The market continues to track the same pattern it performed going into the failed debt ceiling talks of July 2011. As you’ll recall, then as is the case now, US politicians failed to reach a credible solution to the US’s debt problems. What followed was a credit rating downgrade and a market collapse:
Here’s the S&P 500’s recent action:
Here’s the S&P 500’s action going into the failed debt ceiling talks of 2011:
Here’s what followed:
Be forewarned. As noted earlier this week there are no political incentives for the GOP or Democrats to propose a real solution to the fiscal cliff. So it is highly likely
we will be going over the cliff.
Another item holding up the market is hype and hope of more QE from the Federal Reserve at its December 10-11 meeting. I have to admit, I find this proposal completely baffling. Macroeconomics 101 dictates that it takes a full six months or more before a change in monetary policy by the Fed will be fully digested by the system. The Fed just announced a new program three months ago. So the academics at the Fed aren’t even drinking their own Kool-Aid anymore.
Since the Great Crisis began, the Fed has on average funneled some $40+billion per month into the system (even when no official program was in place the Fed was still juicing the markets this much, typically during options expiration weeks).
QE 3, which may as well be called QE infinite because it is open ended (will never end), combined with the Fed’s Operation Twist 2 program has the Fed currently putting $85 billion into the system every month. On an annualized basis this is over $1 trillion. This means that at this pace, by the end of 2013 the Fed’s balance sheet would be $4 trillion. The entire US banking system is $13 trillion.
And somehow pumping more money would work?
At some point some group in the political class needs to actually ask the Fed the following: “You’ve had four years of implementing any policy you like without political consequence. Four years. During that time you’ve spent well over $2 trillion. And the Crisis has not been fixed. Why on earth should we give you more time or money?”
I believe this will happen in 2013. As the US economy takes a nose-dive and the Sovereign Crisis moves into hyperdrive, the triumvirate of the financial system (the Fed, Wall Street, and Washington DC) will begin to increasingly point fingers at one another to divert blame for the fact that we’ve spent trillions of Dollars and things haven’t really improved.
This process has already begun with the Fed firing the first shots: it has sued Goldman Sachs while Bernanke has told Congress that it’s their fault the US is so indebted and facing fiscal ruin.
This process will accelerate next year. At that point I expect Congress and Wall Street to enter the fray more aggressively targeting the Fed. And that’s when things could get very ugly.
Swing by www.gainspainscapital.com [10] for more market commentary, investment ideas, and special reports outlining specific risks and opportunities in the capital markets.
Graham Summers