Should We Kiss the Economy Goodbye?

The plan: Make something so heinous the government would do anything to avoid it.
The reality: Um, it's the government -- the people who like to play Russian roulette with deadlines, and whose bickering would put any reality show cast to shame. Getting them to agree on something is like getting the Palestinians and Israelis to have a calm discussion. In theory, it works; in reality? Not so much.

So what am I talking about? The Budget Control Act, aka, sequestration. And more importantly, what this could mean for your bottom line.

Say what?
You may have heard of sequestration. If you haven't, here's a quick rundown: Sequestration is across-the-board cuts to federal programs like defense, National Weather Service, Medicare, etc., that would go into effect if lawmakers can't come to an agreement on a new budget by the end of the year. While across-the-board cuts may sound unpleasant but doable, the ramifications from these particular cuts are enough to scare even lawmakers. Sen. Lindsey Graham (R-S.C.) went so far as to say, "We do dumb things in Congress. This sequestration idea is the dumbest thing."

The bad, the ugly, and the horrible
Arguably, the companies that'll take the biggest hits are defense contractors like Boeing (NYSE: BA  ) , Northrop Grumman (NYSE: NOC  ) , and Lockheed Martin (NYSE: LMT  ) -- Boeing's biggest contract, the KC-46 tanker, could face a 57% cut, according to The Economist. Northrop Grumman CEO Wes Bush stated in a recent earnings call that sequestration would lower revenue, profits, and cash flow, and Lockheed Martin went so far as to state that they "believe sequestration is the single greatest challenge facing our company and our industry." Would sequestration affect shareholders' profits? Absolutely. And that's not all.

While it's easy to see how defense companies will be affected by sequestration, what's not as apparent is the effect sequestration will have on other areas. Think General Electric (NYSE: GE  ) only makes kitchen appliances? Think again. Along with Samsung Techwin, GE makes the F110 engine used on the F-15 and F-16. In fact, manufacturers like GE are looking at a loss of tens of thousands of jobs overall. Moreover, the White House worries that sequestration will affect everything from cancer research to FBI staffing. Hello, ripple effect.

While it may seem that sequestration is mainly a defense (and its suppliers) problem, the basics of sequestration is this: According to George Mason University economist Stephen Fuller, if it goes into effect, it could cost the U.S. economy 2.14 million jobs (increasing unemployment by 1.5%), reduce GDP by $215 billion (which is two-thirds of America's expected economic growth in 2013), and have an overall negative impact on an economy that is just starting to see improvement.

So should I move to Canada?
Maybe. I've heard the weather's nice. Plus they have maple syrup. OK, I'm not serious. The good news is Congress has until January to come up with a new budget and bypass this whole sequestration mess. The bad news is the mere idea of sequestration happening is already having a negative effect. So what does this mean for your Foolish bottom line?

If sequestration happens, the stock market will probably go on a wild ride. Yes, some companies will escape, but others will trade for new lows. I know I'll be looking at defense and what companies I think can pull through this mess. Then I'm going to stock up and hide in a cave until it all blows over.

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Fool contributor Katie Spence owns shares of Northrop Grumman. She does not own shares of any other company mentioned above. Follow her on Twitter @TMFKSpence. The Motley Fool owns shares of Northrop Grumman and Lockheed Martin. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 10, 2012, at 9:34 AM, JimmyZangwow wrote:

    "Should We Kiss the Economy Goodbye?"

    Pretty much. Sequestration would never happen, even if it were a law. Government spends. The only way to bring back responsibility in government is a hard, hard landing.

    Nobody cares like an owner, and currently, the renters are in complete charge (and no I'm not making allusions to political party but to the change in societal paradigm).

  • Report this Comment On August 12, 2012, at 10:00 PM, neamakri wrote:

    Rhymes with castration.

  • Report this Comment On August 13, 2012, at 7:27 AM, davicar319 wrote:

    You miss part of the equation, the government had to either borrow the money or pull it from the economy in the first place... so the long-term impact of the government not spending the money is positive, because it is back in the hands of the taxpayers.

  • Report this Comment On August 29, 2012, at 11:02 PM, MHedgeFundTrader wrote:

    I was researching comparative Asian wage data the other day and was astounded with what I found. Textile workers earn $2.99 an hour in India (PIN), $1.84 in China (FXI), and $0.49 in Vietnam (VNM). This is an 18 fold increase in labor costs from ten cents an hour since Chinese industrialization launched in 1978.

    This compares to the $8 an hour our much abused illegals get at sweat shops in Los Angeles, and $10 in some of the nicer places. What’s more, the Indian wage is up 17% in a year, meaning that inflation is casting a lengthening shadow over the sub continent’s economic miracle. A series of strikes and a wave of suicides have brought wage settlements with increases as high as 20% in China.

    This is how the employment drain in the US is going to end. When foreign labor costs reach half of those at home, manufacturers quit exporting jobs because the cost advantages gained are not worth the headaches and risk involved in managing a foreign language work force, the shipping expense, political risk, import duties, and supply disruptions, just to get lower quality goods. Chinese wage growth at this rate takes them up to half our minimum wage in only five years.

    This has already happened in South Korea (EWY), where wage costs are 60% of American ones. As a result, Korea’s GDP growth is half that seen in China. These numbers are also a powerful argument for investing in Vietnam, where wages are only 27% of those found in the Middle Kingdom, and where Chinese companies are increasingly doing their own offshoring.

    This is why I have pushed the Vietnam ETF (VNM) on many occasions. I know every time I do this I get torrents of emails from that country bitterly complaining how difficult it is to do business there, and how the hardwood trees are still full of shrapnel left over from the war, and why I shouldn’t buy a 50 acre industrial park there. But, the numbers don’t lie.

    The Mad Hedge Fund Trader

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