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Ahead of Wall Street - Feb 11, 2013

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Monday, February 11, 2013

Without much on the economic or earnings fronts today, stocks will likely struggle to sustain the positive momentum from last week, but the overall trend appears to be to the upside. The budget sequester which takes effect in less than three weeks will likely start gaining more attention in the coming days.

The budget uncertainty could potentially be a headwind for the market rally, but one could reasonably envision a scenario where the market would overlook its negative growth impact and focus instead on its beneficial effect on the long-term fiscal deficit.

The budget sequester remains a key challenge for the economy, but it is of magnitudes lower power than the year-end 2012 ‘Fiscal Cliff’ or upcoming debt ceiling issue. Should the sequester take effect as in current law, there will roughly be $85 billion in less government spending this year or about 2.4% of this year’s projected $3.5 trillion budget.

The sequester would shave off an estimated 0.7% from this year’s GDP growth, which when combined with other fiscal restraints like the higher upper income taxes and the payroll tax expiry, will represent a material fiscal drag on the economy. That said, the private sector economy appears in a good enough shape to withstand this level of austerity.

Even as the ‘headline’ GDP growth dipped into the negative territory in the fourth quarter due to reduced government outlays, spending by consumers and businesses showed a lot more resilience and momentum. The January Retail Sales numbers coming out this week will give us a good sense of whether the fourth quarter’s consumer spending momentum has carried into the current period, particularly following the expiration of the payroll tax cut.

The concern is that the impact will be particularly pronounced for lower income households which could be problematic for companies like Wal-Mart (WMT - Free Report) , Dollar General (DG - Free Report) and McDonald’s (MCD - Free Report) . The most likely scenario is that we will see the consumer spending impact not in one month, but over an extended period in the next few months.

Sheraz Mian
Director of Research

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