The Independent Market Observer

11/12/12 – Real Economy Strong, Financial Markets Weaker

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Nov 12, 2012 9:36:36 AM

and tagged Fiscal Cliff, Politics and the Economy

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The good news on the real economy continues, with consumer confidence hitting a five-year high, per the New York Times (NYT) over the weekend. We are now at a level that is pretty close to the historical average, which illustrates just how bad things have been from a consumer point of view. A five-year high just gets us back to the average? Much of this is due to improvements in the current conditions index, which is mostly about the labor market, and improvements in expectations.

The news confirms what I have been saying for a while: the consumer is back. I base this on the recovering housing market and the recovered auto market. Homes and cars are the biggest purchases most people will make in their lives; they’re multi-year commitments and require a lot of borrowed money. Confidence has to be higher for people to make that commitment. Should confidence stay at this level, consumer spending may well increase substantially above the current levels, which would be an important growth factor. I have a three-part post this week on why employment may continue to improve, so I’ll pass on further discussion of that here.

Business certainly doesn’t share the rosy expectations of the general population, however, and last week’s stock market results show that vividly. The S&P 500 was down about 2.4 percent, with two bad days after the election. The drop can be interpreted two ways: as disapproval of Obama’s reelection and as a renewed focus on the pending fiscal cliff. Both explanations probably have some truth and may overlap each other. Much will depend on how the fiscal cliff negotiations go, as the market averages are now close to or slightly below their 200-day moving averages, which are often treated as warning signs, and they will be subject to any uncertainty created by the fiscal cliff.

The battle has already started, of course, and both sides are digging in even as preparation for negotiations begins. Over the weekend, the NYT put “Obama to Insist on Tax Increase for the Wealthy” on the front page, while the Wall Street Journal (WSJ) had “Obama, Boehner Open to Budget Bargain” on page 1 and “‘We Have a Voter Mandate Not to Raise Taxes’” on the op-ed page. The latter is an interview with Mitch McConnell, the Republican Senate leader, that says pretty much exactly what’s in the headline. The Financial Times (FT) led with “Obama fires opening fiscal salvo” on the front page and had “Obama urged not to yield on budget” on page 4, where Democratic senator Patty Murray does just that.

Today’s editions feature similar stories, including “A dangerous game of cliff-top brinkmanship” and “Democrat takes tough line on approach to budget” on page 3 of the FT; “In Debt Talks, Revived Obama Is Ready to Go Beyond Beltway” on the front page and “Business Chiefs Step Gingerly Into a Thorny Budget Fight” on page B1 of the NYT; and “White House Plans Public Appeal on Deficit” on A4 of the WSJ.

While both sides are laying out hard-line positions, either directly or through surrogates, what’s rather encouraging is that, if you actually read the articles, there is wiggle room. McConnell, for example, is holding firm on rates but not on revenue, and Boehner has made the same distinction. The White House is holding firm on taxing the rich, but the definition of “the rich” is open to discussion. Both sides are committed to talking, and neither will want to take the blame. The Obama-Boehner “almost deal” from the debt ceiling talks is being touted as a possible template.

I suspect we will get a deal, but not until the last minute. There’s no political incentive to come to an agreement any sooner, and both sides need to look like they squeezed every last drop out of the process. Expect more volatility in the financial markets—Europe and the on-again/off-again talks around Greece are a reasonable template—as the negotiations are played out in the press. Take another look at Bob Woodward’s book to find reasons to worry.

Remember, though, that there are enormous incentives to reach a deal—for both sides—and that such a resolution could have enormous positive effects across the entire economy. We’re getting there, but, as usual, the last mile can be the hardest.

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