Should policymakers be able to come to an effective resolution soon, the recession is likely to be shallow, but risks are growing that the recession could be deeper.
It is an open question as to how much a European recession would impact the UK, US and other global markets.
The main risk comes in the form of the intertwined nature of the global credit markets since severe European bank deleveraging could negatively impact US credit availability as well.
Super Committee Failure Creates a Murky Debt Future
The failure of the super committee to provide a plan to reduce the deficit was certainly disappointing, but it would be a mistake to put too much stock in that specific incident.
The deadline imposed by Congress was an arbitrary one and the automatic cuts set to take place as a result of the non-decision will not occur until January 2013.
As a result, Congress still has an opportunity to address deficit reduction, but of course the fact that all of this is occurring with the backdrop of the 2012 elections means that uncertainty levels are elevated.
In our view, the more important question is whether or not Congress will be able to extend the payroll tax cuts and unemployment benefits set to expire at the end of this year.
Should they be unsuccessful in doing so, it would likely create a significant fiscal headwind in 2012.
Stocks Likely to Remain Range-Bound
Somewhat lost amid all of the euro debt and US political headlines has been the fact that US economic data has shown a gradual improvement.
The November payrolls report is set to be released this Friday and indications are that it will be decent. True, last week it was reported that third-quarter gross domestic product (GDP) growth was revised lower, but the inventory reduction that occurred may help set the stage for a stronger fourth quarter.
At this point, fourth-quarter GDP looks to come in at 3% or possibly higher based on improved profits, a better labor market, increased capital expenditures and a low cyclical starting point for inventories.
Economic acceleration should create firmer footing for stocks, but for the time being, we believe markets will remain focused on the short-term headlines. Of all of the factors affecting the markets (US politics, the economic slowdown in China, etc.), the most critical remains the European debt crisis.
Stocks are likely to remain range bound (trading between the 1,100 and 1,250 level for the S&P 500) for now, but should policymakers be successful in gaining some traction, markets could see some better results.
