The Market is Shrugging off Sequestration – For Now

By Walter Kurtz, Sober Look

As the so-called sequestration approaches, jitters among defense contractors are becoming quite visible. 50% of the cuts are expected to hit the Pentagon budget. States like Virginia, where the defense industry is a major portion of private employment as well as a key source of tax revenue, are also becoming uneasy.

The markets however seem to be shrugging off the impact of sequestration.  Over the past few months (including the post-election period) a basket of major defense stocks has performed in line with the S&P500 (see figure 1 below). And in spite of sequestration’s overall negative impact on the GDP, the broad market is near multi-year highs.

Market expectations seem to indicate that these cuts will be avoided – possibly at the last minute. For now however it looks as if sequestration may potentially go into effect.

Bloomberg: – Democrats and Republicans in the U.S. Congress are nowhere near a plan to avert $1.2 trillion in spending cuts about two weeks before they are set to begin.

It’s the latest in a series of fiscal deadlines created by Congress that in the past two years took the U.S. to the brink of a debt default, a government shutdown and middle-class tax increases that neither party wanted. Unless lawmakers act, the across-the-board spending reductions will begin March 1. 

Leaving the cuts in place would shave U.S. economic growth this year by 0.6 percent and cost 750,000 jobs by the fourth quarter, Congressional Budget Office Director Doug Elmendorf said yesterday at a hearing.

About half the cuts would affect defense spending, and military leaders are pressuring lawmakers to avoid them. Allowing the reductions, known as sequestration, to take effect would mean less training for Army personnel and fewer purchases of Navy vessels and Air Force fighter jets, the leaders said.

“It’s pretty clear to me that the sequester’s going to go into effect,” Senate Minority Leader Mitch McConnell, a Kentucky Republican, said yesterday.

And it seems that a number of politicians actually want to see sequestration activated.

 

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Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

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  • Paul Milenkovic

    OK, so Sequestration shaves .6% off growth, not just some imaginary accounting number, but someone losing their job or not getting a job or not being able to pay on student loans or support their family, in other words, real-world hardship to real people.

    The President wants to forgo Sequestration by raising taxes through the closing of “loopholes.” Is this proposal “revenue neutral”, that is, it raises in taxes what it spends by not sequestering? If so, what is the penalty to growth, if any, of this alternative plan?

    Does raising taxes cause less pain then forgoing spending?

    So, not forgoing the Sequester will cause people to lose their jobs. Is there any Amity Shlaes “hidden man” effect, that we will see the jobs saved or lost among State of Virginia defense contractors, but, say, do the policies to keep the deficit at high levels have any hidden effects, at all?

    Or maybe the optimal policy would be the maintain the deficit levels and allow Defense spending to decrease but to cut taxes? National defense is a worthwhile object of spending in the dangerous world we live in, but maybe we could forgo the Defense spending as directed by the Sequester and free that money, through tax reductions, to spending on other things as determined by the private sector through individual allocations of resources as mediated by financial, commercial, and retail markets?

  • Andrea Malagoli

    What does this say about an economy that is still so dependent on Government spending?

  • Detroit Dan

    We could do worse than to follow the example of Ecuador:

    Correa’s and Ecuador’s Success drive The Economist Nuts. Excerpts:

    Ecuadorian president Rafael Correa is the most popular president in the Americas with an “outstanding” approval rating of 80%… NEW highways and motorways snake across Ecuador, lined with billboards reminding drivers how bad the Andean country’s potholed road network was until Rafael Correa was first elected as president six years ago. The towns and villages boast new schools and health clinics. The minimum wage has risen well above inflation, and some 2m poorer people (in a population of 14.5m) get monthly cash transfers… Mr Correa has shown political skill in ramping up social spending in a country where provision was inadequate and poverty reached 64% in 2000 (it is now 27%)…

    At every opportunity, the magazine opted for snark over substance. Correa is “good-looking” and “smooth-tongued” and he “rails” against his opponents and presents a “seductive” message to the voters. The substance of his economic views and his success in predicting economic results of his policies are ignored by a magazine that claims to be devoted to economics and the views of economists.

  • Andrew P

    Everyone who works for DOD is being told that sequestration will take effect on schedule, no iffs, ands or butts about it. In fact it may not matter, since Hagel was appointed for the express purpose of cutting the DOD budget, thus the only difference is across the board cuts (sequestration) vs targeted cuts of the same amount.

  • Explorer

    Private household or corporate spending won’t fix the aging infrastructure across the US.