Macro Wrap – Who Cares about the Sequester

by Enis February 28, 2013 8:00 am • Commentary

One of my favorite blogs on the web (and I follow dozens) is that of Cam Hui, an investment manager in Canada who writes at the HumbleStudentoftheMarkets blog.  Cam has written another timely post this morning with regards to the market’s reaction to the upcoming sequester.

Cam writes this morning:

Has the equity market been conditioned, like Pavlov’s dogs, to expect a last minute sequestration deal? Why has there been no negative market reaction when it was reported (via NBC) that Obama would meet Congressional leaders on Friday, after the sequester deadline [emphasis added]?

So let me get this straight. President Obama is meeting with senior Congressional leaders to discuss sequestration on Friday, after the deadline has passed. Meanwhile, the Dow rallies and defense stocks, which are highly sensitive to government spending, are outperforming the market.

Is the market just conditioned to getting a last minute deal, just like what we saw during the 2011 debt ceiling impasse, or endless eurozone summits over Greece in the same year?

What happens to equity prices if the cavalry doesn’t arrive?

In contrast to the period leading up to the fiscal cliff, the market has been sanguine about the possibility of the sequester hitting growth.  Granted, the estimated impact of the sequester is only around 0.5% of GDP, but add to that the ongoing impact of the payroll tax hike, and the potential for a stall-speed growth seems higher than the market’s current default estimate.

As Cam highlights above, I view the market’s current price action as a case of the “Boy who cried Wolf” parable.  Market participants are unwilling to sell on government gridlock given that they were burned in December reducing risk ahead of an eventual deal.  Though the uncertainty and impact are lower this time around, the actual impact to growth is not insignificant, particularly with other global growth indicators flashing yellow (commodity prices, European and Chinese PMI data, dollar strength).

Equities can certainly continue higher, but the risk/reward backdrop favors the bears.

Markets overnight:

  • Asian equity markets were strongly higher, with Japan and China both up around 2%.  India was the only weak spot, down almost 2%.
  • European markets have traded green for the whole session after dovish comments from Draghi, but are now up only 0.25%.
  • SPX futures up 0.2% in a very quiet overnight session.  The dollar is flat, Treasuries are higher, and commodities mixed with no big moves.
  • Revised GDP data, Personal Consumption, and Jobless Claims at 8:30 am EST.  Regional manufacturing surveys the balance of the morning.