The debt ceiling is much scarier

Dear LOYAL READERS,
FREE EBOOK FOR YOU

Title : 10 Golden Rules Of Investing In Stock Market

Please signup with your email, below.

We respect your email privacy

Subscriber Counter

INVESTORS fearing a stock market plunge – if the United States tumbles off the “fiscal cliff” this week – may want to relax.

But they should be scared if a few weeks later, Washington fails to reach a deal to increase the nation’s debt ceiling because that raises the threat of a default, another credit downgrade and a panic in the financial markets.

Market strategists say that while falling off the cliff for any lengthy period – which would lead to automatic tax increases and stiff cuts in government spending – would badly hurt both consumer and business confidence, it would take some time for the US economy to slide into recession. In the meantime, there would be plenty of chances for lawmakers to make amends by reversing some of the effects.

That has been reflected in a US stock market that has still not shown signs of melting down. Instead, it has drifted lower and become more volatile.

In some ways, that has let Washington off the hook. In the past, a plunge in stock prices forced the hand of Congress, such as in the middle of the financial crisis in 2008.

“If this thing continues for a bit longer and the result is you get a US debt downgrade … the risk is not that you lose two-and-a-half per cent, the risk is that you lose ten and a half,” said Jonathan Golub, chief US equity strategist at UBS Equity Research here.

US Treasury Secretary Tim Geithner said last week that the United States will technically reach its debt limit at the end of the year.

The White House has said it will not negotiate the debt ceiling as in 2011, when the fight over what was once a procedural matter preceded the first-ever downgrade of the US credit rating. But it may be forced into such a battle again. A repeat of that war is most worrisome for markets.

Markets posted several days of sharp losses in the period surrounding the debt ceiling fight in 2011. Even after a bill to increase the ceiling passed, stocks plunged in what was seen as a vote of “no confidence” in Washington’s ability to function, considering how close lawmakers came to a default.

“I think there will be a tremendous fight between Democrats and Republicans about the debt ceiling,” said Jon Najarian, a co-founder of online brokerage TradeMonster.com, in Chicago.

“I think that is the biggest risk to the downside in January for the market and the US economy.”

There are some signs in the options market that investors are starting to eye the January period with more wariness. The CBOE Volatility Index, or the VIX, the market’s preferred indicator of anxiety, has remained at relatively low levels throughout this process, though on Thursday it edged above 20 for the first time since July.

More notable is the action in VIX futures markets, which shows a sharper increase in expected volatility in January than in later-dated contracts. January VIX futures are up nearly 23 per cent in the last seven trading days, compared with a 13 per cent increase in March futures and an 8 per cent increase in May futures. That’s a sign of increasing near-term worry among market participants.

President Barack Obama offered hope for a last-minute agreement to avoid the fiscal cliff after a meeting with congressional leaders on Friday, although he scolded Congress for leaving the problem unresolved until the 11th hour.

Consumers don’t appear at all traumatised by the fiscal cliff talks, as yet. Helping to bolster consumer confidence has been a continued recovery in the housing market and growth in the labour market, albeit slow. Consumers will see their paycheques affected if lawmakers cannot broker a deal and tax rates rise, but the effect on spending is likely to be gradual.

“Expectations are pretty low at this point, and yet the equity market hasn’t reacted,” said Carmine Grigoli, chief US investment strategist at Mizuho Securities USA, here.

“You’re not going to see the markets react to anything with more than a 5 (per cent) to 7 per cent correction.”

A gradual decline remains possible, Golub said, if business and consumer confidence continues to take a hit on the back of fiscal cliff worries.

“If Congress came out and said that everything is off the table, yeah, that would be a short-term shock to the market, but that’s not likely,” said Richard Weiss, a Mountain View, California-based senior money manager at American Century Investments.

“Things will be resolved, just maybe not on a good time table. All else being equal, we see any further decline as a buying opportunity.” Reuters

Business Times : marketwatch

Comments are closed.