Spending Cuts Now Put Stocks on Shaky Ground

I am a proponent of continued cyclical government spending, which differs from secular government spending.  Cyclical government spending is critical in the short-term to keep the economy from faltering and corresponding cuts in long-term spending to keep the deficit under control.  I don’t think those beliefs are at odds with each other

Despite all of the chatter in Washington interest rates are still falling and core inflation is still tame.  High interest rates and high inflation are often seen as reasons to rein in spending.  It seems imprudent in this environment to cut spending and tighten the fiscal belt.

A recent Credit Suisse report (via FT Alphaville) adds fuel to my “fiscal tightening concern” fire by highlighting how fiscal expansion is needed in order to maintain profit expansion and thus a continued rise in stock prices:

• The average duration of profit expansion is 14 quarters going back to 1949.  We are in quarter 10.
• Three of the last 12 quarters have lasted much longer than the average – 32, 31, and 20 quarters, respectively.
• The key to maintaining profit expansion for that long appears to be strong employment growth and/or strong private sector credit expansion.
• Both employment growth and private sector credit growth are weak and still below the previous peak.
• At the same time government liabilities have grown, making the recovery’s reliance on government strong.

The conclusion is essentially that a contraction in government spending will result in a contraction in earnings.  That won’t be good for stocks or the economy.

This is NOT an argument against cutting spending, but a discussion over where and when.  Cutting short-term, economically stimulating spending now is NOT a good time nor is it a good place.