Fiscal-Cliff Sequester: What It Means for Investors

On the first day of the "sequester" -- a bundle of indiscriminate cuts in government spending -- it's fitting that stocks would open lower, with the S&P 500 and the narrower, price-weighted Dow Jones Industrial Average down 0.29% and 0.25%, respectively, as of 10:15 a.m. EST.

Here's the sequester by the numbers:

• The sequester represents $85 billion in across-the-board spending cuts from now through the end of the budgetary year in September and $1.2 trillion over the next decade.

• The nonpartisan Congressional Budget Office estimates that those cuts, as they stand, will knock 0.6% off GDP growth this year.

The impact on GDP growth is clearly a concern with regard to the broad economy, not to mention those workers who will lose their jobs temporarily or permanently as a result of the spending cuts. Six-tenths of a percentage point is not insignificant in an economy that continues to struggle to fly on its own wings. However, the knock-on impact on the stock market is not clear.

The following graph shows 12-month real GDP growth (blue line, left axis) against 12-month real stock-price returns (red line, right axis), with the grey vertical bars indicating recessions:

Note that while there is a clear correlation between stock returns and the growth rate in the economy during recessions, that coupling is much looser outside of those periods, with the two lines often diverging significantly and/or over lengthy periods. There is empirical evidence that stock prices have some value in terms of predicting recessions, but there's little reason to anticipate a recession at this stage (although it's not impossible to imagine). Certainly, the market's recent performance does not suggest a recession in the cards.

The sectors that are at greatest risk are those that are most sensitive to economic activity: energy, materials, and consumer discretionary. Were the sequester to be maintained as is, it could prove a headwind to stocks via a recalibration of earnings expectations. Current analyst estimates still call for a mind-boggling 15% growth in S&P 500 earnings per share in 2013. With costs wrung out of companies' operations, achieving that spectacular figure through top-line growth alone will prove increasingly difficult.

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The article Fiscal-Cliff Sequester: What It Means for Investors originally appeared on Fool.com.

Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him at LinkedIn. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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