Why Wall Street Is Ignoring the Arrival of the Sequester
Washington has a serious case of the blahs. The sequester has arrived, without so much as a pro forma effort to avoid it. The sense of angst was palpable among the White House press corps. After all, they’re going to be hit with a double whammy. They’ll be forced to spend more time writing about topics they’re not interested in and don’t know much about, like the deficit and budgets, and the sharp cutbacks in spending are likely to sandbag the D.C. regional economy, thus reducing the value of their homes.
But on Wall Street, everything seems to be hunky-dory. As House Speaker John Boehner gruffly fled the White House and President Obama plaintively asked reporters for advice on how to deal with the loony House Republicans, the stock market recovered its early losses and drifted higher. By midafternoon, the Dow Jones Industrial Average, nearing 14,100, was in spitting distance of a record-setting close. (The high-water mark remains 14,164.53, on October 11, 2007.) Keep calm and rally on.
How can this be? After all, Washington and Wall Street have frequently been joined at the hip in recent years. From the TARP to the stimulus, from the August 2011 debt-ceiling debacle to the fiscal cliff, D.C. dysfunction has frequently caused market gyrations. In the past week, however, Wall Street has greeted the threat of automatic budget cuts with a shrug. Here’s why:
1. They’re just not that into you.
Wall Street has learned to ignore Washington and simply doesn’t care what the political system does. That wasn’t the case a few years ago, when the markets could move several hundred points in a day based on a failed vote on a bailout package, or on a decision by the Federal Reserve to guarantee a chunk of financial assets, or on a policy announcement affecting mortgage giant Freddie Mac. In 2008 and 2009, government often meant the difference between financial success and failure of large chunks of the system and, frequently, of the system as a whole.
But the era of bailouts, guarantees, and stimulus is over. TARP has essentially ended. Banks have stopped failing—only four little ones so far this year have gone under. Freddie Mac just reported a $4.5 billion quarterly profit. Yes, the markets remain largely dependent on the Federal Reserve, which is based in Washington, to provide cheap money to banks and keep interest rates low, thus encouraging investors to buy stocks instead of low-yielding bonds. Still, the Central Bank has become a boring open book. Federal Reserve chairman Ben Bernanke has committed to buying bonds into the indefinite future. Monetary policy moves as much (or as little) as Donald Trump’s hair.
After the drama of the August 2011 debt-ceiling debacle, Washington has lost its capacity to shock the markets. Sure, D.C. still talks a good game about the fiscal cliff (all the Bush tax cuts will expire!) or debt limits (they’ll never be raised again!). But ultimately it tends to resolve the situations that have the potential to cause real and lasting damage to the economy and the markets. Investors are assuming that the sequester’s full effects won’t hit the economy and the effects that do hit won’t cause severe damage.
2. The fundamentals of the economy are sound.
It’s also possible that Washington has lost some of its capacity to inflict harm on the economy, even if it does cut federal government spending by $85 billion over the next seven months. That’s because the private-sector economy is doing quite well.
A slew of reports this week indicate that the economy has recovered from its fourth-quarter 2012 soft patch and is plowing ahead. First-time jobless claims were down sharply. New home sales were up 29 percent in January 2013 over January 2012. Durable goods orders were good enough. On Friday, as the political class woke up and began to cope with the first day of the sequester, car companies, which represent the largest retail sector and the largest manufacturing sector, reported positive February results: GM was up 7 percent from the year before; Ford, 9 percent. The ISM Purchasing Managers Index indicated that the manufacturing sector is expanding smartly.
Macroeconomic Advisers believes the economy will expand at a 2.5 percent annual rate in the first quarter of 2013. The sequester will put a dent in that figure. But $85 billion of reduced federal government spending in a $17 trillion economy that is expanding at a 2.5 percent rate won’t have a dramatic effect on the trajectory of growth.
3. The market is made up of individual stocks.
Companies that depend on the federal government for most or all of their revenues will certainly see lower revenues and profits as a result of the sequester. And so one would expect the stocks of government contractors such as Lockheed-Martin and Booz Allen Hamilton to fall.
But in aggregate, stocks today aren’t bets on the volume of U.S. government spending or even on U.S. economic growth. Rather, they’re bets on the future of the global economy. The typical member of the S&P 500 index gets about half of its revenues, and most of its growth, from outside the U.S. borders. For the truly massive companies that comprise the Dow Jones Industrial Average, like Intel, or Coca-Cola, or IBM, the proportion of revenue coming from outside the U.S. can be as high as 70 or 80 percent. Sure, declining government spending could ultimately lead to falling sales for McDonald’s, which has outlets on several military bases, or on General Electric, which sells equipment to defense contractors. But for the overwhelming majority of publicly traded companies, short-term changes in government spending are nonevents or very small events. It’s hard to imagine how the sequester is going to affect the sales of Apple, or ExxonMobil, or Facebook, or Starbucks.
In the past, vicious market reactions to Washington policy outcomes helped to push the two parties to the table. Nothing concentrates the mind like a 500-point drop in the Dow. But that’s not on the table. The stock market is not going to push Republicans to abandon their rigid no-revenue approach to resolving the sequester.