EDITORIAL: A bump in the road in April as equity markets lose ground

The equity markets lost some ground in April as renewed fears of a European crack up and slower U.S. growth rattled investors here and abroad. This offset the good news of strong U.S. first quarter corporate earnings. And, worries about oil supply disruptions out of the Middle East seem to be ebbing.

S&P 500 stocks lost 0.6 percent last month but are still up 11.9 percent year to date. Overseas in Europe, markets were softer with the Stoxx 600 off 2.3 percent in April. China posted 8.2 percent economic growth in the first quarter. The Shanghai index jumped 5.9 percent last month.

Bond yields fell back to just below 2 percent on the ten year Treasury after having reached 2.35 percent in March. The Federal Reserve met in April and reaffirmed their expectation of rock bottom interest rates through 2014.

WTI oil gained $2 to $105, while commodities in general (Dow Jones-UBS index) were flat over the month and year to date. Of note is that warmer weather and lower natural gas prices have more than offset the increase in gasoline prices, which has steadied consumer spending so far this year.

The Looming Fiscal Cliff

There has been much talk about a fiscal cliff facing the economy in 2013. USA Today says “Tax cut impasse has many in limbo” while BusinessWeek warns the “End Is Coming” in January 2013. And the New Your Times offers “Coming: Taxamagedon.”

This is the result of some serious can-kicking by policymakers in Washington.

Basically a series of automatic tax increases and spending reductions have been postponed until after the election and if not resolved could drag the economy into recession when they take effect on Jan. 1, 2013.

Federal Reserve chairman Ben Bernanke was asked if easy monetary policy could offset the fiscal cliff. He said “the size of the fiscal cliff is such that there’s no chance that the Fed could or would have any ability whatsoever to offset that effect on the economy.”

Goldman Sachs has these estimates for scheduled fiscal tightening in early 2013 unless something is done:

• Automatic cuts from last year’s debt deal: $100 billion

• Bush tax cuts not extended: $212 billion

• AMT fix not extended: $132 billion

• 2012 Payroll tax cut not extended: $109 billion

• Expiration of unemployment benefits: $34 billion

That adds up to almost a $600 billion reduction in the budget deficit which is 3 to 4 percent of GDP. Add that negative to a 2 percent underlying growth rate for the economy and you get negative growth. That is, a recession.

Most believe nothing is likely to get done in the run up to the election. Both parties think they will get leverage and be in a better position to get their way after Nov. 6. So a compromise deal must get crafted in a six week lame duck session or cuts/increases will occur automatically beginning in 2013.

ISI Strategies believes that there is a meaningful chance of a temporary expiration of the Bush tax cuts. Still, their base case is optimistic with a budget deal sometime in 2013 that will substantially reduce future deficits and be equity market friendly. In any event, uncertainty is in the air and that’s not good for business or investments near term.

By the way, the budget deficit this year is worse than expected, suggesting that we may reach the $16.4 trillion debt ceiling sometime in the fourth quarter. Remember how much fun that was last summer when the two parties jockeyed over raising the debt ceiling, and America lost its AAA rating?

Driving off a cliff is never a good idea. Perhaps cooler heads will prevail and the ongoing game of fiscal chicken between the elephants and the donkeys will end well. Recent surveys of investor expectations put the odds at 50/50. That’s not reassuring.

Jeff Pantages, CFA, is the chief investment officer for Alaska Permanent Capital Management, a $2 billion investment management and advisory firm located Anchorage.