Wall St holds its nerve as spending cuts near

NEW YORK (AP) – With barely a week to go before $85 billion in automatic government spending cuts kick in, Wall St. is holding its nerve.

The Dow Jones industrial average has gained 6.8 percent since the start of the year as investors largely ignored the latest installment of Washington’s budget drama. The Dow Jones climbed close to its record level at the start of the month and the Standard & Poor’s 500 notched up a streak of seven straight weeks of gains, before easing back this week. Even after its weekly loss of 0.3 percent, it’s still up 6.3 percent this year.

Wall St. is betting that the cuts, which the Congressional Budget Office estimates will take 0.6 of a percentage point of economic growth this year and cost 750,000 jobs, won’t be enough to derail the recovery. Investors may also have become used to Washington brinkmanship, having seen last-minute deals brokered after a series of political standoffs.

David Bianco, chief US equities strategist at Deutsche Bank, says the automatic spending cuts could actually be a “net positive” for stocks, despite the drag that they would put on the economy. That’s because a set of known, measurable spending cuts are better than no budget reduction at all.

“Significant spending cuts are needed,” Bianco says. “Until that happens, people are going to worry that this is still a problem that needs to be solved.”

Bianco estimates that the impact of the spending cuts on corporate profits will be limited, reducing the income of companies in the S&P 500 index by just two percent.

Sitting on the sidelines during the political wrangling in Washington hasn’t been a winning strategy in recent years either, as stocks have rebounded and come back stronger each time, says David Kelly, chief strategist at JP Morgan funds.

The Dow has returned 24 percent since the end of August 2011, after plunging following the showdown that month over raising the country’s borrowing limit. The index is also 12 percent higher since bottoming out in November after the election, when investors sold stocks on concern that a divided government wouldn’t be able to come up with a budget compromise.

“Twice already investors have learnt the lesson that if you wait for everything to calm down in Washington you’ll miss out on the rally,” Kelly says.

Analysts and investors generally agree that the huge amount of attention being paid to the $85 billion of cuts far exceeds the actual impact they will have on the $16 trillion US economy, particularly given that the cuts will be phased in over time, and some will ultimately be reversed.