No Mini-Deal Next Week If Debt Ceiling Included. Day Trade From the Short Side

December 27, 2012

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The market has been pricing in a fiscal cliff deal and it is not going to get one. Traders could not imagine that politicians would be this irresponsible. I’ve been skeptical and you know I’ve been expecting this decline.

My forecast has changed slightly. I thought a “mini-deal” was possible at the last second and that the market would bounce on the news. That excitement would wane quickly and the debt ceiling would quickly come into focus. Now, I don’t believe we will get that bounce.

To this point, all of the negotiations have been about tax revenues. Republicans have been willing to negotiate to a point, but Democrats are not willing to cut spending or to discuss entitlement reform. They claim that cost savings (Medicare and interest expense) will reduce spending by $300 billion over the next 10 years. Because they’ve done such a great job on cost savings (which they should do anyway), they want $50 billion in stimulus money next year. That is the extent of their spending cuts and Republicans view this counter offer as a complete joke.

The GOP knows that the debt ceiling is the only way to force serious spending cuts and entitlement reform. We will hit the debt ceiling in the next week and the U.S. Treasury can hold off default for about 60 days. When we went through this process a year ago, our credit rating was downgraded. Fitch has already stated that it is ready to take action if the process gets ugly.

We will hear rumors of a “mini deal” in the first week of the New Year. I doubt it will happen. Democrats will offer to extend the Bush tax credits for Americans making less than $250,000 per year. They will look like heroes to the American public, but there will be a giant string attached. Republicans will have to agree to extend the debt ceiling. This is their last bargaining chip and I don’t believe they will cave-in even if it means losing face.

Our country is spending $1.3 trillion more than it makes each year. When you hear about $1 trillion spending cuts, realize that we are talking about a 10-year time frame ($100B/year). Politicians are not trying to balance the budget; they are haggling over miniscule spending cuts.

Baby boomers are retiring at a pace of 10,000 per day. Instead of paying into the system, they will draw from it. This is a “double whammy” and the problem will explode in the next few years. All of the new tax revenues will only finance the government for a week. Spending and entitlement are the real issue.

We are probably too far down the road to avoid a national financial crisis. In fact, we are too far down the road to avoid a global financial crisis. The US, Europe and Japan are all in similar situations and collectively we represent 75% of the world’s GDP. This Ponzi scheme will continue as long as everyone trusts the central banks.

Nationalized healthcare, bureaucratic agencies, Social Security, Medicare and wasteful defense spending are all causing our debt level to soar. I wish I could blame one party, but all of our elected officials let this happen over the course of decades. We are all to blame – we voted for them.

Deep in our hearts, we all know that trouble lies ahead. No matter what the statistics say, conditions are not improving.

The unemployment rate is not falling because of new jobs. People have stopped looking for work and if you add them back into the labor force, our unemployment rate would be somewhere around 11.5%. Household incomes continue to decline. Skilled/educated workers are forced to settle for lower paying jobs. One out of every six Americans is on food stamps (50% increase in the last 4 years) and the average baby boomer has less than $50,000 saved for retirement. Consumers are hanging onto their money.

MasterCard reported that merchants increased retail revenues by .7% during the last two months. That was much lower than the 3.5% analysts were expecting and it is the lowest level since 2008. Retailers were open longer and the discounts were deeper than ever before. Surprisingly, they could not attract buyers. This morning, consumer sentiment came in much lower than expected.

Corporations also know that conditions are weak. Instead of investing in plant and equipment/IT, they are issuing dividends ahead of tax increases. They see this as the best use of capital. Balance sheets are strong and stocks are attractively valued if companies can preserve the bottom line. Unfortunately, Q4 guidance has been dismal and earnings season is a few weeks away.

The government also knows that conditions are dire. That is why the Fed promised to keep its foot on the accelerator indefinitely. Our central bank has thrown the kitchen sink at the recovery and interest rates are at zero. All of this easing has not sparked economic activity.

Central banks around the world are printing money like mad. The Fed is backing the ECB by offering attractive (limitless) swaps and we are all joined at the hip.

I honestly don’t know how long this will continue, but it won’t be more than a few years. Global debt levels have gone parabolic and one crisis is all it will take to topple everything. That is why Greece has received so much attention.

The market has fallen below the 100-day moving average. Asset Managers are reducing risk and there is some tax related selling that will end today (T+3 settlement).

We will hear rumors of a “mini-deal”. The market will get excited and we will have a few small relief rallies. Democrats will propose to extend the Bush tax credits for Americans making less than $250,000 per year and Republicans will reject it because it will be contingent on a debt ceiling extension. Democrats won’t budge and we will go right into the debt ceiling negotiations. Defense spending, payroll tax credits, deductions, entitlement reform and unemployment benefits will all get rolled to one giant bill. The process will be ugly and the solution will be watered down.

The market won’t rally into year-end and that is a warning sign. I believe conditions could get ugly in the first quarter.

From a trading standpoint, there will be great opportunities on both sides. Focus on stocks that rise to the top of the Live Update table and my daily comments should keep you on the right side of the action.

Today’s comments were a bit “heavy”. I wanted to get this off of my chest. Tomorrow’s comments will end the year on a positive note.
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