Looming Automatic Spending Cuts: What to Expect From Stock Prices

Deficit hysteria is sure to grow this week when a quarrelsome Congress attempts to draw up a budget ahead of those March 1 automatic spending cuts. We’ve all heard that the wrong-sized budget could have dire consequences for the economy. But what, really, will all this do to our stock portfolios?

Some experts think your stocks will tank if Congress doesn’t definitively and deeply cut government spending. Wells Fargo Strategist Gina Martin Adams maintains a very bearish 2013 S&P 500 target of 1390 in large part because high government debt “will inhibit capital formation and risk taking in the near term.” More than 100 corporate CEOs have joined the “Fix the Debt” group imploring Congress to enact large spending cuts. They predict a rash of business-averse consequences if high debt continues, such as inflation that dissuades corporate investment and increases the cost of living.

On the other hand, economists expect stocks to tank if government cuts back spending too much, arguing that such action would put the country right back into recession. Government budget cuts mean job losses, in the public sector and in companies that rely on government contracts, like Raytheon (RTN), Lockheed Martin (LMT) and General Dynamics (GD). Their stocks have fallen harder as sequestration (those March 1 automatic cuts) grows more likely, as seen in a stock chart.

RTN Chart

RTN data by YCharts

Markets, however, are not exactly panicking over this. Risk taking, in the form of mergers and acquisitions, hasn’t been this high in ages. In the past few weeks, private equity groups have announced plans for a $24.4 billion buyout of computer make Dell (DELL) and a $23 billion takeout of ketchup maker Heinz (HNZ). US Airways Group (LLC) and American Airlines announced an $11 billion merger, and Comcast (CMCSA) agreed to pay $16.7 billion for General Electric’s (GE) stake in NBC. All of that was just in February, which isn’t even over yet.

In fact, so many investors are optimistic about corporate America’s future fortunes that the S&P 500 is trading near an all-time high.

^SPX Chart

^SPX data by YCharts

The 10-year Treasury yield is rising as investors grow more comfortable with the stock market. The cost of living has remained relatively flat in recent years even as the government deficit built to record levels.

US Consumer Price Index 1-Month Percent Change Chart

US Consumer Price Index 1-Month Percent Change data by YCharts

Former Federal Reserve Chairman Alan Greenspan told CNBC that he has little faith in Congress’ ability to avoid those automatic budget cuts. He, too, is quite concerned about how the stock market will react, but not because he’s worried about losing money there. Rather, he believes the market’s strength will be a key determinant in the economy’s health going forward. If the stock market can survive the original hit of this known threat, he predicted, the long-term negative effect of government budget woes will be “rather minor.” Investors, he seems to be saying, will go a long way in determining their own fates here.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.



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