Monday, September 3, 2012

A Lame Duck Falls off the Fiscal Cliff as the Four Witches Meet in the Autumn...

Several ominous clouds continue to gather on the horizon.

Of greatest concern, the US election seems certain to lead to status quo and continued gridlock. As the heat turns up in Washington in the final stretch to the election, I expect neither side to yield one inch in their negotiations for the federal budget and sequestration. Ideally, there would be a clear and decisive election, with a substantial majority sweeping to power in both houses and the presidency.

But a decisive victory is unlikely to happen. Based on current data, it appears that Mr. Obama will keep his job; Republicans will keep the House after ceding just a few seats to the Democrats; and Republicans will either take the Senate or leave it in ~50/50 split.

If this happens, then Mr. Obama may promptly be served with sequestration. If Mr. Romney wins, there could be some brief respite from the partisanship, but with inauguration several weeks after the sequestration deadline, there could be a period of great uncertainty, regardless.

Hence, in either case, it appears that uncertainty will reign for at least a month or so, unless pre-emptive action is taken in the next month. There are a few catalysts for action that may save us from calamity:
  • The next quadruple witching event is in September, at which point futures contracts will be sharply in focus. This event quite often passes without notice, but this time, there will be the fiscal cliff, the election outcome, the drought, uncertainty in the Eurozone (some believe September could be the month of exit for Greece), and the slowdown in China. It's been a long while since witching mattered this much- perhaps as long ago as September 2001. 
  • Second, the sequestration hits to the defense sector could start to appear as early as mid September, as the large contractors begin to plot a course through very choppy waters.  With companies like Lockheed Martin ($LMT) signaling huge negative pressures ahead, it seems that hundreds of thousands of layoff notices could hit, eventually resulting in more than a million job losses. N.b. there is already some criticism that Lockheed and others will play up the layoff scenario because the election will take place just a few days after the layoff notices are due; however, many of the layoff notices are indeed compelled by law, and the remainder are consistent with the view that sequestration could indeed be catastrophic. 
  • In response to the defense contractor hit, it appears that State credit downgrades may occur, particularly in Virginia and Maryland- two States where defense is a substantial chunk of total business output. From the electoral standpoint, swing-state Virginia is very important to watch.
All of these event could place substantial market and political pressure on Washington.

All told, there will be very few clear signals to entice investors whose ~$3T is still on the sidelines; there are very few solid opportunities and an almost incalculable risk. One short-term bright spot is Apple ($AAPL), which will introduce the iPhone V in a few weeks. I suspect that Apple's new phone may spike interest in Sprint ($S), due to bandwidth issues and the possibility of a partnership. After two months of solid growth in the $CORN ETF, I have lost interest: it appears that the drought is now priced in, and one now has to look to foods and fuels to see inflation. Overall, energy prices appear unlikely to budge unless and until sequestration is dealt with conclusively, one way or the other.  If it does occur, fuel prices could revisit catastrophic lows from Sept '08. If it does not, prices should continue their slow meanderings.

Long story short: the only stocks and ETFs that interest me right now are $AAPL, $S, and $GLD. As sequestration looms, I will again become more interested in energy and financial bear funds and bonds.

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