Are 'Equity' Vigilantes Keeping The Press Honest On The Fiscal Cliff?

Tyler Durden's picture

In the past it has been the bond market whose vigilantes had rampaged across the fields to keep policymakers honest - but something has changed with the Fed's boot on the bond market. As BofAML notes, when the Fed was too soft on inflation or the fiscal deficit was out of control, interest rates spiked higher. In our view, this has changed and today the stock market is the disciplining force for Washington. We have argued this perspective for a while - that nothing will be done until we get a stock market crash - but the press will continue to make molehills out of mountains it seems as BofAML adds, the most obvious lesson of the last week is that when Washington approaches a policy impasse, the financial press tends to signal a resolution of the crisis many times before it happens. Don’t believe it. After elections there is always conciliatory talk: no one wants to be seen as a sore loser or a gloating winner. The risk remains huge and the four hurdles to a grand bargain seem to be getting larger - no matter what the press wants us to think.


Via BofAML: Taxing Negotiations

In the past week, Democrats and Republicans have staked their initial negotiating position on the fiscal cliff. The news is not encouraging. As our regular readers know, we expect a complex negotiation process that takes many months and multiple brinkmanship moments before full resolution of the cliff. The news in the last week confirms several of our concerns.

Press fakes
Perhaps the most obvious lesson of the last week is that when Washington approaches a policy impasse, the financial press tends to signal a resolution of the crisis many times before it happens. This was evident in the first few days after the election. In his acceptance speech, the President said: “You elected us to focus on your jobs, not ours. And in the coming weeks and months, I am looking forward to reaching out and working with leaders of both parties to meet the challenges we can only solve together.” On a similar note, House Speaker Boehner said “Republicans have signaled a willingness to accept new revenue if it comes from growth and reform.” These positive statements prompted several days of optimistic headlines.

Don’t believe it. After elections there is always conciliatory talk: no one wants to be seen as a sore loser or a gloating winner. Moreover, surveys show the US public wants politicians to start working together. However, we believe investors should look past reassuring rhetoric and focus on the underlying reality. Recent budget impasses have virtually always gone to the last minute and sometimes beyond. In the latest incarnation, the two sides have dug in their heels on income taxes and have not even started to discuss the rest of the cliff. The disagreements between the two parties run very deep and neither side wants to give ground until it has to. The stakes are particularly high in the first round of negotiations: policy steps today could set the tone for the next several years.

Wile E. Coyote moment

The recent commentary also underscores the risk of going over the cliff before a compromise is reached. As we have noted before, in the run up to the election a wide range of commentators were suggesting that going over the cliff is not such a bad idea. They argue: (1) it won’t hurt the economy if it is temporary, (2) it is a good way to extract concessions from the opponents, (3) it resets the starting point for debate (it is easier to restore tax cuts and rescind spending cuts than to do the opposite), and (4) it allows time to get a better crafted deal. In his first press conference after the election, President Obama hinted that he, too, might be willing to go over the cliff, arguing that that raising taxes on the wealthy must be the first step in any budget deal. Keep in mind that the path of least resistance is down: it is much easier for one party to block legislation, and go over the cliff, than to forge a compromise and avoid the cliff. Some people argue that the weak showing of Republicans in the elections means they will be more inclined to compromise, reducing the risk of going over the cliff.

We are not so sure. After all, the Republicans need to first sort out why they did poorly. Moreover, while the election result may have softened the Republican position, there are plenty of early signs that it has stiffened the backbone of Democrats. For example, President Obama has repeatedly argued that the election is a “very clear mandate” to raise taxes on the wealthy. By contrast, Republican vice presidential candidate Paul Ryan said that there is no such mandate because the public also “reelected the House Republicans.” Are the two sides closer together or farther apart? It is hard to say, but clearly the gap remains very big.

The Grand Distraction

The post-election discussion underscores the futility of trying to get a quick “grand bargain,” putting in place a long-term plan for deficit reduction. Speaker Boehner has emphasized that any increase in tax revenues should come from broad-based reform: “in order to garner Republican support, the President must be willing to reduce spending and shore up the entitlement programs that are the primary drivers of our debt.” While tax and entitlement reform are good long term goals, are they really feasible in a few months?

A near-term grand bargain faces not just one, but four major hurdles:

  1. A low starting point: Neither party has even scratched the surface in presenting a feasible plan for either tax or entitlement reform, in our view. Tax reform requires tough choices around which loopholes to cut, a topic that has been carefully avoided by both parties. Medicare reform also requires tough choices around how care is rationed. Republicans have offered a voucher plan, but haven’t mentioned that it will only reduce costs if patients have large out-of-pocket expenses so they have an incentive to limit their spending. Democrats have offered to cut payments to providers, but without any impact on service. The American public needs to be educated about the true options it faces.
  2. Bi-partisan cooperation: As was clear in the 1986 tax reform, getting complicated and contentious reforms enacted is very hard without true cooperation, particularly with relatively evenly divided government. The leaders of the two parties have to stand together and fight the special interests.
  3. High complexity: The US tax code is extremely complicated and any attempt to change it creates many winners and losers. It has big impacts on the many special interests with tax advantages. It also redistributes income across not just income classes but between states (ironically, high-income people in the “Blue states” that voted for the Obama have the most to lose since those states tend to have high mortgages and high state and local taxes). If anything, Medicare reform is even more difficult since it involves life and death choices and there are fundamental disagreements about the relative role of markets and administration in controlling costs.
  4. A sizable gap in view: The two parties strongly disagree about how tax reform impacts the economy. Republicans argue that most of the revenue from tax reform will come from creating a stronger economy. In the past week, President Obama countered: "What I will not do is to have a process that is vague, that says we're gonna sorta, kinda raise revenue through dynamic scoring or closing loopholes that have not been identified."

We agree that it is important to start laying the ground work for tax and entitlement reform, but we also believe it is also important to get the sequencing right. First, dismantle the fiscal cliff, and then start negotiations on the longer term solutions.

Stock market “vigilantes”

Historically the bond market has been a disciplining force for policymakers. When the Fed was too soft on inflation or the fiscal deficit was out of control, interest rates spiked higher. In our view, this has changed and today the stock market is the disciplining force for Washington. Stocks have generally endorsed Fed policy. We estimate that stock prices rose a cumulative 15% in the past three years in response to Fed announcements or actions. While some investors have misgivings about what the Fed is doing, the overall market likes it. By contrast, the stock market is giving a clear no-confidence vote to fiscal policymakers. This was particularly clear when the TARP bailout plan failed to pass and at the end of the debt ceiling debate.


Today, the stock market “vigilantes” are gathering again. In early September we argued that “there is a high risk of a risk-off trade in the markets after [the Fed meeting on] September 13.” We argued that market focus would shift from Fed and ECB easing to fiscal policy risks. In the event the Fed meeting did mark a turning point in the markets, and with the election over and the fiscal cliff taking center stage, the downward pressure has accelerated (Chart 1). This weakness has occurred despite better news on the economy and an unremarkable earnings season.

The fiscal cliff is unlikely to be resolved quickly or in a completely benign fashion. Our advice:

“fasten your seatbelts and remain seated until Co-pilots Obama and Boehner turn off the fasten seatbelt sign.”

In particular, we would be leery about a big air pocket in late December, when our political pilots decide whether sharply drop altitude or not.


Source: BofAML

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slaughterer's picture

AAPL unch

silver -1.27% 

Feeling that sinking feeling yet?

edifice's picture

Yep, and I'll be at the coin shop this evening, picking up some PMs.

Lewshine's picture

Real enuf! That rhetoric didn't keep the stops on my puts from firing off. Sons of bitches!!

HappyCamper's picture

Don't set stops on options.  You're just begging to get gang-raped.  Random noise will often take you out of a good trade.

youngman's picture

Right now they can blame everything on the Hurricane.....and I mean everything...and they will for months

Quinvarius's picture

No.  Just lemmings running off a cliff to sell assets for pieces of paper so they can get wiped out by twinkie price driven hyper-inflation.

slaughterer's picture

Uhhhhh. Still remaining SHORT?  Thought so.  Well, sorry for your loss next week.  

Boilermaker's picture



Jonas Parker's picture

"Keeping the press honest" is like trying to convert a tiger into a vegan... it probably won't work out well, and will certainly piss off the tiger...

BraveSirRobin's picture

I have a light and airy feeling. And the view is fantastic, as the wind rushes through my hair. You know, going over the cliff ain't all that bad, so far.

adr's picture

I bet you feel the best you ever have in your whole life in the few short moments your car is in the air as you drive off the cliff.

kaiserhoff's picture

I was looking at some commodity spreads today, just in case anything sane could be done.  No such luck.  Seems to be way to much hot money around.

One side effect of this volatility is that put spreads are cheap.  I don't have the nerve to try to time this bitch, but if you're long in a pension account or whatever, you might want to check that out.

surf0766's picture

It has much lower to go before they come to a bipartisan agreement for the benefit of the American people.

Long ky and towels !

spooz's picture

So who are these vigilantes controlling our legislature?  Who has the power to tank the markets as a warning to those who refuse to follow the policies that have been deemed important by those that control the financial press?  We see banks controlling LIBOR, silver, oil, why not equities?  It seems the banks are hoping that fiscal cuts will leave them on life support instead of resolution.

SheepDog-One's picture

I dont believe for a minute everything is suddenly focused like a laser on the 'fiscal cliff' drama, its just more BS diversion free drinks and string quartet while the ship sinks. 

BraveSirRobin's picture

We will not go over the cliff. They will delay the date to go over or make some sort of resolution. Taxes will go up, and there will be phony budget cuts.

razorthin's picture

Keep this filed away -

If IWM breaches 75, the uptrend from March 2009 is broken.  And, the trannies are right now sitting exactly at their support for the same period.

Now, what was the question again?

fuu's picture

C'mon Kevin finish it like a maestro.

hedgehog9999's picture

Beautiful straight up ramp = fake

Watch Monday Morning guys.


razorthin's picture

Maybe, but volume is decent.

hedgehog9999's picture

The sell off is after markets close wih the futures when longs can't do shit.

razorthin's picture

Yes, AH will be a good test.

Manthong's picture

“fasten your seatbelts and remain seated until Co-pilots Obama and Boehner turn off the fasten seatbelt sign.”

Um, minor problem.. they’ve got us squeezed into the standing room only section on Ryanair where there are no seat belts and there is no safety.,0,7439965.story

adr's picture

Well they are pointless...

Wow a crappy strap that looks like it came out a 1965 Buick is going to save my life when the plane hits the ground at 500mph.

Beam Me Up Scotty's picture

Seatbelts in airplanes aren't there to keep you from dying if you crash.  They are there to keep you from breaking your neck if there is severe tubulence.  When you are cruising along at 500 mph and suddenly the jet drops 50fps, your head is on the ceiling if you aren't belted in.

Manthong's picture

Beat met to that point.. The seatbelts are there to keep them having to peel you off of the overhead when you hit that massive pocket of turbulence at 30,000 feet or when the plane hits something on the ground or slides off of the runway.

Not really much use in a major crash but I can think of 185 people who were glad to be buckled up.

surf0766's picture

We need another stimulas package that people in Congress can front run and make millions off. More road and bridge fixes for teachers.

adr's picture

SOOO which PD got a phone call at 11:00 letting them know they would get a sweet deal on a couple billion dollars if they used it to buy up as much AAPL and FB and they could?

chrisd's picture

If we are serious about the debt, just don't do anything on the fiscal cliff

adr's picture

won't do anyting. What part of $115 billion beyond revenue in mandatory spending doesn't compute.

Beam Me Up Scotty's picture

Yup adr, thats the problem.  On the mandatory side, we have the seniors who are taking out way more from Social Security than they put into it.  But they are entitled!!  I PAID INTO IT I SHOULD GET IT BACK!!  Same with medicare, you don't pay $50k into it and take $500k  in medical care out of it in your lifetime.  It doesn't work.

Miss Expectations's picture

Nothing causes air sickness like an airpocket.  Even if you're not prone to air sickness, the smell of vomit filling the cabin will set everyone off.

Joebloinvestor's picture

The press is "in the bag".

Watch how many try to save their own asses when the system blows up.

John Law Lives's picture

Talk of fiscal reform is pure piffle.  What politician set to serve in Congress next year has the GUTS to make deep spending cuts in Social Security, Medicare and Medicaid etc. or regular old "pork barrel" spending that would negatively impact their own constituents.  Anyone?  Anyone?  Most of the gutless SOBs just want to stay in power as long as they can.

100% FUBAR.

spooz's picture

How about the military? Its something most Americans agree should be cut.

Why do we spend so much more than the rest of the world?  To protect special interests investments?


John Law Lives's picture

I have no problem whatsoever with responsible cuts to defense spending.

'War is a Racket: The Profit Motive Behind Warfare' - Smedley Butler

mkhs's picture

 This weakness has occurred despite better news on the economy and an unremarkable earnings season.

No, nothing remarkable about the Q3 earnings.

DowTheorist's picture

Good insight that of "equity vigilantes"


Maybe the "vigilantes" have overdone it because today the Transports by closing down flashed a primary bear market signal.


This is not a good omen for stocks.


Here you have the details:


elementary's picture

"no one wants to be seen as a sore loser or a gloating winner"

Obama always gloats.  After winning in 2008, he declared "I won" when he was confronted about ecenomic issues he couldn't understand. And once again, after winning this past election, he declared that he won and the fiscal cliff would be addressed his way.

Fucking petulant child!

orangegeek's picture

And on October 1, the top in the NASDAQ100 was identified.


These moves down in the last two weeks gave warning signs back in September.

dunce's picture

The immutable laws of economics dictate more downward pressure, they can fiddle with the numbers that they release, but neither "i am the law" obama nor  these career politicianscan can avoid the eventual collapse.

d edwards's picture

Keeping the press honest? That'd be a bloody miracle!