The Sequester: What Investors Need to Know

Absent some quick progress in Washington over the next few days, the sequester– $85 billion in across-the-board federal spending cuts – will most likely hit this Friday.

While some of the cuts may be rescinded during March budget negotiations, at least some should stick.

Despite their modest size, the cuts will be, at least temporarily, disruptive to the US economy and markets. Here’s why:

• The Sequester Will Increase Fiscal Drag.  Fiscal drag from the spending cuts alone is likely to be as high as 0.5% of US GDP. But fiscal drag from the cuts and recent tax hikes combined is likely to be around 2% of 2013 GDP, a large hit for an economy that barely grew by that much last year.
• Today’s Low Interest Rate Environment Could Strengthen the Sequester’s Impact. There is also some evidence that the damper on the economy from spending cuts and higher taxes could be even greater when interest rates are close to zero and other countries are going through the same austerity exercise.
• Slow Growth Should Slow Stock Market Gains. The sudden drop in government spending and recent taxes will likely mean modestly slower US growth during the first two quarters of this year.  This, in turn, may slow equity market gains as we move into March.

Given that the overall economic environment is likely to deteriorate a bit in the near term thanks to significant fiscal drag, market gains will get tougher from here and investors should be prepared for a rocky road ahead. In other words, last week’s market selloff and volatility spike could be a sign of things to come over the next couple months.

That said stocks can move higher in 2013. While investors were rightly concerned last week about slow growth, their worries about the end of the Federal Reserve’s quantitative program were premature. In fact, if the Sequester hits , the Fed would be even more likely to keep up its asset purchase program in an effort to offset the drag on economic growth.

The upshot? As at least some of the sequester’s resulting fiscal drag is likely to be temporary, investors may want to view any equity market volatility as a long-term buying opportunity.

Source:  Russ Koesterich, BlackRock Chief Investment Strategist

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

The Jacksonville Business Journal has ranked D2 Capital Management in 

the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida.

D2 Capital Management is a Member of the Southside Businessmen's Club and the Beaches Business Association