Via Michael Naso of FBN Securities,
One of my favorite movies, recently relegated to AMC with commercial interruptions every five minutes, is “Armageddon,” starring Bruce Willis who leads a ragtag band of energy drillers enlisted by NASA to save the world from an impending catastrophe courtesy of an asteroid the size of Texas. I will not spoil the ending for those who have not seen it save the presence of a “zero barrier” which if breached by the mammoth rock would end all life as we know it. Yesterday’s price action offered a messy preview of what lies around the corner, for the U.S. economy confronts its own Biblical demise, otherwise known as the fiscal cliff, when it slips past its own zero barrier which I estimate as the December 21 triple witch expiration.
To be sure, I do not equate a near guaranteed recession and significant pullback in equities as calamitous as what Mr. Willis et al faced; however, the inevitable squabbling by each party would cause significant damage to an already fragile recovery. Despite President Obama’s supposed olive branch across the aisle during his victory speech Tuesday, Senate Majority Leader Harry Reid quickly reminded everyone yesterday that tax hikes on the rich are a necessity. On the other hand, Republican Senator Pat Toomey (PA) spewed the Romney debt reduction proposal plainly on CNBC yesterday afternoon with Speaker Boehner emphasizing the position further with the mirage of his willing to accept new revenue sources. In short, the two sides are as far apart as ever as the Democrats will be emboldened by the Election while the GOP will point to roughly 50% of the country, exemplified by the popular vote, who agree with its views.
Politicians fail to understand that the markets project forward such that as each faction drags its feet, the damage done to stocks could be substantial. In fact, some leaders in Washington have argued that going over the cliff actually would be welcomed given the amount of income it will bring into the Treasury Department’s coffers. This is foolhardy such that the pressure of cutting a fast deal after such a dislocation would produce something few would applaud. Other analysts are hopeful for some sort of compromise that kicks the Bush tax cuts well into 2013. I do not suspect President Obama would cave so easily after such a resounding win in the Electoral College while Moody’s and/or Fitch would not look so kindly on the U.S. sovereign credit rating as a result. In retrospect, my comparison to “Armageddon” may be unfair simply because the current fiscal crisis might not even have a zero barrier as the most plausible scenarios, when leveraging game theory, hints at an unfavorable outcome.
I do not subscribe to the speculation that Mario Draghi’s downbeat comments on Germany lit the match of Wednesday’s aggressive decline, for most investors had already reached the same conclusion about contagion spreading from Southern Europe for quite some time. A simple gander at the economic figures, most notably the PMIs, backs this thesis. More importantly, though, a recession for the EU’s economic engine would not only paralyze Europe, but also many large multinational corporations. In short, the 12.5% expected earnings estimates for the S&P 500 for the next 12 months remain highly optimistic such that an inevitable reduction would weigh on shares.