Thursday, June 02, 2011

Stock markets and debt ceilings

The stock market took it on the chin yesterday (after an unexplained melt up the previous day) on fears about Europe - this is not a repeat of every other Wednesday for the past 12 months - and weak ADP numbers.

On the ADP data - I've been arguing for years that this is perhaps the worst piece of pseudo information the market looks at. Their numbers have virtually no correlation to the actual jobs data and when everyone starts jumping ship over ADP numbers I'd be willing to bet the other side of that equation (namely the BLS jobs numbers to be released tomorrow) may surprise on the high side.

Banks have spent the past 24 hours drastically cutting their expectations for tomorrow's number but as I've said before many, many of the BLS jobs are either new business start-ups and government positions, both of which don't show up in ADP data (although local governments have been cutting jobs recently). I'll have to see where consensus falls but my guess is that there is a fairly strong chance the BLS number tomorrow might beat expectations. We'll have a chance to debate the validity of that number tomorrow but I think the headline may look surprisingly good relative to the ADP data.

Here's the next problem for the Fed: QE2 is planned to wind down at the end of this month. This is the end of the free money gravy train for the banks and that means things could get dicey for the stock market. The Fed can't justify any further easing (the much rumored QE3 is said to be DOA) with the stock market within a whisper of it's all-time highs, but if stocks fall without the Fed backstop what does that say about the value of Fed easing? The Fed has painted itself into a corner here and I don't see an easy way out.

If the stock market was just some number scrolling across the screen it would be one thing, but this has deep ramifications around the country. Here's one example: Let's say the market falls 20% from here - this would be a steep decline given corporate profits but sentiment can turn quickly. Well, every pension fund that is heavily invested in the market will now see the value of their assets shrink while their obligations continue to grow. How do they make up that gap? Well, they force their plan members to kick in more principle. For the local school district that might mean more money leaving the instructional budget (teacher cuts). A falling stock market also weakens consumer and corporate confidence. However, if the Fed keeps the market elevated on Hopium (Hope + Opium :) you are looking at higher inflation - $5 gas anyone? - and weaker consumer sentiment. Choose your poison.

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We're again at the lower end of the trading range for stocks over the past 4 months. They've gone up and down within this 1,300-1,375 range since the beginning of February. A sustained breakdown through 1,300 could really start gaining some steam but every test of that region has been bought furiously in recent months. We'll see if this time is any different.

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All long-time readers know how much I loathe the double talk that comes out of Washington and the "vote" on raising the debt ceiling was another fine example of politicians acting in their own self-interest. However, there was some value in that vote because Congress tipped their hand and showed exactly what they are all about --- self-preservation.

You see, they didn't randomly chose to raise the debt ceiling by $2.4 trillion because they liked the sound of it. $2.4 trillion is almost exactly the amount of money the Federal government will need to survive until late November 2012 -- RIGHT AFTER THE NEXT ELECTION -- if tax receipts tumble and the economy sputters.

Congress can only see things through the prism that is their next election. Consider why both parties want to push this issue out past 2012: If the Republicans win the White House and sweep Congress they'll increase the debt ceiling without batting an eyelash as they did repeatedly under President Bush. If the President Obama wins but the Republicans control Congress, the Republicans can go on the attack the day after the election "You see OBAMA wants to burden your great, great grand-kids with more debt". This is a win/win for the Republican spin machine (in their eyes - the American public still loses).

If Obama wins and the Democrats somehow ride his coattails back to power in Congress guess what happens? The debt ceiling gets raised again and no one outside of the talk radio nutjobs will notice. If the Republicans sweep everything, the Democrats can suddenly act like faux fiscal conservatives and start screaming for spending cuts before extending the debt ceiling. I've said it before and I'll say it again, the finances of our country our too important to be managed by people that are constantly running for re-election. If we were serious about battling our budget woes we'd pull the power of the purse from Congress because neither party has your best interest at heart, they only see how it impacts them in the next election.

Cheers!

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