Weekly Recap & Outlook – 07.29.11

Tower Private Advisors

Capital Markets Recap

 

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There isn’t much to talk about today, other than the elephant in the room, the debt ceiling debacle. The stories, news, and research continue to roll in, but we have a good group of what we like to call strategic partners, but which, in truth, are no more than mercenaries. They give us their opinions, models, and figures in exchange for a lot of money. They’re no more partners with us than your dentist is with you. No pay, no partner. Still, it sounds better. Any way, BCA Research published its weekly Global Investment Strategy piece and had these things to say, amongst others, about the debt ceiling, but not before having this to say,

The dispiriting squabble over the U.S. debt ceiling is certainly not inspiring confidence, and is casting a shadow over equity markets. Unfortunately, there is little insight we can offer on how this debate will evolve, as no one knows what is really going on behind closed doors. Nevertheless, it looks as if the stock market may begin to lose patience as the political gridlock drags on. From an investment viewpoint, a few comments surrounding the debt ceiling fiasco are in order.

  1. First, the U.S. government does not face any solvency problem, and there is absolutely no funding pressure on the U.S. Treasury market. This debt ceiling crisis is entirely man-made and politically driven, and has been greatly intensified by the looming 2012 presidential election.
  2. Second, what would happen to financial markets in the event that the gridlock drags beyond the August 2 deadline? … The arithmetic suggests that in the event the gridlock drags behind next week’s deadline, the U.S. government will have absolutely no problem honoring its interest payment obligations. This is the key reason why bond yields are still sitting at less than 3% despite all the default talk.
  3. Third, in the case of no deal being reached after the deadline, the U.S. government will have to cut back on its ordinary payment obligations. This could represent a serious fiscal constraint to the economy at a time when growth is anemic. Hence, the debt-ceiling crisis would prove to be more of a shock to the stock market than the bond market in the near term.
  4. Finally…this crisis will prove to be a temporary irritation to financial markets. Investors should resist any knee-jerk reaction to short-term events or negative news.

We believe that’s the correct response for our clients and have advised accordingly. But here’s what’s troubling about that. I get the sense that most folks are saying that, most advisors are talking people off the ledge. That means there’s reluctantly-patient money in the market. In terms of downside, naturally, if there’s a positive resolution–if things play out like BCA envisions–there’s little downside, but probably a lot of upside. On the other hand, if things go badly, there is a lot of money in the market that didn’t want to be there, but that wants out–and yesterday.

So while one might assign probabilities to the various scenarios, below, as follows…

….one also has to consider the outcomes in those scenarios, which might be as follows.

So that’s a bit worrisome.  Financial advisors seem to generally be telling their clients that either the Everything’s fine or Delay scenarios are most likely and, indeed, they probably are. But if we’re wrong…

Here’s how I would characterize our view toward risk markets presently.

And to simplify immensely, here is a major hurdle in each time span.

And here is the biggest risk to that vision, namely, what we had expected to be long-term issues become short-term issues.

No need to put away the sharp objects, however. Don’t worry; be happy. Here is a look at the most popular searches on Google today. Notice, there are no searches for “bomb shelter,” or “dehydrated food,” or “assault rifle.” Relax.

 

 

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