No Rest For The Weary

Well that was an interesting month. An interesting six months really!  I can’t remember a time when there were so many breathtaking, heartbreaking, earth-shattering headlines: Middle-East uprisings, Japanese catastrophes, bin Laden dead, European sovereign debt crises, US debt ceiling debates, floods, etc.  And to top it all off the sensational and controversial conclusion of the “OJ Simpson-like” murder trial of Casey Anthony.

While the 1^st half of the year has been disappointing, we expect the 2^nd half to provide a better environment for gains as there is resolution on Greece/Europe and the US debt ceiling, among other things.  Very similar to last year, May and June were tough months; however July 2010 through December 2010 produced a 20%+ rally in the S&P500.  2011 could be similar as negative headlines wane—case in point: markets having already staged a tremendous rally over the last week of June and into July.

In June, our focus was on Europe where it appears that Greece has been given a new (temporary) lease on life.  Despite agreement on the Greek bailout, there are still questions on how a debt roll-over will be treated by the ratings agencies, whether or not the Greeks will deliver on their austerity promises, not to mention the health of other periphery European countries (in particular Portugal whose debt rating was lowered to junk by Moody at the time of this writing).  Despite these hurdles it appears that many of the near-term major issues have or will be been resolved.

Now in July, our focus has shifted to US politics where political empowerment seems to be taking priority over common sense and the need for financial stability.  In our opinion, Republicans need to compromise and agree to some tax hikes and Democrats to significant budget cuts.  However, so far, Republicans have been unwilling to compromise and this has manifested itself in predictions for if/when the US debt ceiling will be raised.  According to predication markets leader, www.intrade.com, there is only 33% chance that debt ceiling will be raised above $15.1 trillion by July 31, 2011.  See figure 1 below.

Figure 1: The chart above shows the likelihood that Congress will approve an increase in the US debt ceiling to $15.1T or more before midnight ET 31 Jul 2011.  Source: www.intrade.com

If the debt ceiling is not raised before the August 2nd deadline, then the current rally that resumed at the end of June will be hindered.  Despite the importance being given to raising the debt ceiling, it is important to note that the US congress (Republican and Democrat controlled alike) has raised the debt ceiling 22 times since 1981—from $1 trillion to the current level of $14.3 trillion (source: Wikipedia).  So this is nothing new.  What is different this time is the extraordinary polarization of American politics, partially attributable to the Tea Party’s rise to power in the past election.  We are confident that a deal will made, however the timing is questionable.

On a final note, I apologize for so much gloom over the past several commentaries … I am usually a much more cheery person!  Sometime (hopefully soon) the tone of these commentaries will turn rosy again and we will be talking about how many gazillions of dollars people are making from social media stocks or some other extraordinarily positive news.

Bottom Line: No rest for the weary.  Although we are getting close to resolution on most outstanding issues, it is not time to head to the Soggy Dollar to sip Pain Killers during the summer slowdown quite yet.  The US debt stalemate is a huge issue, but, as history suggests, it is a resolvable one.  As such, we still consider corrections as buying opportunities in select markets.  As we have stated over the past several commentaries, with resolution we should see a substantial lift to the markets.  We saw it with Greece; now hopefully we will see it with the US debt ceiling.  Should the situation in Europe significantly deteriorate again or the US Congress prove unable to reach an agreement, then we will reassess our position.