I think U.S. investors believe whatever happens in Congress, there will always be a last minute deal, which is the main reason for the recent major stock market surge on nothing more than hope. The markets, of late, have not been trading on fundamentals; they have been trading on news. This is a dangerous phenomenon, when news is bad; there is no backstop to the market. It causes volatility to surge and institutional confidence to falter. In order to illustrate the overreaction by the media and our elected officials to the recent shutdown shenanigans, I offer the fact that the United States has lived through 17 shutdowns of the federal government since 1976, which is why shutdown number 18 was more like the market that cried wolf.
This shutdown does have its consequences from the furloughed workers to economists slashing GDP expectations for fourth quarter of 2013. Yet, stocks are hovering at just 1.3% off of record highs. Go figure. Clearly investors should understand the dire impact of what’s going on in Washington. However they believed the odds of the U.S. first ever debt default was slim to none.
We expect the administration to continue to play hardball because the President is not constrained by having to endure another election cycle for himself. This means unfortunately a resolution that lets America continue its habitual and serial borrowing. It shouldn’t be a surprise to anyone, since this is the President, the only one to my recollection that vowed to fundamentally change America. Those kinds of promises don’t come cheap.
I pride myself on being able to see through the façade and call BS where it is warranted, so let’s get our shovels ready and start to shovel some of these “myths” to the dung heap. Firstly, the October 17 drop-dead date set by Treasury Secretary Jack Lew wasn’t really a “drop-dead date.” According to Bank of America Merrill Lynch, they believed the U.S. Treasury could get through up until October 31 and that November 1 was the real drop-dead date. That’s when Social Security, veterans and Medicare payments come due, but that isn’t necessarily a default. After that, they say it is unlikely that the Treasury Department would be able to meet its obligations. Even with this analysis and speculation, the truth is, through the 14th Amendment, Obama can constitutionally bust through the debt ceiling like Willie, Charlie and Grandpa busted through the roof in the “Wonka-vator.” There was no real threat of default, don’t let anyone fool you.
The fact remains; these budget battles take advantage of crises orchestrated to draw focus from extra-constitutional powers. “Obamacare” violates both the “Origination Clause” and the “Commerce Clause” of the Constitution. The GOP played right into the hands of the Administration and as a result has allowed the media to paint them with the wide brush of fanaticism and treason. There is much damage control to manage in the coming months or the GOP, which finds itself even more on the outside looking in, and will for a long time.
But people outside the Beltway need to not get too carried away by the drama of government shutdowns. The real story is the equity bubble that is being fueled by excessive liquidity in the economy and declining liquidity in the financial markets. Are these the conditions that will provide the backdrop for the massive busting of the equity bubble? I fear that we shall soon see.
Neither tapering nor complete elimination of the quantitative easing will prevent the formation of massive asset price inflation. The Fed’s QE has created a Mount Everest of mal investment in U.S. equities and junk bonds. It’s as if financial markets have “pigged out” on speculation. It hasn’t paid off to fight the Federal Reserve, yet $85 billion of the Fed’s monthly bond buying has coerced U.S. investors into the U.S. risky financial markets. Investors seem to have been addicted to this QE fixation. S&P 500 earnings minus the financials are expected to be down significantly. Bottom line is that the financial markets are on a slippery slope when earnings slump. Advisors need to be very wary of the “news” driving the market. This is a traders market and novice traders and advisors almost always get their hats handed to them eventually.
The smarter and shrewder investors have already sidelined themselves 36 months ago because of this “look Mom, no earnings growth” market that keeps getting jammed upwards
on headlines and insignificant stories. Fears of crossing debt-ceiling deadlines
will be minor compared to the scary lack of earnings of U.S. companies.
Grid-lock in Washington is nothing new, especially to Washingtonians like myself, but is seems more like a way of life to everyone in the U.S. In the course of the standoff, the U.S. economy was caught between a rock and a hard place. The direction of the stock market will soon follow suit. The smart money will be invested in hard assets, plus prudent investors will have short market positions in portfolios, as well as cash holdings, but not money markets.
As my father used to say, “cheer up, it’s going to get worse, you should count on it.”