Via Michael Naso of FBN Securities,
I attended a business school which hosted classes where the demand for a seat easily outdistanced the supply. To assuage the imbalance, the administration allocated auction credits to the students for their bidding on various sections. Thanks to a dynamic professor and the practical subject matter, an offering in Negotiations consistently owned the highest clearing price for those trying to gain access to the course.
Spending over 50% of my two year allotment on this single topic was well worth the price of admission. Not only were the lessons taught helpful when navigating large personal purchases such as an automobile or a house, but they also provided a guide in trying to predict the behavior of the major players engaged in the current fiscal cliff debate. Frankly, based on what I learned, I question the most recent tactics enacted by the Administation.
I had written in Wednesday’s “Missive” of Senator Reid’s frustration that progress had stalled as he blamed the Republicans for not bargaining fairly in trying to iron out a compromise. This declaration signaled to Speaker Boehner that the Democrats will play hardball as well.
However, yesterday’s Wall Street Journal article, via quotes from Erskine Bowles, claimed the White House will be flexible when proposing a raise to the top marginal tax rate. This perceived increase in the probability of a near term accord appropriately rallied stocks aggressively to produce the first outside reversal since the session that spawned the bounce off the November 16 trough.
I question why Mr. Obama would leak his best alternative to a negotiated agreement (BATNA) so early in the process, for classic bargaining strategy suggests keeping that information close to the vest as long as possible. Moreover, since the Senate already has passed legislation that augments revenue only via the higher income levels, the President had enjoyed the upper hand in the debate. He may have forfeited that head start on the release of yesterday’s comments. More troubling, given the ideological divide between the two factions, this newfound willingness to compromise may actually transpire to an intractable divide as we move closer to year end.
From the Republican standpoint, the Administration’s concession generated an odor of weakness such that Mr. Boehner has no incentive to budge from his stance of rejecting a hike to marginal rates. He can reasonably assume that the White House’s new position does not represent its BATNA such that the Speaker’s potential of getting his most preferred outcome is very much in play. Logically, he will press that advantage. On the other hand, if the Democrats actually did announce their final offer more than a month ahead of the New Year, then, in theory, they will not shift either forcing an unfortunate stalemate between the two parties.
Complicating matters, Mr. Obama declared a preference to strike a deal by Christmas which approximates the Friday, December 21 “zero barrier” I have written about previously. If we push past that date without a formal agreement, it behooves the President to sit on the ball and run out the clock. Immediately after going over the cliff, he would simply present the aforementioned Senate bill that increases rates only on income over $250K as a tax cut to House Republicans. Couched in this manner, such legislation will be very difficult for the GOP to reject especially if the market has dislocated in the interim.
Ironically, if the Republicans acquiesce to yesterday’s posturing by Mr. Bowles, then the likelihood of a Moody’s and/or Fitch downgrade rises, for the ratings agencies would almost assuredly be disappointed by a lower than anticipated level of incremental revenues. If Mr. Obama somehow manages to overcome Wednesday’s misstep to achieve his optimal course of action, then the “resolution” would dent an already fragile recovery as exemplified by an extremely weak New Home Sales report. That is the punch line of this whole dilemma, for no matter what path the negotiations traverse, the ultimate outcome will produce at least some negative consequences.
In the short term, I expect the Democrats’ apparent flip toward compromise will rally equities especially in light of money flows that often arise with the turn of the calendar. This suggests we should continue to grind up through Monday evening. As we move deeper into December, the headline chasing environment will only exacerbate as the “theta” of the risk premium associated with the fiscal cliff increases daily without the consummation of a deal. If the tape continues to afflict investors with a serious case of whiplash by tracing 25 handle intraday ranges for the S&P 500, managers will have difficulty putting money to work amidst the skittishness.
Lost among the sparring in Washington was significantly downbeat comments made by Chakravarthy Rangarajan, India’s economic advisor to the Prime Minister, who acknowledged that its top 10 global economy is “going through a difficult phase.”
Combined with China and its unraveling equity market, the hope for a stimulus rising out of Asia has dimmed. Thus, while prospective cooperation in managing the budget crisis would generate a snapback in early 2013 as consumers and businesses release pent up demand, the longer term prospects for the U.S. recovery will continue to stumble as the rest of the world jogs in place.