This week the Congressional Budget Office issued a dire warning that the U.S. will be pushed into a recession if we don't get our budget in order prior to reaching a fiscal cliff at the end of the year. The report raised many questions, not least of which are: what is the fiscal cliff and how will it impact stocks? In the attached clip Mark Luschini of Janney Montgomery Scott explains the looming impact on the market.
"If you look at the calculation as to what's set to expire at the end of 2012 and in addition to that some of the budget control act starting to cutting into fiscal spending collectively the number can be high as a half a trillion dollars," he says.
By Luschini's math, the $500 billion hit to our $16 trillion economy translates into a 3-4% reduction of GDP. With growth stuck at 2% and falling, we're going to be in a recession by the first quarter of 2013 if policies proceed as scheduled.
Inasmuch as markets attempt to be forward-looking, participants will begin cutting estimates for corporate earnings. At that point traders will start to "de-risk equity markets."
The way the markets will predict the future is through the most likely election results. If a majority of those elected seem dedicated to finding a solution to the looming fiscal crisis, the equity markets will start to relax.
But don't forget about the Debt Ceiling which Luschini says could rear it's ugly head as soon as Labor Day. The U.S. political system being what it is, Luschini isn't particularly optimistic about these issues being properly handled.
He maintains the Debt Ceiling debate is worse than it was last year. Europe is worse, China is slowing, and the U.S. economy is no great shakes. Baring a miracle improvement overseas there's nothing to save America from itself.
"Earnings drive share prices and if the economy is set to slow obviously that's going to impair our balance and as a result equities will likely be marked down," says Luschini. With that, he neatly sums up why traders are so focused on the so called Fiscal Cliff.