What, Me Worry? (Default Edition)


“You’re in then you’re out, you’re up then you’re down.” – Katy Perry, Hot ‘n Cold

Early Friday before the market’s open, a young Bloomberg correspondent expressed astonishment on air at the market’s rip-relief rally on Thursday. Nothing had been really solved yet in Washington, the reporter lamented – any hypothetical deal was still up in the air, and the six-week extension under discussion would simply land us back in the same situation next month. The week before Black Friday, as it turns out, not exactly great timing for consumer sentiment.

All very true, but what the reporter was missing was the yearning of the Street not to miss the big relief rally that literally everyone is expecting, but have been afraid to completely believe in quite yet. People do remember Lehman Brothers, but they also remember something more recent, the New Year’s Eve of some nine months past when a last-minute, midnight-hour budget-and-debt deal produced a 5% rally in two days. And if that wasn’t enough, the market had become oversold! Before you smirk, it was only the third occasion this year that stocks were in such a state, so one can hardly afford to be dilatory in such circumstances.

It must be admitted that to a large extent, the Street simply doesn’t care about the logic of any of it, just so long as there is no actual default. It just offers more volatility to trade. The scenario of a six-week extension deal next week gives traders another crack at a move upward, and if it’s accompanied by the government reopening, why then 1750, here we come. Then traders can slide back to the other side of the trade, wait for another 4%-5% fade as the next deadline looms, and then ride the Ferris wheel back to the top again. Just so long as it doesn’t break.

Could it, would it break? The Washington struggle is above all a political one, and it would be wise to remember that politicians tend to stick with politics until the uttermost extremis – one only has to remember the massive 10% beating the Dow Jones took the day of the first TARP failure in November 2008, and how utterly surprised the working rich were in Washington.

The six-week extension is at bottom a political maneuver, and from that point of view a respectably shrewd one. Any glance at the latest poll numbers show it’s time for an attempt to displace the burden of failure back onto the administration’s shoulders – hey look, we compromised, we tried, we gave him the chance to negotiate and he refused – and remake public opinion.

It’s a calculus that ordinarily doesn’t matter to most House Republicans in most scenarios. Perhaps 30 or 40 are Tea Party zealots ready to fall on their swords as a matter of principle anyway. As politicians go, they don’t seem to be terribly concerned about losing their seats in the process.

The majority of the House GOP does want to get re-elected, of course, and quite a few of them are in air-tight conservative districts where there is some threat from the right and very little from anywhere else, not even the center. The best interests of the national party and those in the Senate can often safely be ignored by a representative who has a much different situation back home in the district.

There are exceptions, but even they can be a case of damned if you do, damned if you don’t. Many representatives who did change their vote and approve TARP to save the financial system from meltdown were rewarded for their pains by being bounced out of their seats two years later by ideological purists. That’s a known effect. Had they refused, the system would probably have collapsed into Depression and they still would have gotten bounced, getting the blame either way – but to many voters, that’s an unknown outcome. They won’t believe it until it happens, and some would be obstinate enough to blame it on sunspots.

A political segment that House representatives can’t afford to ignore, however, not if they want to remain in politics, is the governor’s chair. Governors matter very much in the crude and dirty business of redistricting, and losing control of states can mean losing control of everything else. It’s one thing to retreat to the safety of one’s super-pure district, but another to find the district itself disappearing.

The risk of being seen to be helping the administration and its sinful gang of free-spending liberals is well known. Against that is the unknown risk of default. Despite all that’s happened, many retain a serenely cloistered vision about the events of the financial crisis, and believe that a default could be safely navigated. That world-view may be very much behind the lack of optimism of the aforementioned Bloomberg correspondent, who is Washington-based. Anyone who attends congressional finance hearings on a regular basis has got to feel a chill at the notion of these people doing the judging.

A lot of political analysis for a market column, you may well be thinking, perhaps too much. Yet I thought it worthwhile from an investment point of view to elucidate the essentially political nature of the battle. It will mean a political struggle and a political step – I don’t want to say ending, because an ending may not happen for years. The fact that no one wants to be saddled with the default doesn’t mean it can’t happen. I don’t think it will, but in the end, politicians will be making political decisions, not financial ones, and they may lose sight of what the rest of us are doing – if only for one critical moment. I’m not going to believe in any outcome until I see it.

The Economic Beat

The satirical webzine the Onion recently ran a piece sniggering about how outraged Americans were that Congress was behaving exactly like the voters – polarized, obstinate, and so on. Watching the usual talking heads on the business channels certainly rhymes with that view.

And if the market seems complacent, why then so is the public: The small business confidence poll was virtually unchanged, while consumer sentiment barely ticked downward. Weekly retail sales, one of the few other data points available during the week, continue to suggest soft dealings at the register, as do the few same-store results available, but – and it’s a rare occasion when I find myself talking like a retailer and blaming sales on the weather – I do think that a balmy September and indeed, fall season so far, has kept people away from buying fall apparel.

The queue of pending reports continues to jam up and now includes September jobs, retail sales, and price inflation, along with August wholesale sales and inventories, factory orders and international trade. One report that is still getting through is weekly claims, which zoomed upwards on the strength of California’s long-delayed backlog (the state is responsible for about 1/6 of all claims). The new tally of 374,000 is a catch-up number, and in this case the seasonally adjusted four-week moving average may be the best representation, at 325,000.

While the economic data backlog builds, it could start to unwind on a day’s notice. It won’t grow much next week anyway, as the economic calendar is mostly either private or Fed-based (the Fed has its own funding). Earnings season starts to get underway in earnest as well. If there is a deal and the government re-opens, a mass of data will hit the market in a compressed period, but the usual outcome in these cases is neither panic nor exultation. Rather it’s confusion, as so much information is digested. It would have to be decidedly one-sided to get a strong reaction.

The Fed and its branches will release the New York manufacturing survey on Tuesday and the Philadelphia edition on Thursday, the latter day also comprising the September industrial production report. The Beige Book comes on Wednesday.

From the private sector comes the homebuilder’s sentiment index on Wednesday, which should tell you where housing starts went. They’re slated for release on Doomsday, Thursday the 17th, but even if the government has re-opened by then it could still be in catch-up mode. The Leading Indicators is scheduled for Friday and comes from the non-governmental Conference Board, but at the moment several key pieces of government data are still missing, so don’t be surprised to see that date slip too – not that the market really cares about it much anymore.

Monday’s earnings calendar will be light, as much of the US will have the day off, thanks to Columbus Day. Banks will be closed, along with the postal service and many private companies. However, the stock market will still be open.

Tuesday starts to bring in more big guns to report third-quarter earnings, for which expectations are very low: Coca-Cola (KO), Johnson & Johnson (JNJ) and Citigroup (C). Wednesday completes the Gang of Four with Bank of America (BAC); American Express (AXP) and IBM report after the close.

Thursday features Goldman Sachs (GS) and Google (GOOG), and Friday – assuming we’re all still alive – has GE in its traditional end-of-week slot, along with Honeywell (HON), Morgan Stanley (MS) and Schlumberger (SLB).

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