices, and a slowing global economy, economic headwinds are increasing.

Based on the market’s near yawn this week over the sequester, it looks like Americans are becoming desensitized toward Washington’s dysfunction. US stocks, as measured by the Wilshire 5000 (VTI), are up 138% since their lows in March of 2009. What does this March portend? Does lion or lamb await?