Bull or Bear Market for 2013? We’re About to Find Out

A great deal of attention has been paid to the “looming fiscal cliff” in recent months, and now it’s time to broaden your scope and track a series of key economic data points that might really spell out which kind of stock market we’ll see in 2013. I’ll get to that in moment — after some follow-up thoughts on that dreaded fiscal cliff’s near-term effect.

More bark than bite?
Earlier this summer, a series of surveys found that companies were starting to freeze important spending plans on fears that these investments would come to fruition just as the fiscal cliff was tumbling our economy into a deep recession. The mere fear of such eventual paralysis led some to conclude that economic activity in the third-quarter would slow and that fourth-quarter gross domestic product (GDP) might show deep weakness.#-ad_banner-#

Well, that view was wrong. Recent economic data — in manufacturing and housing — have been better than expected, and the expected slowdown may not materialize. In September, the Institute for Supply Management‘s manufacturing PMI rose 3.6% to 51.5, which indicates that the manufacturing sector is expanding. In addition, U.S. home prices increased 11% in September, according to the National Associations of Realtors (NAR).

Still, you need to stay tuned this Friday morning, Oct. 26, when the Commerce Department releases its first GDP reading for the third-quarter. Right now, the consensus forecast calls for GDP of 1.8%, which would be a slight improvement from the second-quarter reading of just 1.3%. Still, 1.8% is hardly pleasing. We still need to see how the fourth-quarter will shake out. Based on commentary from companies that have reported third-quarter results thus far, the fourth-quarter is likely to be tepid — at best — in terms of economic activity. The rate of GDP growth is surely to affect the market’s direction in 2013. As I noted in this piece, GDP growth below 2% can be troublesome while more robust GDP growth can create the perfect backdrop for a surging bull.

If the U.S. economy exits the current year growing at a 2% rate or less, then investors should be quite concerned about the outlook for 2013. And not because of the fiscal cliff, but of the plan that replaces it.

The early 2013 landmark agreement
If the fiscal cliff policies were enacted — which entails a radical amount of cost-cutting initiatives, then the economy would roughly take a 3% to 4% hit, according to various economic reports. Coupled with an existing economy growing at a tepid 2%, this drag would surely push the economy into recession. The good news: Fears of this happening will be enough grounds for Washington to come up with a different, perhaps milder plan.

Instead of the fiscal cliff, get ready for less impactful moves, though there will still be government spending cuts and tax raises (or at least close tax loopholes). Therefore, we’re likely still talking about at least a 1% to 2% drag on the economy.

This is precisely why the third- and fourth-quarter GDP readings are so important. If the economy grew at least 1.8% in the third-quarter of 2012 currently expected, and can use housing, manufacturing and perhaps consumer spending as levers to deliver a fourth-quarter GDP growth rate above 2%, then the economy may just have enough momentum to blunt the effect of whatever economic package Washington ultimately delivers.

As soon as we process the results of this Friday’s third-quarter GDP report, all eyes will pivot to next Friday’s big economic news. The Bureau of Labor Statistics will announce the monthly employment report on Friday, Nov., just a few days before the presidential election. For undecided voters, this figure may help them determine whether we should stay the course with President Barack Obama, or make a change with former Massachusetts Governor Mitt Romney. 

Suffice it to say, the election outcome has a range of implications for how government policies deal with the eventual fiscal agreement that Washington will have to enact. Make no mistake, neither Obama nor Romney may be able to avoid a recession in 2013 if we exit this year on a slowing note.

Risks to Consider: As an upside risk, a range of other economic reports will be released in coming weeks, and if they show vigor, then the economy may have just enough animal spirits to fight off any flaming daggers coming from Washington in the form of belt-tightening. 

Action to Take –>  Even as you play close attention to earnings season, it’s time to put a lot more energy into analyzing economic reports, which are usually released at 8:30 a.m. or 10 a.m. EST.

Other key economic items to watch:

  • Consumer Confidence, Oct. 30, 10 a.m. EST
  • Chicago Purchasing Managers Index, Oct. 31, 9:45 a.m. EST. (The Chicago region mirrors the nation in its distribution of manufacturing and non-manufacturing activity, so this is usually seen as an important economic indicator.)
  • NFIB Small Business Optimism Index, Nov. 13, 7:30 a.m. EST