The Federal government has agreed to reduce spending by $1.2 trillion over the next nine years, which amounts to $130 billion a year. This is set to start immediately and then ramp up over time. This fiscal year, $85 billion in cuts are required, and then $85 billion the year after. Subsequently, the spending cuts ratchet up in the years following.
Keep in mind, U.S. GDP is $16 trillion, and the budget deficit is 5.3%,
or $840 billion. Therefore, spending cuts of $85 billion takes the U.S.
deficit to roughly $760 billion. As U.S. government spending decreases,
it reduces GDP, reduces corporate earnings, and could have a negative
effect on the market over the short-term.
While the sequestration will be a negative for economic growth in the
short term, we believe the spending cuts will result in a rise in
private growth over the long term.
The U.S. Federal deficit needs to be reduced in order to raise the
long-term growth rate potential of the economy. As the U.S. government
continues to run a deficit, there is an increasing amount of debt that
is issued in the form of treasury bonds.
This debt crowds out investing in the private sector. In the private
sector, new ideas, products and companies may not get funded at a lower
rate because investors tend to purchase government debt as opposed to
lending to corporations. As the debt is reduced, or at least stops
growing at such a rapid rate, the economy will benefit over the long
term because it will lead to positive growth for the private sector. We
believe this is why the market has not reacted negatively to the
sequestration. At the end of the day, cutting spending helps long-term
The biggest problem with sequestration is that it does not address
entitlement programs. Medicare and Social Security are not being
touched. Politically, both sides of the aisle do not want to touch
entitlement programs that support the elderly because of the historic
consequences on national elections.
The stock market is soaring to new highs, largely, because of the Fed’s
quantitative easing programs. The biggest risk to the market is the
reversal of those programs as we believe that would trigger a massive
sell-off in the equity market.
Cutting spending actually reduces the risk that quantitative easing will
stop. This is because the budget cuts soften the economy, which allows
the Fed to continue to essentially print money. Effectively, budget
cuts increase unemployment and therefore reduce the chance that the Fed
is going to scale back their quantitative easing programs anytime soon.
Cutting spending has become a sideshow. The Fed is the key. The fact
that the stock market is approaching new highs is proof that the market
and economy are fine with these cuts.
Down the road, we need to see the politicians agree to more spending
cuts, and agree to do it rationally. This would help the stock market
and the economy. So far, they are not doing it in a coherent,
economically efficient, fashion.
-- Mitch Zacks, ZIM Weekly Update
The sequester has been advertised as “cutting” discretionary spending
over a ten year period by $995 billion. After inflation adjustments and
exempting more than a trillion dollars of defense and non defense
discretionary spending from the sequester, the CBO projects (in its
Table 1.1) discretionary spending to increase by $110 billion
over the decade. There is no actual $995 billion cut after the CBO
applies its magic adjustments. Rather there is a $110 billion increase.
[In other words, instead of increasing by $1105 billion, it will increase by $110 billion. So about a 90% reduction of increased spending.]