Heading into the end of 2012 headlines about the pending “Fiscal Cliff”, an uncomfortable combination of spending cuts (sequestration) and tax increases due to kick in on January 1st, dominated the news. Ultimately, Congress made a deal on tax rates but decided to kick the can down the road again on sequestration to buy some time to negotiate before spending cuts were imposed. Two months later the new deadline of March 1st is upon us and still nothing has been decided. Once the sequestration cuts go into effect the impact for this year will total to be worth about $50bn, the equivalent to about 0.5% of GDP over that period.
The cuts are to be split between the Department of Defense and discretionary spending areas like education, food inspection and federal courts. The cuts were designed this way to entice both sides of the aisle to work towards a compromise. Clearly, that has not worked so far leaving the very real possibility of these budget cutting measures being enacted. If the sequester becomes a reality many government workers are likely to see reduced hours in an effort to avoid the need to lay people off. All in, as many as 1.8 million government employees could find themselves losing full time status. That would be the equivalent of cutting about 400,000 jobs from the economy.
These cuts will trickle down to the state level as well. Here in Massachusetts as many as 350 teacher and aide jobs may be lost due to decreased federal government funding. In addition to this, programs concerning clean air and water standards, child care programs for disadvantaged families and nutrition assistance for seniors are also liable to be greatly impacted. While the actual outcome of the sequester is unknown at this point, we do know that the cuts would cause most government agencies and programs to significantly alter their operations going forward.
The implications for the investing climate are uncertain, but cuts of this nature can be expected to trim GDP growth, creating more headwinds for an already fragile economy. Due to uncertainties in the world, such as the sequestration process, we have remained focused on higher quality investments and businesses that should be less volatile through an economic cycle. Our portfolio structure also provides us the flexibility and liquidity to take advantage of market volatility and we stand ready to add to our portfolio of high quality investments in investment markets become rattled.
It seems the time for compromise coming out of Washington has passed and the sequestration cuts will go into effect. While the outcome in the months ahead is unknowable, we have designed our portfolios to protect clients in downturns while still allowing for participation in times of market strength and are confident that are current investments will withstand any near term volatility.