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The US Fiscal Cliff: A Cue to Start Hoarding

August 20, 2012 | About:

You may not be surprised to see another article about the U.S. fiscal cliff. In fact, you might be tired of it, as exhausted as the analysts bombarded by incessant talk about Greece and the euro.

But turning a blind eye won’t stop it from coming, and there is no investment guru that hasn’t heard about it at this point.

A quick search of “fiscal cliff” in GuruFocus yields nine — only nine — posts that make at least a slight reference to it, of which I found three to be reminders of what is to come.

Jim Rogers had this to say about it (all emphases mine):

“The United States is the largest debtor nation in the history of the world. Our debts are skyrocketing every year and nobody’s doing anything about it. Every country in history that’s gotten into this situation has had a crisis or a semi-crisis, or both. In 2002 we had an economic slowdown, which was fairly serious, and then in 2007 and 2008 we had another one, which was worse because the debt was so, so, so much higher. The next time around the debt is going to be that much more catastrophic.

The FPA Capital Fund’s Q2 Commentary (all emphases mine)?

“Both democrats and republicans have made clear what they fundamentally believe needs to occur in order to reduce the deficit, but the differences in philosophy are fairly profound. We are skeptical that anything will be accomplished until after the national election in November, and believe any resolution to the oft discussed fiscal cliff will be deferred into 2013. This would result in automatic spending cuts to take place in the Department of Defense and other programs not tied to Social Security, Medicare, Medicaid or other entitlement programs. The so-called Bush tax cuts and other temporary tax cuts will also expire at the end of this year. All of this fails to inspire businesses or individuals to feel confident about the economic outlook for this country. Unless Congress and the White House agree to reduce the growth of entitlement spending, enact meaningful tax reform, and remove the regulatory burdens on businesses, we believe these headwinds will continue to exert downward pressure on the growth rate of our economy.”

Seeing as how I’ve yet to see an article directly tapping this, last quarter the Congressional Budget Office released a paper that details the “economic effects of reducing the fiscal restraint that is scheduled to occur in 2013”. You can find it easily by Googling the document, and the keywords have practically been given to you — I just gave you the title!

If you were to read the whole thing word for word, you would come to realize (or accept) a great buying opportunity is coming: a recession might just hit the country in 2013 H1.

Indeed it might crop up, but only on the condition our friends in Congress and whoever wins in the November elections do not harden their hearts and somehow renege on the stipulations of the sequestration imposed by the 2011 Budget Control Act without imposing any further policy changes.

Politicians face three choices, according to the CBO.

“They could address the short-term economic challenge by eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years… Alternatively, they could move rapidly to address the longer-run budgetary problem by allowing the full measure of the fiscal restraint now embodied under current law to take effect next year… Or… they could enact a combination of policies: changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law…"

Short-term hardship? Utter destruction in the long-term? Or the idealist’s favorite: the middle ground?

The sequestration as it is currently known will reduce a net $560 billion from the federal deficit between fiscal year 2012 and fiscal year 2013, taking into account a $47 billion “economic feedback” resulting from the subsequent strike on the economy. CBO estimates the $607 billion gross reduction to come from the following sources:


With a net $560 billion being removed from the economy (and take note this is largely ephemeral considering forecasts are inaccurate by design), the CBO expects this divestiture will weaken the economy in the second half of 2012 and “a much larger impact… in 2013,” magnifying expected restraint in household spending and business investments/hiring to the extent real GDP is projected to “increase by just 0.5% next year under current law …reflect[ing] a contraction in output at an annual rate of 1.3% during the first half of 2013… then a renewed expansion in output at an annual rate of 2.3% in the second half of 2013.”

The CBO does not even forget to emphasize any economic forecast is made more uncertain by the Euro Crisis and any further developments in the US Housing market.

What I find interesting here is how the CBO — without saying it outright — is claiming the politicians in charge of this country won’t find a way to completely prevent GDP contractions short of abolishing the fiscal restraint. Table 2 of the CBO May 2012 report flatly depicts that real GDP will move by a range spanning a 0.4% drop to a 3.8% growth in 2013 H1 under the alternative fiscal scenario that “reflects a combination of changes to current law, including changes that would maintain major policies that have been in place for a number of years” (e.g. extension of expiring tax provisions, indexing of AMT to inflation, and extinguishment of the automatic spending cuts, to name a few examples).

If the pols somehow find completely and utterly remove the fiscal restraint and return to the unsustainable status quo without doing anything to reduce the fiscal deficit and the federal debt over the long run, the CBO expects these liabilities to start rising significantly faster than GDP thanks to the Baby Boomers and inflation in healthcare, causing “a growing portion of people’s savings” to government debt rather than “investments in productive capital”, necessitating higher interest payments that will increase taxes or reduce government benefits while restricting the ability to use tax and spending policies in response to Black Swans.

Should human nature be of any indication, I find myself concurring with FPA Capital’s commentary. It’s hard to forget how the U.S. politicians squabbled over the debt ceiling dilemma last year, only to kick the can.

Joshua Brown of The Reformed Broker has even gone so far as to assert “there are precisely zero solutions” last week for the simple fact that everything crushing the U.S. economy is within budgets coddled by political interests.

The bottom line is that there’s a decent chance we’re going to get knocked around next year.

I’m not saying we should forgo purchasing investments now, when there are plenty of opportunities to be found thanks to the volatility present in today’s market environment.

I’m saying this is a cue for us to begin hoarding capital, just in case this recession comes to pass, drags market prices down with it, and gives value investors the opportunity to average down.

About the author:

Ry Zamora is a value investor with a 2010 Bachelor's degree in Mgt from the Ateneo de Manila University in the Philippines. He started his investment portfolio in his junior year and, showing much love for money management, exhibited a strong willingness to learn and continues to find thrill in making money.

Rating: 3.7/5 (6 votes)


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