January Surprises As The Fiscal Cliff More Bark Than Bite

Forget about " A September to Remember" for those shunning equities in January that just plain stings. The S&P 500 advanced an impressive 5.2% as fear of the fiscal cliff faded into memory. Once again our fearless leaders dragged us into the 11th hour before they agreed upon a compromise that was on the table eight months earlier. The temporary Bush tax cuts became permanent for most taxpayers and now appropriate policy once they could be re-branded. Of course the heavy lifting on the titanic budget deficit was postponed until the arguments can be framed out to blame the other party when entitlement program cuts and raising taxes need be introduced. Once again both parties utilized scare tactics using the media as their podiums to galvanize their bases that the "Fiscal Cliff" would cripple the country. The recent announcement that fourth quarter GDP fell -.1% after expanding +3.1% in the third quarter seems to support those threats. Time to pull back the curtain and shed some light on what really happened. Two main detractors to fourth quarter GDP, 1.Defense Spending -22%. Many government agencies sensing the upcoming budget cuts exhausted funding in a "use it or lose it" mindset in the third quarter. 2. Inventories inventories inventories. This is where policy effected corporate behavior. The uncertainty surrounding the onslaught of tax hikes combined with the sun-setting of Bush tax cuts and the expiration of the 2% reduction of the payroll tax cut lead many retailers to draw down existing inventories leaving the shelves barren due to lack of reinvestment. Combined these two events accounted for nearly -2.6 percent negative growth. Then an interesting thing happened on 12/31/12 at 12:59:59 a compromise was reached to extend the current tax rates (no longer referred to as Bush tax cuts) for 99% of ordinary folks. You can see the results in the market. January had its best start in 30+ years. The message should be loud and clear to all, the US economy is itching to spread its wings and take flight again, Washington just need to get out of the way! What's happening! Jobs: Let's start with the most important factor, employment. The real time indicator for job creation/destruction is weekly unemployment claims. Weekly Claims have moved down from a previous range of 160,000-185,000 to 130,000-155,000 range as hirings ramped up to meet improving demand. The monthly numbers, Non-Farm Payroll grew by a not too impressive 157,000 for January. However, the revisions to December and November added an additional 127,000 jobs for a three month average of 200,000. We're clearly heading in the right direction. Housing: We're not ready to pop the corks but housing appears to officially have bottomed and should no longer be a drag to the economic output and job creation in general. The housing market index continued to hold at its best levels since 2006. In December housing starts increased 12.1% to an annual run rate of 954,000. Home prices as measured by the Case/Shiller Index rose 5.5%. Lastly, building permits which is a forward looking indicator grew +.3% to a 903,000 annual run rate. So we note a continuation of the trend. Leading Economic Indicators: LEI came in at +.5% the best showing in three months. The gains reflect strength in the labor market, low interest rates and gains in stock prices. When we factor in the rebound in housing/construction it would continue to support the bullish thesis. Institute for Supply Management: ISM releases their reports for both Manufacturing and Non-Manufacturing (referred to as the services measure). We received good news on both fronts suggesting the economy is expanding on all fronts. ISM Manufacturing came in at 53.1% in January vs 50.2 in December (a number above 50 suggests an expanding economy). The new orders component posted a 3.6% increase to 53.3%. Also impressing the masses, the employment component accelerated + 2.1% to a 54 reading. The ISM Non-Manufacturing eased a bit to 55.2 vs 55.7 however once again we see strength in the employment component as it leapt to a 7 year high of 57.5. Back to 4th Quarter GDP and why we maintain our bullish posture in the face of the negative report. 1. Consumer spending and income. The GDP reports shows consumers after tax income rose 6.8% the fastest pace since the recession. 2. Business investment rose 8.4% 3. Home building. Home construction rose at at 15.3% annual rate 4. Inventories. They were drawn down by strong sales and an unwillingness by retailers to restock. They'll need to be rebuilt. 5. Government spending reduced GDP by 1.3% Forward: The equity market sprung out of the gates in January but we believe some of the gains were a give back from the December Fiscal Cliff Fright that saw some investor liquidations ahead of potential higher capital gains and income taxes. Global Central banks have the spigots wide open and are flooding the banking system and financial markets with unprecedented amounts of stimuli and liquidity. The good thing is markets are responding. The challenge will come when those same spigots need to begin to lessen the flow and whether the economy and markets can stand on their own. The current results are promising. The US economy is, arguably about to re-accelerate (IF DC gets out of the way) and China's economy has resumed expansion mode. The EU has been stabilized, India is liberalizing it's economy, Brazil, Mexico and emerging markets in general are gaining traction which all bodes well for global trade as a rising tide lifts all boats. While trading should remain volatile, overall the trend remains positive and our year end target for the S&P 500 remains in tact and most likely overly conservative and will need to be updated as the resolution and details of the budget debate come to light. For now we maintain our aggressive posture to the markets but are on alert for any changes to policy or geopolitical events and will be in contact immediately should any changes be necessary. Thank you again for your confidence and patience in these challenging times. Yours in pursuit of the KWAN! James