Weighing the Week Ahead: Time for a Debt Ceiling Deal

Public policy in the US system of government is often the collective result of decisions made by several different institutions.  When the institution is a house of Congress, the outcome is the cumulative result of hundreds of individual actions.  The overall system has a high tolerance for extreme and partisan behavior — as long as there are enough votes for reason and compromise.

After many months of posturing, the time for action has arrived.  The US budget deficit is a long-term problem, and an important one.  Many have called this a crisis, but that is not accurate.  Defaulting on US debt would lead to a crisis.

Here are a few of my favorite articles for those wanting more background:

Calculated Risk describes the three best options still available.  This analysis is closest to my own viewpoint.

CNN has a helpful “cheat sheet” on the background and consequences of failing to act.

James Hamilton also has a good discussion of how things could work out.

I’ll make a few more comments on the likely outcome, but first let’s do our regular review of the past week’s data.

Background on “Weighing the Week Ahead”

There are many good services that do a complete list of every event.  That is not my mission.  Instead, I try to single out what will be most important in the coming week.  If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

Readers often disagree with my conclusions.  That is fine!  Join in and comment.  In most of my articles I build a careful case for each point.  My purpose here is different.  This weekly piece emphasizes my opinions about what is really important and how to put the news in context.  I have had great success with my approach, but some will disagree.  That is what makes a market!

Last Week’s Data

The economic news may have seem mixed to most, but I think the balance is turning positive.

The Good

There was good news in important indicators.

• Building permits upticked a bit.  Housing has to stabilize before we’ll see any growth.  Even a flat housing market represents about 1 1/2% difference in GDP from what we have recently experienced. 
• Money Supply Rebound.    The Bonddad Blog tracks this, and notes the improvement in financial conditions as the only bright spot in recent data.
• Earnings and Revenues are strong.  According to Bespoke Investment Group (click through for their chart), the beat rate is over 70%.  If it holds up through the season it will be the best record in years.

The Bad

The pattern of weak economic data continues to show up in several indicators .

•  Initial jobless claims of 418,000 — still too high to expect solid job growth.  There has been no progress on this front.
• Earnings guidance has been weak.  Here is the chart from Bespoke Investment Group.

A Blast from the Past

Lou Zickar, editor of the Ripon Forum invokes a concept from the “brilliant but disgraced” Richard Nixon — the “silent majority.

The debate is dominated by the political extremes. Those on the far right would rather have the federal government default on its financial obligations than give ground on what is anathema to most conservatives: raising taxes. Those on the far left would rather risk default than give ground on what is anathema to most liberals: reducing entitlements.

Caught between these two extremes are those Americans who want their leaders to set aside ideology and do what’s best for the country. This is America’s silent majority. These are the Americans who watch ESPN and HGTV at night instead of MSNBC and Fox. They vote in most elections, although they’ve been known to miss a primary or two. If they contribute to a campaign, it’s usually to a local candidate or a friend who’s running for the school board.

While not many are citing Nixon, quite a few observers are sounding this theme.

The Indicator Snapshot

It is important to keep the weekly news in perspective.  My weekly indicator snapshot includes important summary indicators:

• The ECRI Weekly Leading Index and the derivative Growth Index
• The St. Louis Fed Stress Index
• The key measures from our “Felix” ETF model.

There will soon be at least one new indicator, and the current choices are under review.  In particular, I am considering replacing the ECRI method with the equally effective and more transparentapproach from Bob Dieli.

 

The indicators show continuing modest growth at a slowing pace, with little indication of economic risk.  The market fears, as is often the case, are greater than one might expect from the data.

Felix is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.

[For more on the penalty box see this article.  For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I’ll do my best to answer.]

The Week Ahead

Until the debt ceiling issue has been resolved, the regular economic news will take a back seat. It is a light week for data anyway, with Case-Shiller housing and consumer confidence the most important items.

The debt ceiling story has played out as I have predicted all along — no early deal and plenty of posturing for political constituencies.  The brinksmanship has unnerved equity investors and provided plenty of material for the news and talk shows.  The bond market does not anticipate a default.

Even conservative leaders like Grover Norquist, President of the Americans for Tax Reform, is calling upon Republicans to pass the debt ceiling and make it a campaign issue.  Roll Call reports as follows:

“It is gambling with the economics of the country to get that far,” Norquist said. “Rather than close the government down or go into default, let’s take it to the American people, go into the next election, and fix things then.”

Polling shows that most people blame both parties for the impasse.  Polls also show that a majority of Republicans think that GOP leaders should do more to compromise, including permitting revenue increases.  This message has been communicated pretty clearly.

My expectation now is that the most likely outcome is a two-stage increase, with the limit extended immediately and then further when there are further agreements on deficit reductions.  My hope is that the general outlines will be agreed, with specifics and drafting to be done later.

Investment Implications

The debt limit situation will create a negative climate for the start of the week, but things will improve dramatically when there is a solution and attention turns back to earnings.

In trading accounts we were fully invested throughout the week and will remain so this week.

For investment accounts we were cautious last week in establishing new positions.  I still believe that holdings with more economic exposure will excel in the second half of the year.  These include technology and cyclical stocks.  As I have noted in recent weeks, the investment time frame requires looking for opportunity when traders are scrambling.