These are interesting times to say the least. While we have been enjoying a relatively positive time in the markets since September of last year, dark clouds are on the horizon. The first sign came in the form of the relatively uneventful budget battle in Washington over the budget for the rest of the fiscal year. With Tea party Republicans calling for $100 billion in cuts on one side and the Democrats finally relenting to a modest compromise of $32 billion, the threat of a government shutdown was enough to temporarily halt the rally which gave me a good entry position for a nice move in LUK.
But now we are faced with bigger fish to fry. A government shutdown could be seen as only a temporary inconvenience compared to what we are facing now – US default on it’s debt obligations. You see there was a law that championed fiscal responsibility that was first passed in 1917 that placed a sort of credit limit on US debt that could only be raised by a debate and a vote in Congress. The big difference here is that when you reach your credit card limit, you must tighten the belt and start paying it back before being able to spend while in Congress, the debt ceiling was raised about a dozen times since WWII without any significant measures to pay it down. This brings us to present day, with the US debt quickly approaching the current ceiling level of $14.3 trillion dollars, a major showdown between Republicans and Democrats is about to unfold. Though I sincerely hope that a show is all it is, because surely not even politicians would play with the kind of fire that would unfold if the US defaulted on it’s debt. Just imagine, we would immediately return to a fiscal collapse much greater than the fall of the titans of 2008. Soup lines, and shanty towns would become a reality and it could damage US credibility irreparably. Not to mention the gigantic loss that many would incur in their investments in US government bonds. It would be a devastation so great that it would shatter the two party system, destroying the credibility of Republicans and Democrats alike (though that might be the only positive outcome).
This threat was enough for the S&P rating agency to threaten to downgrade the US credit rating from it’s prized AAA rating which prompted Timothy Geithner to come out and assure investors that the debt ceiling will definitely be raised. I wouldn’t be surprised to see some ratings agency regulations surfacing in the national debate as a retaliation to such an affront (after all should a country’s future be at the mercy of unscrupulous shadow rating agencies?) Coupled with this, June will herald the end of the Fed’s Q2 quantitative easing – a program in which the Federal reserve purchased massive amounts of government debt thus pushing the value of the dollar down, strengthening export, and keeping borrowing costs low. An effort that has proven to work in stopping the downward spiral of the economy, but not very well in propping it back up to health. Expect a lot of finger pointing in June on who is to blame for the persistent unemployment problems faced in the country and the evermore limited ways there are to dealing with it.
On that note, we also have the elephant in the room – the fact that corporate profits are higher than ever before but the employment situation hasn’t changed. This is because corporations have outsourced work to other countries and have become adept masters at tax loop holes. This means that not only is the US propping up companies that don’t contribute their share to the solution to the fiscal woes, but the country is paying the bills for their run to the exits (after they set the place on fire of course). This problem will inevitably leads to talks of class war. Where Republicans will focus solely on taxing the poor to coddle the rich and the Democrats will just as blindly try to put the entire burden on the rich without touching the Middle Class.
All of these issues will be enough to shake investor confidence in the coming months. It appears even modestly positive second quarter earning results will not be enough to stave off uncertainty. In the best scenario the people in power will agree to set aside political rhetoric and hash out a reasonable compromise that would spread the burden evenly across the board and help us tighten our belts the right way (warning! Japan lost decade) in order to avoid the worst scenario which is the Hindenburg moment of the US economy which will plunge the country into a state of despair that could take generations to recover from. If we stop and take a moment to think of the leadership of this country as a whole we could trust them to do what is right over what will get them votes… but you can expect a confidence shattering circus show in the process.