Debt Ceiling Musical Chairs
The news is still all about Washington’s dueling plans to avoid default or credit downgrade. The August 2 deadline – at which point the Treasury may be unable to pay some of the government’s bills – is now less than a week away. We may yet see a triumphant last-minute agreement between the parties. If so, it will serve only to further delay the inevitable.
One puzzling aspect is that no one – other than a few in the Tea Party wing – seems particularly serious about spending cuts. Plans from the White House, the Senate Democratic leadership, the House Republican leadership, and even the supposedly-hawkish “Gang of Six” will not actually balance the budget. All employ a variety of unrealistic projections and assumptions.
Traders are well aware of all this, of course, which suggests that the possible outcomes are already priced in to the financial markets. That would mean the forecast is not so bad. On the other hand, new and previously-unforeseen possibilities could emerge. If they do, market prices can (and will) adjust quickly.
Ben Bernanke and the Federal Reserve are curiously quiet. We will not be surprised to see the Fed chairman ride in on a white horse to save the day sometime soon. He can easily create whatever liquidity the Treasury needs. This may be why gold bullion is setting record highs.
We still think outright default is unlikely but a downgrade of Treasury paper to AA is quite possible. This will set off a scramble by portfolio managers who are mandated to hold only AAA bonds. Institutions with the ability to change their policies quickly are now doing so. This should serve to contain the impact of a downgrade. At the end of the day, U.S. Treasury bonds will remain the world’s safest haven, relatively speaking. The dollar in which those bonds are denominated is a different story. We live in interesting times.
The Energy sector further padded its lead in the last week, again without much help from crude oil prices. Better-then-expected earnings reports in the Energy Services segment are driving the whole sector up. Technology moved into second place but may not stay there long. Resistance near the current level turned Tech around twice before (in February and May) and the sector was hit hard in today’s action. Consumer Discretionary slipped a notch to #3 and Materials held on to fourth place. Defensive sectors occupy the middle ground. Telecom flipped negative, joining Industrials and Financials at the bottom of the list.
We continue to see a dichotomy between the Sector and Style rankings. For the last few months, the Style categories pointed toward a more aggressive market environment while Sector rankings said otherwise. Today we see that pattern reversing. The traditionally “defensive sectors” have slipped out of leadership while the “defensive styles” of Mega Cap and Large Cap Growth top the Style chart. How this will resolve itself is unclear. In any case, investors continue to prefer Growth over Value across the board. This is especially apparent in the Large Caps with Large Cap Value in last place even as Large Cap Growth tops the list.
The world got flatter since last week, thanks mostly to a surge in the previously-underperforming regions. Five categories flipped from negative to positive momentum scores. We are not yet too excited, however; the newly positive readings are all quite modest and could reverse again quickly. Currency fluctuations are still a big factor. A 4% surge in the Euro the past two weeks finally began slowing today. An apparent breakout in Japan proved unsustainable in today’s downside action, so we could see a new leader soon.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“There’s something happening here. What it is ain’t exactly clear.”
For What It’s Worth, Buffalo Springfield, 1967
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