It's remarkable how nonchalantly the U.S. stock market has treated the disappointing results reported by Cisco Systems Inc. earlier this month.
Despite a warning from Cisco's CEO John Chambers that public-sector business will continue to be challenging for several quarters, investors shrugged off the darkening outlook, arguing that the miss was a one-time event and limited only to Cisco.
Wrong and wrong.
State and local governments in the U.S., which represent 13 per cent of GDP, are in disarray and need to slash spending to close massive fiscal gaps. As a result, companies that sell into this part of the economy are vulnerable to cutbacks in sales. It is hardly likely that this loss of revenue is limited to Cisco, which proved to be a key bellwether at turning points in the market in both 2000 and 2007.
The fiscal mess at the state and local level will probably be the front page story in 2011 and the retrenchment in this sector poses the greatest headwind regarding the economic outlook.
The promise of government intervention that caused everyone to hyperventilate back in early September has been revealed as threadbare. Neither the Federal Reserve's promise of a new round of quantitative easing nor the U.S. mid-term elections have been able to create the conditions for a sustainable recovery.
Based on the high hopes surrounding government intervention, bullish investors began in August to drive up stocks and commodities, ranging from corn to crude to copper, in hopes that asset reflation would rear its lovely head. But over the past two weeks, the markets have been pricing in the likelihood that the Fed and Congress actually have precious little to offer in terms of any stimulus in the near future.
In fact, the political shift in the United States from left to right is characterized by a powerful move toward budget cutting both in Washington and at the state level. Voters apparently want their government to practice a frugality similar to what they are attempting in their own households.
Withdrawing Life-Support
This raises the question: How well will the economy do without continued life-support from the government?
The U.S. economy is already fragile, with real GDP growth likely to slow to a 1.7-per-cent annual rate this quarter, below the consensus view of 2.2 per cent. The negative fiscal shock we are likely to see early in 2011 from declining government spending could well trigger something closer to zero growth in the first quarter.
In other words, we will very likely again be debating a double-dip scenario in coming months. In the meantime, the core producer price index (which removes the effects of food and energy) just came in at minus-0.6 per cent in October, so evidence of any sustained inflation at the final stage of production is hard to find.
The housing market cannot get out of its own way. Gasoline prices are high. Extended jobless benefits are about to lapse at a $70-billion (U.S.) cost to personal income over the next five months. Holiday shopping surveys show a marked falloff in spending plans among low-end households.
Given the gathering clouds, it seems likely that the stock market will be on a declining path, at least through year-end. The number of new lows on the New York Stock Exchange rose dramatically last week and the share of stocks trading above their 50-day moving averages has declined in the past three weeks from 90 per cent to 70 per cent. In other words, there is less momentum supporting the market than meets the eye.
The S&P 500 has been locked in a rough range between 1,000 and 1,200 for 14 months. Most pundits still believe we are in a cyclical bull market but that is not the case - it has been a sideways market now for more than a year. Moreover, after testing support in July, the market hit resistance levels in November, so it would seem logical to expect the index to make a run at the low end of the range. The only question is whether investors will rush to support it at that lower level.
David Rosenberg