The proximate cause of Friday's market rally was likely short-covering -- many traders and investors didn't want to go home short in fear of a weekend agreement in Washington, D.C.There was no agreement over the weekend. At Friday's close, the S&P 500 stood within 2% of the old high, and the 30-day Treasury bill yield has spiked to 0.21% -- which compares with its recent zero-interest-rate-policy (ZIRP) range of between zero and 6 basis points. This is something of a contradiction in terms and in markets. (I typically favor the predictive value of the fixed-income markets over that of equity markets.) One can only conclude that Mr. Market is not meaningfully worried about the dysfunction in Washington. This weekend's impasse, however, suggests that the odds of missing the Oct. 17 deadline have grown somewhat larger. How much, I don't know, nor does anyone else. It also should be emphasized that the Oct. 17 date is a political issue and largely symbolic, as the Treasury will have $50 billion in payment capacity on that date. While a technical default is still possible, a debt default is as close to zero possibility as one can get without it actually being zero. Though the Treasury's payment capacity will not run out of cash until the end of October, the Treasury does have a $67 billion payment to make on Social Security, defense and Medicare due Nov. 1 My base-case expectation of a late compromise -- that is, sometime on Wednesday or Thursday -- remains odds on.
"Profits are the 'mother's milk' of stock prices." -- Larry Kudlow, "The Kudlow Report"The economic damage to business and to consumer confidence, grows with every passing day. That's a dangerous state, considering the domestic economy has not reached escape velocity and is not yet self-sustaining after four years of ZIRP and quantitative easing. Profit forecasts for the fourth quarter and for the first half of 2014 are too optimistic (again), and revisions are heading lower in the months ahead. Confidence is falling at the fastest rate since the Lehman Brothers collapse (see here and here). Domestic economic growth is faltering as well, and top-line sales are nothing to write home about. Outside the financial sector, earnings were lower in the second quarter and not much better in the third quarter. Profit margins are near a 58-year high and 70% above the five-decade mean. The S&P P/E ratio is up 2 points from 2012's year-end, and we still have questions about the global economic growth trajectory, particularly after China's big exports miss (reported Saturday). Given all that, I believe the rally late last week should be sold and, absent a reasonable sized correction, dips should not be aggressively purchased.
"Price is what you pay, value is what you get." -- Warren BuffettA heavier-than-typical invested position is justified when stock prices are inexpensive, when pessimism abounds and/or when there is clarity of fiscal and monetary policy. Right now, few of these conditions exist. Volatility and uncertainty will be with us for a while. While that's candy for the opportunistic short-term trader, it's a bogeyman for the long-term investor. In sum, the current debt-ceiling/budget impasse too shall pass, and the markets will survive. But the damage and toll on a fragile global economic recovery will accumulate, too. Under the aforementioned conditions, it is difficult for me to envision a multiple expansion (i.e., valuation); it is far easier, at least for me, to expect a multiple contraction. I continue to subscribe to the view that the year's high was put in place in August, and the range for the S&P 500 over the balance of this year will be roughly between 1630 and 1700. Friday's close, if you'll recall, was 1703. We are at the crossroads.
This column originally appeared on Real Money Pro at 8:17 a.m. EDT on Oct. 14.