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How the Next 6 Weeks Will Decide the Fate of the U.S. Economy in 2013

By: David Sterman
Posted: 1/14/2013 1:00:00 PM
Referenced Stocks: GDP

Roughly 18 months ago, I spelled out the relationship between economic growth and thestock market . 

My key takeaway still stands: "The difference between 2% and 3% (economic growth) may not seem like much, but it is." Although it is an inexact science, quarterlygross domestic product ( GDP ) has subsequently been a pretty good harbinger of stock market activity. The market rallied nicely higher in the fourth quarter of 2011 and the first quarter of 2012, at a time whenGDP growth averaged roughly 3%.

And it's no coincidence that the S&P 500 has risen just 3.6% since the end of 2012's first quarter. Theeconomy has had only one decent period of growth in that time (the third quarter), and JP Morgan cautions that the end of 2012 finished on a weaknote . (The official government figureswill be released on Jan. 30). 

February's noise
Right now, clear signs are emerging that the U.S. consumer is ready to boost spending. As I noted in early January , consumer debt loads are now in reasonable shape and households again have the capacity to increase borrowing.

Yet as I noted back in December , economic data points emanating from the corporate sector are not nearly as robust.

Still, on balance, the U.S. economy is giving off signs of increasing strength. And with a few breaks, we may finally be headed for a period of sustained 3% economic growth -- which would helpstocks move up to fresh highs. For example, UBS' Maury Harris expects the U.S. economy to grow 2.1% in the current quarter, 2.8% in the second quarter and at a 3% to 3.5% pace in the second half of 2013.

But before we get there, we have another mountain to climb. Whereas the past fewquarters have been characterized by a looming "Fiscal Cliff," this coming mountain of worry can be laid squarely at the feet of Washington as well. By the end of next month, Washington will need to address the hard choices that it deftly avoided a few weeks ago.

Signs are emerging that Republican members of the House believe they have already made all of the tax concessions that they are going to make. "No newtaxes " is this current rallying crew, which ostensibly forces President Barack Obama and Democrats to chip away at the budget crisis solely through spending cuts.

There are two problems with this. First, President Obama and Democrats are likely to make a strong push for more tax changes, likely in tandem with proposals to overhaul entitlement spending. But unless one or both sides are willing to make major concessions, get ready for another market-rattling showdown in the next four-five weeks. The media will likely again focus on apocalyptic government shutdown fears, and the market hates that kind of uncertainty.

The other key problem: even if the two sides manage to make real progress, then you can count on spending cuts that will make it hard for the economy to grow at 3% later this year, as UBS' Harris anticipates. Economists figure that the ultimate budget agreement that arrives will trim GDP by 1% to 2%. This means the private economy would have to generate an organic growth rate in excess of 4% to offset that drag. And that's quite a stretch.

Before we start to look out over the course of 2013, you need to stay focused on the current quarter. Even as investors are digesting the results ofearnings season , they'll be keeping one eye on the economic calendar -- especially with regards to corporate America. Here are three key economic data points that will arrive before the coming government budget talks really heat up again. Each of these data points will give a clear read on whether Washington's intransigence is starting to materially affect corporate spending plans. 

Risks to Consider: The markets are off to a solid start in 2013, and analysts generally expect the current earnings season to be mostly positive, especially since analysts sharply lowered their forecasts for the quarter in recent weeks. Still, tepid forward guidance could create just enough noise in the market as we head into the crucial month of February when government budget talks heat up.

Action to Take --> If the market and the economy can survive the next six weeks without too much damage, then the stage may be indeed for a rising economy in 2013. And if we start to head toward a 3% GDP growth rate later in the year, as UBS anticipates, then the S&P 500 would likely be poised for yet another year of double-digit gains.

-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.