Deal Unlikely – Meeting Is All Show. Get Ready For the Debt Ceiling Battle.

December 28, 2012

Pain now or pain later – that is the question. Our prosperity is in the hands of our elected leaders.

If Republicans cave-in and they raise the debt ceiling, the market will rally. Democrats will have a blank check and they will kick the can down the road as far as they can. Spending cuts will be delayed and entitlement won’t be touched. The party will continue and we will worry about the bill later. This is the “pain later” scenario.

Unfortunately, our national debt will balloon. In a matter of months we will eclipse $17 trillion and we will be well on our way to $20 trillion. Our credit rating will suffer, but who cares? Central banks around the world are printing money and running massive deficits so their credit rating will be downgraded as well. On a relative basis we will maintain our status.

If Republicans hold their ground and they do not raise the debt ceiling, the market will decline. The battle lines will be drawn and Social Security, Medicare, unemployment benefits, payroll tax credits, fiscal stimulus, defense spending cuts, and tax hikes will all be negotiated. This process could get very ugly. A watered-down solution will be reached after 2 months of haggling and finger-pointing. The market will recover in the second half of 2013. This is the “pain now” scenario.

In each of these cases, the rally will be temporary. We are bumping up against the debt ceiling with greater frequency because our deficits are spiraling out of control.

If meaningful spending cuts and entitlement reform are passed, the market will stage a deep decline and we will be in a recession for most of next year. This scenario has a 5% chance of happening. Politicians don’t have the “stones” to do what’s right. The recovery after such a recession would have legs if we continue to address spending and entitlement.

Decades of overspending can’t be solved overnight. It will require an unwavering commitment to belt-tightening for 10 years or more.

President Obama is meeting with leaders from the House and Senate today at 3 PM Eastern time. The market rallied on the news yesterday and I believe this is nothing more than theatrics. This is the last chance for a mini-deal.

Obama could offer to extend the Bush tax credits for Americans making less than $250,000 per year. Republicans might vote to pass this as long as the debt ceiling is not extended. This is a big stretch for both sides and it is not likely to happen. If it does, the market will give both parties a “free pass” for a few weeks as we head into the debt ceiling negotiations.

Earnings season will be upon us soon. We could get warnings in the next two weeks. Consumers have been very cautious and corporations are not hiring/investing. The guidance has been weak and the market is vulnerable after almost testing the highs of the year.

I believe the price action will have a negative bias and we won’t reach a deal. There will be rumors and promises along the way and that will result in short covering rallies. The pattern will be two steps down and one step up. I will still be day trading until I see how all of this plays out. Keep your overnight risk exposure small and use stops.

This will be my last post in 2012 so I want to finish on a high note. The problems I referenced yesterday and today have been building for decades. As long as we are aware of the issues we can prepare. Work hard, live within your means and value time with your family. Keep your focus and you will rise above all of life’s challenges.

The party has already lasted longer than I thought, so who’s to say that it can’t last a few more years. I’ll ride the wave as long as it lasts.

I know that we will see many market swings next year and that means there will be many trading opportunities.

May you and your loved ones find health, happiness and prosperity in 2013.

Happy New Year!
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