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On September 27, the Senate approved legislation to fund the federal government for the first six weeks of the fiscal year (starting October 1), and to restore money for the Affordable Care Act. This Senate legislation was a response to the Republican bill that the House passed on September 20 to prevent a shutdown, including a provision to defund the ObamaCare. Kristina Peterson and Janet Hook reported.

The next move belongs to House Speaker John Boehner (R., Ohio), who has said the House will not pass the Senate bill but hasn't yet laid out how he plans to amend it. House leaders face a difficult situation. Mr. Boehner doesn't want to alienate the dozens of lawmakers who won't back any spending plan that doesn't in some way limit the reach of the health law. At the same time, Senate Democrats say they will reject any measure that alters the health law. Underscoring the dilemma, a group of 62 conservative GOP lawmakers emerged with their own demand late Friday: delay the health-care law for one year as part of the spending bill…The standoff both between the two major parties and within the GOP brings the federal government to the brink of a shutdown with little obvious room for resolution. Unlike in previous showdowns, there have been no major negotiations among congressional leaders or with the White House, which is taking an increasing combative tone.

("GOP Hunts for Budget Plan," The Wall Street Journal, September 28-29, 2013)

The fiscal battles now become much more complicated because the budget negotiation is tangled with a modification of the Health Law. They do also because three related issues - the budget resolution, all stopgap measures with the sequester, and the borrowing-limit increase - can be approached with a somewhat independent manner in a different time frame, but the concern about the Health Law is dominated so that all three issues are on the table all together. As a consequence, there are too many options and strategies to resolve all of them at this point for the both parties. An editorial of the Wall Street Journal warned the Republicans.

This all-or-nothing posture also usually results in worse policy. The most recent example was the failure of Mr. Boehner's fiscal cliff "Plan B" in December 2012, which was the best the GOP could do because Mr. Obama had the whip hand of automatic tax increases. The fallback deal that was sealed in the Senate raised taxes by more and now complicating the prospects of tax reform…The best option now is for the GOP to unite behind a budget strategy that can hold 218 votes, keeping the sequester pressure of discretionary spending cuts on Democrats to come to the table on entitlement. The sequester is a rare policy victory, the GOP has extracted from Mr. Obama, and it is squeezing liberal constituencies that depend on federal cash.

(REVIEW & OUTLOOK: "The Power of 218," The Wall Street Journal, September 17, 2013)

In retrospect, starting the last election there were seven distinguishable dates of major political and fiscal events that can be divided into two groups. The first group were Nov. 6 2012 (the U.S. election), Dec. 31, 2012 (the tax deal), and Jan. 23, 2013 (the Debt-Limit Extension bill) The following four key milestones were the second groups: On March1, the sequester was set, followed by a March 27 deadline for all stopgap measures, having a formal budget outlines on both chambers of the Congress on April 15 (with a pay-withholding provision), and finally reaching a critical point at which the postponed debt-limit authorization expired on May 18.

The Market Stress Index (NYSE:MSI) was compiled with the data of the first group, as shown in Table 1. The MSI and the S&P 500 index clearly show the negative relationship each other: The higher the MSI, the lower the S&P, and vice versa.

Table 1: The Relationship between The MSI & the S&P 500 Index.

EVENT

MSI

S&P 500

BEFORE

vs.

AFTER

BEFORE

vs.

AFTER

ELECTION

30.6

<

39.8

1,414.39

>

1,384.33

TAX DEAL

53.1

>

34.7

1,425.24

<

1,456.36

DEBT LIMIT

59.2

>

37.8

1,478.39

<

1,500.10

Note : Figures are seven-day averages. < = higher. > = lower.

The table 2 is an updated version of Table 1. The column 5 (% ch MSI) is the growth rate of the MSI from the pre-event figures to the post-event ones. The column 9 (% ch S&P) is the growth rate of the S&P from the pre-event numbers to the post-event ones. Here we can see not just the negative relationship between the MSI and the S&P, but how much they changed from pre-event to post-event.

Table 2: The Relationship between the MSI & the S&P 500 Index (11/6/2012 - 9/30/2013)

EVENT

MSI

S&P 500

PRE-EVENT

vs.

POST-EVENT

% CH MSI

PRE-EVENT

vs.

POST-EVENT

% CH S&P

ELECTION(11/6/2012

30.6

<

39.8

26.1%

1,414.39

>

1,384.33

-2.1%

TAX DEAL (12/31/2012

53.1

>

34.7

-41.9%

1,425.24

<

1,456.36

2.2%

DEBT-LIMIT (1/23/2013

59.2

>

37.8

-44.1%

1,478.39

<

1,500.10

1.5%

SEQUESTER (3/1/21030

32.7

=

32.7

0.0%

1,515.95

<

1,549.99

2.2%

STOP-GAP BILL (3/27/2013)

46.9

>

38.8

-18.9%

1,555.44

<

1,561.58

0.4%

BUDGET PLAN (4/15/2013)

33.7

<

36.7

8.5%

1,569.74

>

1,564.94

-0.3%

DEBT-LIMIT EXO (5/18/2013)

38.8

>

29.6

-26.9%

1,645.89

<

1,655.35

0.6%

BUDGET (9/30/2013)

41.8

?

?

?

1,696.27

?

?

?

DEBT LIMIT (10/17/2013)

?

?

?

?

?

?

?

?

Note : Figures are seven-day averages. < = higher. > = lower.

Note : The percent change formula: 200*(B-A)/(B+A)

The relationship between them, however, becomes less clear with the second group. First, on March 27 and on April 15, the S&P made a token change, 0.4% and -0.3 %, respectively, from pre-event to post-event. The election (11/6/2012) and the budget blueprints (4/15/2013) had the same pattern: The pre-event MSI was lower than the post-event one, and the pre-event S&P was higher than the post-event one. This pattern was the opposite to the other events. The market disappointed the outcomes of the election and the budget preparation.

Second, the stop-gap bill on March 27 showed the negative relationship as other events, but there was no significant change, even though the level of the pre-event MSI was pretty high, 46.9.Third, for the sequester on March 1, there was no change in the MSI from pre-event to post-event. But pretty high (2.2%) was the growth rate of the S&P that was the same rate on the tax deal on Dec. 31, 2012. Why was the rate so high? Because the pre-event S&P was held back unduly due to an exaggeration of the impact: "The White House has said repeatedly that the sequester could have calamitous effects." ("Fiscal Pain to Be Parceled Out Unevenly," The Wall Street Journal, March 1, 2013)

For six months from March to September, the Congress and the administration has accomplished almost nothing on a budget consolidation or all other related fiscal problems. The budget blueprints of the House and the Senate were far apart each other, and there has been no effort to narrow the gap. The debt-ceiling expired 27, but the Treasury has been using emergency step since then, with the current limit, 16.7 trillion until now.

In October the market is likely to weaken and to be more volatile as a partial shutdown occurs. As the borrowing-limit deadline nears, the market may become tumultuous. A major financial storm, however, is not expected because the global economy is in a relatively better shape, and the Federal Reserve (Fed) is in the room to watch intensively the event. The U.S. economy has shown its resilience, the Euro-zone economy begins to rebound, and the Asian economy led by China, South Korea, and Japan become stronger. The Fed is ready to deploy the accommodating policy to mitigate the short-term blow caused by the fiscal standoff.

The showdown would be brief as both parties and the White House could reach a resolution. But the odds of a prolonging standoff cannot be completely ruled out because not only there has been no negotiations so far among lawmakers or between the Congress and the White House, but "Mr. Obama may…figure that stigmatizing Republicans over a shutdown-default crisis is the only way that Democrats can retake the House in 2014." ("Obama Goes to War, REVIEW & OUTLOOK, The Wall Street Journal, Sept. 18, 2013)

What should we do now? First, be aware of the binary trap. Making a binary decision prematurely is a fallacy. Second, build up the cash. One might wonder how to increase the cash in a weak market. My current Cash to Capital (CC) Ratio is 11% by depleting it to increase TIPS (Treasury Inflation Protection Securities) recently. The CC ratio is scheduled to go higher to a 25% level.. With a dual (a long-term and a short-term) portfolio, it's not difficult to increase cash in a relatively short period of time. There are three ways to raise cash: (NYSE:A) Exchanges between mutual funds,. (NYSE:B) Rebalancing, and.(NYSE:C) Taking profits (or losses for tax purpose).

My major holding in the long-term portfolio (80% of capital) are the counterpart Vanguard mutual funds of Vanguard Total Stock Market ETF (NYSEARCA:VTI), Vanguard Extended Market ETF (NYSEARCA:VXF), Vanguard Value ETF (NYSEARCA:VTV), Vanguard Total Bond Market ETF (NYSEARCA:BND), i Shares Barclays TIPS Bond ETF (NYSEARCA:TIP), and SPDR Barclays Capital Intl Treasury Bond ETF (NYSEARCA:BWX). Equity ETFs and bond ETFs has been recently decoupled. Therefore, either an equity ETF or a bond ETF can reach a selling point. The proceeds are sent to my saving account at American Express. The savings yield is currently 0.85%, with one restriction allowing only six withdrawals per month,

Back to Table 2. The MSI of the budget event (9/30) was pretty high at 41.8, but lower than the debt limit (3/23) at 59.2, the tax deal (12/31/2012) at 53.1, and the stop-pap bill (3/27) at 46.9. The shutdown is expected not to be short lived. Janet Hook, Kristina Peterson, and Carol E. Lee reported.

Lawmakers and White House dug in Tuesday for a long fight as the first feral government shutdown in nearly two decades showed no sign of breaking, increasing the likelihood it will become entangled in an even larger battle over the Treasury's ability to pay the government bill. The two parties held no negotiations to resolve the impasse, instead trading blame." ("Capital Digs In for Long Haul," The Wall Street Journal, Oct. 2, 2013)

A very special day, October 17, entered in Table 2. Treasury is going to be out of money on that day. The consequences of a failure of the borrowing-limit resolution is far much harmful than a budget disarray that we have now. "Right now, nearly everyone expects Congress and the president to lift the borrowing gap in time, but Washington is so dysfunctional that no one is completely sure." ("Fiscal Follies' Big Risks," David Wessel, The wall street Journal, Sept, 19, 2013)

Yesterday (the first day of October) the market moved higher smoothly all session. When the market is quiet, prudent investors must be alert and due diligent to prepare for coming pullbacks. When sea is calm, veteran sailors are busy to make sure of the readiness to survive coming major storms. The first half of October is a very crucial time amid the budget and borrowing-limit standoff. Do you need a guide? The Daily Market Stress (a daily post of the Market Stress Index) can be your companion

Source: As The Fiscal Showdown Looms, The Market Stress Index Rises