The ECB is fiddling while Rome burns–that wasn’t far from the truth this past Monday, when Italian markets hit the skids. In Washington there appears to be some fiddling, too, although perhaps the better word picture would be the theoretical unstoppable force meeting the immovable object.
Anyway, here is our view on these two hot-button items.
Our position for now remains that we are bullish in the short term (i.e. weeks) while bearish in the intermediate (months) and longer term (years.) We are, however, like a long-tailed cat in a room of rocking chairs with respect toward peripheral Europe (aka the PIIGS), while believing that any problems related to the debt ceiling would be short lived.
We are, however, lining up the nuclear option for portfolios in the event these events continue to heat up. The Europe thing is going to come to a head, it’s a matter of when—not if—and, increasingly, it’s not a question of will the Euro Zone be in existence in five years (it will), but what will it look like.
Regarding the potential for a U.S. default, we still do not see it showing up in the places most likely to reflect it; namely, in interest rates and Credit Default Swaps (CDS). The 10-year Treasury note’s yield took another drop today (to 2.94%). That amounts to the low for the year (2.86% on 6/24 is the low.) The CDS market is where one goes to insure against a default by an issuer, including sovereign governments, like the U.S. There, the action in U.S. debt is very subdued. The mathematical odds of a U.S. default—based solely on CDS pricing—is 1.06% on one-year debt.
When I think about the Debt Ceiling issue—and default—it reminds me a lot of Y2K, when we all woke up on New Years Day—or had stayed awake to be sure—and found that the lights still came on. The market didn’t leap ahead the next day, nor had it sold off in advance. (We all know, though, that corporations had been on a Y2K-related technology spending boom, the end of which spelled the bursting of the technology bubble a few months later.) The markets tend to do pretty well dealing with problems that have a specific date, so that leaves us fairly sanguine, albeit nervous, on this subject.
Graig P. Stettner, CFA, CMT
Vice President & Portfolio Manager
Tower Private Advisors