This Week in Stock World Weekly: Deadlocked(Excerpts reviewing the week and looking ahead)
US Debt Ceiling Deadlock
One line of reasoning from the “no tax hikes” crowd is the inaccurate premise that the very wealthy, the top 0.1%, are job creators. If they’re the “job creators,” it might be in the public interest to protect them from excessive taxation – thereby allowing these top 0.1% to spend money on creating jobs. This is incorrect.
The overwhelming majority of U.S. jobs are ‘created’ by ordinary Americans when they spend their paychecks. Consumer spending drives about 70% of our GDP. When average Americans are struggling with high unemployment, which recently popped back up to 9.2%, they are reluctant to spend money on anything beyond basic necessities. The broader U6 unemployment number – which includes the underemployed and “discouraged workers” – is 16.2%.
Meanwhile, U.S. companies are not stepping up hiring due to weakness in the economy – there is no demand. As Paul Ashworth of Capital Economics wrote, “Businesses aren’t confident enough, and the longer this goes on, the harder it is to convince them that they should be.” (Dearth of Demand Seen Behind Weak Hiring)
The impasse between the President and the Republican leadership reached new lows on Friday when talks broke down and Rep. Boehner walked out of negotiations. “The White House deal for the House would have required that alongside these cuts, tax revenues would go up by $1.2 trillion, largely through a rewrite of the tax code to eliminate many deductions and loopholes. That’s substantially less in revenue than the $2 trillion in the “Gang of Six” plan. The problem is that while much of the cutting would start right away, most of the revenue increases would be put off, in part because a tax-code revision would take months, and in part to allow spineless House Republicans to say they did not agree to any specific tax revenue increases (i.e. they planned on lying to their constituents).
“Democratic lawmakers were rightly furious when they heard about these details, calling the plan wholly unbalanced. But, in the end, it was Mr. Boehner who torpedoed the talks. He said Friday evening that he and the President had come close to agreeing on $800 billion of the revenue increases (the equivalent of letting the upper-income Bush tax cuts expire as scheduled next year — not much of a heavy lift) but could not stomach another $400 billion ($40Bn a year!) which the White House wanted to raise by ending tax loopholes and deductions.
“So, on the eve of economic calamity, the Republicans killed an overly generous deal largely over a paltry $40 billion in annual deductions. Mr. Obama was willing to take considerable heat from his liberal critics over the deal, and the Republicans were not willing to do a thing to anger their Tea Party base…” (Weekend Reading – Deal or No Deal?)
Let Them Eat Cake
The Republicans are standing firm against raising taxes, in an era when many American corporations are already paying surprising little in taxes.
Russ Winter of Winter Watch at the Wall Street Examiner discussed the gap between what people think corporations pay in taxes, versus what they really spend. For example, Microsoft “lowers its effective tax rate a full 7% by taking foreign income to $19.2 billion from $15.4 billion, and lowering US income (and expenses) from $9.6 billion to $8.9 billion. Today MSFT is effectively a 68% foreign operation. In return it gets all the benefits of stimulus and minimizes the costs of supporting the US system…
Little wonder so much largesse flows into the hands of so few. Matt Taibbi gets into some of the particulars. Bloomberg’s Jesse Drucker estimated that Google all by itself has saved $3.1 billion in taxes in the past three years by shifting its profits overseas. If the U.S. is looking for a source to close its out of control deficits I have some suggestions…
“Mark Kreiger writes a spot on piece regarding the high end luxury bubble that includes this gem – ‘The social crisis facing the country as a result of the most egregious plundering in modern American history will spell the end of the ‘high end’ theme. Buying into this trend now is like getting long Marie Antoinette’s unsevered head in 1792.'”
Debt Ceiling & the Markets
One fear regarding a U.S. default is that creditors will demand higher interest in return for issuing new debt. Considering how enormous the U.S. debt load currently is (roughly $14.5Tn), higher interest rates would add a crippling burden to an already high burden. This leads to the question of how the markets would react if the U.S. defaults on its debt obligations.
analysing market action last week and next, Lee Adler of the Wall Street Examiner submits,
“Last week I worried about the possibility of a short squeeze in Treasuries if there’s no deal on the debt ceiling, because of the temporary lack of supply during the period where the Treasury is unable to issue new debt. I dismissed that outcome as unlikely. Now, having seen the markets rally in the face of all this nonsense, I’ll rate it as a tossup. For sure, the Treasury will make the interest payments and will redeem maturing bonds, and that will reassure investors, regardless of any action by the hated ratings agencies. I would not want to be short the Treasury market until it becomes a little clearer how this drama will unfold. It just doesn’t look like a good bet to me right now. In fact, in spite of the consensus bearishness on Treasuries, the charts suggest that my concern of a continuation of the rally may not be crazy at all. Sorry, Russ [Winter].
“Going into the end of next week, bears will face a huge test. The Treasury has a lot of paper to sell. Most of the new paper will settle on Monday, August 1. On Thursday, July 28, a sizable paydown will put cash back in investors’ pockets. Continuing fears over the European situation may drive ongoing capital flight out of European paper and European banks into shark infested U.S. pool. So what will happen to all that cash?
“If Monday’s settlement is accompanied by no noticeable disruption to stocks or bonds, then that could be a sign that a perversely bullish scenario could be playing out. If bonds crack but stocks hold up, then the “stocks as safe haven” thesis would be gaining currency. That could be grounds for an upside breakout and an extended run in U.S. equities. If both stocks and bonds sell off, that could be great news for precious metals.
“Again, I don’t want to give the impression that I know what might happen… I’ve given you my contrarian concern on what might happen if there is no deal. It goes against the grain of the universal consensus that a failure to increase the debt ceiling would lead to catastrophe. It may, but I’ve put an opposing view out there for you to consider. It could be bullish because of the lack of new supply… (Why Not Having Debt Ceiling Deal May Be Bullish – Are Stocks The New Safe Haven?)
Discussing the market on Friday, Russ Winter observed,
“Friday looked like one of the strangest market days yet. Going into the weekend and hours before the wheels fell off the fiscal negotiations, the markets just drifted cluelessly higher on extremely low volume and volatility. The intermediate-term volatility, the VXZ, is now within earshot of breaking to lowest number witnessed back in 2007. The same is true of the 2-year T-Note yield. This goes beyond cognitive dissonance. There is no fear, no worry in this market. It’s completely brain dead and comatose. It’s ironic given the end-of-the-line ungovernable situation we are witnessing. I have compared it to the last days of the Soviet Union – if that system had financial trading markets. The best comment I’ve spotted on the causa proxima of all this was made in the public feedback section of another site. Someone who goes by the name ‘sbernard’ used the term ‘hubris obliviana.’ It’s such an apt descriptor that I’m going to adopt it as a Winterism.
“Wrote sbernard: ‘The truth is that Wall St suffers from a serious disease called hubris obliviana, fuelled by endless government interventions, bailouts, stimulus, and Fed money expansion. One of the ‘unexpected’ consequences of this monetary heroin in that Wall St has lost all perception of risk. They reflexively have too much unending faith in the power of government to fix all their troubles. Thus, they are setting us all up for even more risk — risk the government cannot avert because it is the (weak link)!'” (Unbridled Faith in Hubris Obliviana)
For the latest update on the debt negotiations before this newsletter concludes, Zero Hedge predicts: “With 23 hours left until the Asian open (or, more importantly, 19 hours until FX trading resumes) and with today’s round of talks now officially over after a one hour meeting in Boehner’s office with congressional leaders achieving nothing, it is becoming clear that the final debt ceiling outcome will be “no change” in spending or taxing habits and a temporary hike in the debt ceiling, so that the soap opera can be repeated again every three months…and again…and again…and so forth for an ‘extended period of time’ as ‘transitory solutions’ become the new grand consensus. At least we now know the phrase for complete, impotent incompetence on the Hill is: ‘Two tiered approach’ which is how Nancy Pelosi called the last minute attempt at compromise.” (Good News: It’s Almost Over After Pelosi Says Congress Looking At “Two-Tiered” Deal)
We have several option trade ideas for the coming week, two shorts (GMCR and oil) and two longs (PLX and SONC). These plays can be revised using stock strategies rather than option strategies, for those so inclined. See the inset boxes on this page (to read the full newsletter, sign up for a free trial here).
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