Saturday, May 26, 2012

Fiscal Cliff

I began to hear about this fiscal cliff in 2013 last month and the talk will get louder as the year goes on.  The expiration of the Bush tax cuts and federal spending cut mandates are due for 2013 but that is if the politicians let it be.  Will they let it be this time?  They didn't in 2010, extending the Bush tax cuts for 2 years.  And last year, they extended another gimmick, extending payroll tax cuts.  Obama is no dummy.  He knew that if he didn't do the tax cut extensions, the economy would turn into what Europe is right now.  And he would have no shot at reelection  And Republicans never met a tax cut they didn't like. 

But this time, it will be tougher.  The Republicans do not want the economy to have hope heading into the elections, and tax cuts give it hope.  So they will try to make deals with the Democrats that they know won't be accepted to keep anything from passing.  This political game will cause the market to have another temper tantrum, like last fall, but this time, it will be over something domestic, not European or fake, like the debt ceiling.   The U.S. economy is addicted to tax cuts, and needs them, like a crackhead needs another hit.  If it doesn't get that hit, it crashes hard.   I am expecting the S&P to at least test 1120, sometime in the 2nd half of the year.  The three legged stool has lost 1 leg, Europe, and another leg is badly maimed, Asia, the US is the last leg standing.  It will get chopped down soon.

Greece and the Eurozone is a red herring.  Those are well know facts at the forefront of the financial news cycle.  The real catalysts for 2nd half weakness is the fiscal cliff and the popping of the Chinese real estate bubble.  China is in deep deep trouble, and only recently getting some press

All the fund managers have crowded into the last safe haven, US equities, and they will get blown out as the negative fiscal situation takes center stage.  An alarming fact is that Apple, mostly by itself, drove the S&P to new 52 week highs.  And I see Apple near the peak of its earnings prowess as competition, the law of large numbers, and margin pressure will deflate the stock over the long term.  You chop off the head, Apple, the body goes with it.  Earnings growth is slowing down rapidly sans Apple.

Europe has already been shot and left for dead, a situation that is deemed hopeless by the fund community.  There is no hot money left in that region, only sticky, slow money that is mandated to invest in Europe by charter.   And of course short sellers.  Europe will outperform the U.S. in the 2nd half this year, after badly underperforming the past 2 years.  The economy will worsen ahead of the fiscal cliff as corporate spending slows down in preparation.  Corporate profit growth will go negative, spooking the bulls.  It will be a doozy of a 2nd half, this time the downturn will be led by the U.S., not by Europe. 

The reflexive buying of dollars in a downturn will be turned on its head, it won't happen.  The Fed will do a QE3 later this year ahead of the elections as an FU to the Republicans who hate Banana Ben.  This will rip the face off the shorts, but this time, it won't cause a lasting rally, because the economy will be unrecoverable at that point.  It will only fuel a run on the dollar, confounding dollar bulls who think the dollar goes up when the market goes down.  Gold will go through the roof.

But let's not get ahead of ourselves, we should consolidate the up move from earlier in the year and digest those gains, make a false move higher in a couple of months, and then begin a new bear market.

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