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Near the US debt Ceiling, No One Can Hear You Scream

Let’s set the stage…

Jacob Lew, the Treasury secretary, just whispered that the next market crash begins no later than mid-October.

Of course, he didn’t say those exact words. But he did report that the Treasury’s ‘extraordinary measures‘ to avoid hitting the debt ceiling will be ‘exhausted in the middle of October‘.

The US debt ceiling is a legally imposed limit on federal debt. You may remember the 2011 debt ceiling talks and the drama around a government shutdown.

This led Standard & Poor’s to downgrade the US’ credit rating for the first time ever. The market fell more than 15% while all of this was going on from April to August.

Well, we’re looking at something like that all over again as the government’s debt presses up against that ceiling.

Even though Lew’s whispering those words now, soon he’ll begin screaming about it. The budget deficit crisis will likely be front-page news in the month of September as the brinkmanship over the debt ceiling ramps up again. I think we’re in for a rough couple of months.

It gets worse. There’s a second clue that tells us more about the upcoming collapse.

As John Williams at ShadowStats points out, the Federal Reserve has bought 110% of the net issuance of US Treasury this year. Meaning the Federal Reserve Bank has bought every new dollar of debt issued and then some. As Williams says, this is ‘a pace suggestive of a Treasury that is unable to borrow otherwise.

By mid-October, the Federal Reserve’s purchases should be approaching 140%, by his calculations. This is clearly absurd and can’t go on forever. (If for no other reason than the Fed will eventually own the entire federal debt market. As it stands now, it owns about a third of it!) When it ends, interest rates will likely rise. That could also bring the easy-money party to a close.

Ironically, right before Labor Day weekend, the government issued its revised GDP numbers. It claims the economy grew at an annual rate of 2.5% for the second quarter. This was a 47% boost from the initial government estimate of 1.7%.

Officially, the government is telling us that the economy has now completely recovered from the 2008 crisis. Economic activity is now higher than it was at the 2007 peak.

What’s most interesting is the contrasting picture of a glowing GDP report with everything else.

No other major economic series has shown a parallel pattern of full economic recovery,‘ Williams points out. ‘Either the GDP reporting is wrong, or all other major economic series are wrong.

There is a lot of nonsense in economic reporting, and GDP is the worst of all. (Williams himself admits that GDP ‘remains the most worthless and most heavily politicized’ of the government series.) But let’s look at something that’s harder to fudge: median household income. See the chart below.

If you look at that, you don’t see any recovery. And these are the government’s official numbers. The point is there has been no full recovery.

Let’s put these clues together. We have another fiscal crisis imminent with a looming debt ceiling drama. We have a Federal Reserve that is already doing a huge and unsustainable amount of ‘stimulus’ buying. And we have an economy far weaker than it’s been in more than a decade despite the bluster over GDP.

The bigger concern is that the market doesn’t have any of this priced in at all. It’s true that August was the worst month for stocks since May 2012. Yet the market fell just 3.1% and is only 4.5% off its all-time high. That’s barely a scratch.

What’s odd is that the stock market has pushed higher this year — putting in a new all-time high on Aug. 2 — even though earnings growth has clearly slowed. Earnings growth for the S&P 500, a broad proxy for the market, was up just 2% for the second quarter.

That was all due to the financials (banks, insurers). If you take them out, earnings actually fell 3%. Analysts have been adjusting their estimates. Earnings growth for the third quarter is now just 3.7%, versus 6.5% at the start of the quarter — a 43% correction!

Slowing profit growth and rising market mean valuations have climbed. Bloomberg reports that ‘Valuations last climbed this fast in the final year of the 1990s technology bubble, just before the index began a 49% tumble.

I don’t think we have that big of a decline ahead of us, simply because we’re starting at a much lower valuation. In 1999, the market went for 30 times earnings. Today, it goes 18 times earnings. That’s still a high number, reflective of too much optimism about future growth.

Most still see earnings and the economy growing briskly in the back half of the year. Barron’s recently polled 10 of the most influential Wall Street seers. They project 8% earnings growth in the second half! When it becomes obvious that is a fairy tale, the market is going to be in for a shock.

Keep your powder dry and your portfolio small.

After reading the above, you might be tempted to sell everything and wait for the storm to blow over.

I don’t think you should.

First off, we have to realise that all of the above analysis could prove way off. Maybe Congress raises the debt ceiling without a hitch, buying more time. Maybe the Fed pulls some new rabbit out of its hat, buying yet more time.

Besides, guessing at what the market is going to do is just that — guessing. Humility before an unknowable future is the first step toward any sensible investing strategy. The only thing we can really do is to decide what risks to take.

Second, while I think now is a time to be cautious — simply due to the relative scarcity of cheap stocks — I don’t think you should let market worries put you off a solid long-term investment plan. As Marty Whitman once said, ‘You make more money sitting on your ass.

In other words, you’re often better off doing nothing and holding onto good companies growing their net asset values over time, rather than trying to play market timer.

So we will continue to invest in what cheap plays we find.

Regards,

Chris Mayer
for The Daily Reckoning Australia

Ed Note: Near the US Debt Ceiling, No One Can Hear You Scream originally appeared in The Daily Reckoning USA.

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From the Archives…

Is a 50% Market Decline Possible?
30-08-2013 – Greg Canavan

Why The 30/20 Tax Rule May Rise Again
29-08-2013 – Vern Gowdie

The Investment Industry: Confusion, Conflicts and Cash
28-08-2013 – Vern Gowdie

The Federal Reserve’s Crucial Next Step
27-08-2013 – Greg Canavan

Superannuation Overtakes Bank Deposits
26-08-2013 - Greg Canavan

1 Comment

  1. slewie the pi-rat says:

    does snuff count as dry powder?
    how about a small portfolio of tobaccy stocks? good idea?

    “Philip Morris is also suing Australia for damages because of tobacco regulations, despite the country’s High Court ruling that it has no right to sue. Philip Morris moved assets to Hong Kong to be able to sue Australia under a bilateral trade agreement, and the TPP would open the floodgates to similar suits.”
    ["Trans-Pacific Partnership Secrecy Tightens"
    ~by PETE DOLACK (http://www.counterpunch.org/2013/09/06/57437/)]

    prez0 and the tobacco lobby are setting up more lawyers-for-life with the TPP which is simply what the PPT said while lo^oking in the mirror.

    the Trans-Pacific Partnership is a NWO sovereignty-adjusting [free?] trade agreement which is nearing completion and, as a gift to the world, may be the first international trade agreement to be passed before anyone even near the rank of pi-rat knows what’s in it.

    in related news: the boilerplate works are running three shifts and have introduced legislation to add an 8th day to the week…

    “Buoyed by the ministerial engagement and their commitment to actively guide the negotiations, negotiators advanced their technical work this round on the texts covering market access, rules of origin, investment, financial services, intellectual property, competition, and environment. They also made progress on the packages providing access to each other’s markets for goods, services, investment, financial services, temporary entry, and government procurement.” [US Office of Trade Representative's summary (ditto link)]

    and : Apparently wishing to end any pretense of independence, the Australia Department of Foreign Affairs and Trade issued the same four-paragraph release, word for word. The New Zealand Ministry of Foreign Affairs & Trade couldn’t be bothered to issue a report at all, merely publishing the chief negotiators’ joint statement, which was similar pablum. [dbl ditto]

    and: In the meantime, legislators around the Pacific Rim continue to demand access to the secret TPP text. Two years ago, in 2011, the New Zealand government denied a hearing on the TPP asked for by 13 organizations and there is no indication that any hearing will be held. A Canadian opposition member of parliament, Don Davies of the New Democratic Party, has asked the government of Stephen Harper “to give Canadian MPs the same information that US Members of Congress have about the ongoing Trans Pacific Partnership negotiations.” [dbl secret ditto]

    after reading stuff like this, i recommend pretending to be a NWO bankster, just to try to calm down and feel a bit better.

    or, maybe go with the nice, soothing, “10-minute vacation” Sanskrit mantra:
    “…Technecrats Uber Alles Hum…”

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