Published December 28th, 2012
Twelve days ago, the markets ripped when Boehner put on the table a one-year extension of the debt ceiling, and he also caved-in on higher tax rates for people making over $500K a year.
In return, Republicans expected a fair trade, and wanted spending cuts in 2013 & 2014 from the President, but they essentially received nothing.
It therefore appears increasingly likely that Washington lawmakers will strike a small deal to send the market higher ? but only temporarily.
Last night, we said we would probably see one more moment of fear, and then a 30 to 40 yard punt ? a deal without an extension of the debt ceiling, basically forcing another deadline on January 30th, when we will have to deal with it.
With this scenario, the markets will rally, and we are advising you to sell the rally hard unless there is an extension on the debt ceiling.
We have been buying dips, selling half our positions on rallies ahead of a small 30-yard punt. If we get a deal, roughly $150 billion to $300 billion of 2013 tax increases, which won?t include a 1-year extension of the debt ceiling, sell the rally. Once we get the relief rally, the markets will focus on the recessionary forces that will arrive like a storm in the South Atlantic, which will once again batter the markets.
We are currently predicting a choppy January, as these tumultuous forces start to clash with one another ? the financial stability of the United States, facing off against the recessionary forces still deeply entrenched in the economy.
We will be sending a note out shortly on the 17 Lehman Systemic Risk Indicators, which stand today 65% below their May / June, 2012 levels. Thus, we can buy the moments of fear in the market, without the risks of serious downside. I see a 3-5% selloff as a worst case once we hit the Fiscal Cliff, followed by a substantial relief rally once a deal is secured.
With only five days left before year-end, there has been no material progress to report toward a compromise to avert the fiscal cliff. President Obama and Senate Majority Leader Harry Reid (D-NV) appear focused on pushing forward with at least a smaller deal to address some of the largest elements of the fiscal cliff, but getting even that accomplished is far from certain at this point.
Following Speaker of the House John Boehner?s (R-OH) failure to pass his Plan B through the House, the political dynamics have shifted to the Senate from the House. Our partners in Washington, AGC Analytics reminded us this morning, Senate Minority Leader Mitch McConnell (R-KY) is reluctant to risk political capital by actively pursuing any compromise, especially given that he is up for re-election in 2014. The real question now is whether McConnell seeks to block any compromise at all.
There are three practical outcomes in the short-term:
(1) Plan A is resurrected and passed ? down to a 10% chance;
(2) A small deal is passed that mitigates roughly half of the cliff?s fiscal impact, leaving another battle for the first half of 2013 over the debt limit and spending cuts ? most likely outcome with a 55% chance; or
(3) No deal is reached at all before the new Congress is seated on January 3 ? the odds of this outcome have risen in the last few days to 35% and will go substantially higher if McConnell threatens a filibuster.
With President Obama and lawmakers returning to Washington today from their shortened Christmas recess, we will continue to monitor developments toward avoiding, or at least mitigating, the fiscal cliff.
Before leaving for Christmas vacation in Hawaii, President Obama explained that while he was still hoping for a larger deal, Congressional leaders should at least be prepared to pass a smaller deal that would extend the Bush tax cuts below the $250,000 threshold, suspend the $109 billion across-the-board spending cuts of the sequester, and continue extended unemployment insurance benefits.
Conspicuously, Obama did not mention increasing the debt limit, which until now he had insisted was necessary for any deal he signed.
Besides speaking by phone with Boehner, Obama also met at the White House with Reid, signaling greater Senate involvement in the next phase of negotiations. This smaller deal is not necessarily an easier sell with Republicans than the Plan A that Obama and Boehner were discussing before Boehner broke off negotiations, primarily because it still includes a tax increase on upper income tax brackets and does not include any spending cuts, two of the most contentious issues for the GOP. Nevertheless, this is where the focus has shifted in recent days.
Democratic hope that enough GOP members may be willing to pursue a smaller deal is based on two premises:
(1) Given that public polling has clearly indicated that Republicans will get the most blame for going over the cliff, a small deal is better than no deal; and
(2) While addressing some of the biggest elements of the cliff, a small deal theoretically leaves the GOP with leverage to continue to fight for further spending cuts in exchange for a debt limit increase in the ensuing months. Our partner, ACG Analytics has consistently expected that any compromise would first be voted on in the Senate, providing political cover for House Republicans.
However, we also assumed that the compromise would have first been struck between Obama and Boehner, leaving McConnell free to not officially support it while eschewing whipping against it. With a smaller deal needing to not only be navigated first through the Senate but also likely being negotiated there, it remains unclear whether McConnell is willing to play a facilitating role the way he did during the 2011 debt limit increase and last December?s payroll tax holiday extension. Even though we have been told that McConnell has an understanding in place with Tea Party favorite Rand Paul (R-KY) that Paul will not publicly support a primary challenge to McConnell in 2014, Paul likely would relish McConnell facing such a challenge given how McConnell opposed Paul?s candidacy during the 2010 GOP senatorial primary.
Additionally, McConnell is wary of a Democratic challenge in the general election from celebrity singer/actress Ashley Judd, who will have prodigious fundraising ability. This situation leaves us with the critical question of whether McConnell will allow Reid to push for passage of a smaller deal or will block it entirely with a filibuster.
Our partner, ACG Analytics believes McConnell will choose to limit his involvement as much as possible while neither supporting nor filibustering any compromise that Reid attempts to pass in the Senate. However, this stance by McConnell does not ensure success for a smaller deal ? though it does give it a fighting chance. With 54 members of the Senate Democratic caucus, Reid will likely only need six Republican votes to pass any deal, assuming a 60-vote threshold is established.
There should be enough moderate Republicans, including several retiring Senators, who will be willing to vote in favor of a smaller deal. Should a bill move out of the Senate, the House will still need to pass any deal before sending it to the President. The open questions are whether Boehner would receive a ?majority of the majority? in support of any bill and, even if he does not, would he be willing to allow a vote given that he is up for a vote on his speakership on January 3.
As Plan B would have garnered approximately 200 Republican votes, we believe that any deal that successfully navigates the Senate would likely receive ?majority of the majority? support in the House. Even if such a bill did not appear likely to do so, we believe Boehner would still allow it to come to the floor for a vote and let the chips fall where they may.
The 3 Possible Outcomes
1. Best Case
It was only last week that negotiations toward a broader compromise were moving steadily along with a clear vision of the likely endgame. By splitting their remaining differences, Obama and Boehner could have found $1 trillion in both new revenues and further spending cuts, respectively. The major Republican concession would have been higher tax rates starting at a threshold of between $400,000 and $1 million.
The major Democratic concession would have been some specific entitlement reforms that would have affected beneficiaries, such as using chained CPI for determining Social Security payments and potentially further means testing of Medicare, but real 2013-15 cuts are crucial to winning over the GOP in the House.
This package also would have created the framework for broader tax and entitlement reforms to be addressed in 2013. And it would have facilitated solutions on most of the other elements of the fiscal cliff, minimizing the likely fiscal drag to approximately $180 billion for 2013. While this scenario arguably presents a better outcome for Republicans than a smaller deal, it will only be possible if Boehner assertively re-engages in negotiations with the White House?that no longer looks likely in the wake of Plan B?s failure.
2. Base Case
This is where the White House and Reid are now focusing their energies and such a bill stands a legitimate chance of success if McConnell chooses not to play the role of spoiler. It is important to point out the fact that if Plan A was never really seen as a solution but only a down payment, then this outcome seriously raises the question of whether a broader solution is even possible before the United States faces a true fiscal crisis.
A small deal would :
1. Extend the Bush tax cuts below a certain threshold, probably higher than the $250,000 level preferred by Obama, but likely not greater than $500,000.
2. Suspend the sequestration spending cuts for 2013.
3. Include an extension of unemployment insurance, the Alternative Minimum Tax (AMT) patch.
4. Stave off scheduled Medicare Sustainable Growth Rate (SGR) cuts (popularly referred to as the ?Doc Fix?).
Despite these measures, there is a lot that such a bill would not do.
The massive loss of perennial tax extenders, which include the R&D tax credit and Wind Production Tax Credit, would expire and not be applied to 2012 unless retroactively addressed in 2013.
Above all, there would not be a debt limit increase included in a smaller package, setting up another debt limit showdown in early 2013. While the Congressional Budget Office (CBO) expects that this issue would become ripe in February or March, ACG Analytics believes that CBO?s assumptions are conservative and that a debt limit showdown could extend well into the second quarter of 2013.
In other words, Treasury Secretary Tim Geithner, may have more emergency cash than he?s let the market believe.
Another reason to sell the rally on a small deal, the fiscal drag for 2013 as a result of such a deal would likely be approximately $300 billion, but that does not include either the direct impact of spending cuts that could be coupled with a debt limit increase or the indirect impact of the prolonged uncertainty due to another debt limit battle. Passage of a small deal, ironically, could have a greater chance of inducing a U.S. credit downgrade as such a deal is unlikely to be deficit-neutral, let alone produce deficit reduction. The need for a small deal and a separate debt limit fight in 2013, would also seriously undermine prospects for comprehensive tax reform or entitlement reform.
3. Worst Case
There is a slightly better than 1-in-3 chance of fully going over the cliff at this point.
While many media commentators are arguing that the expected resulting adverse reaction in the financial markets will lead to a deal in early January, it is worth noting that the seating of the new Congress on January 3 could complicate any crisis mitigating legislative efforts.
The Treasury Department did not move to change the withholding tables in time to impact the first paychecks of 2013, but the reductions would be put in effect by the end of January. There would be an approximate two week lag before medical providers felt the impact of the reduction in Medicare payments. OMB would also have to move quickly to work with federal agencies to implement the across-the-board spending cuts as a result of the sequestration.
In the early weeks of January, these savings could likely be achieved through reduced travel and IT spending, but if the sequester dragged on into the Spring, there would be mandatory furloughs and service delays and disruptions. Our partner ACG Analytics expects that Congress, and particularly House Republicans, will come under enormous pressure to pass legislation to address the adverse impact of the cliff, but it very well could take weeks rather than days to turn this pressure into a successfully passed piece of legislation.
Source: http://www.redliontrader.com/streamingnews/reviving-brands-that-arent-quite-forgotten/
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