Greece, Italy, Done: Next Crisis - The Super Committee

Includes: DIA, QQQ, SPY
by: Michael Shulman

The market does not seem to jump crisis to crisis – it is jumping crisis to crisis. As Mark Cuban said yesterday on CNBC, the market is no longer a venue for raising capital, it is a platform for traders and hedge fund types to make money independent of the real value of a stock, the growth in the economy and other things related to the real world.

Greece is no longer a crisis due to a new Prime Minister, the ascendancy of Italy as a crisis and the blissful ignorance of traders unwilling to recognize Greece is not only going to default in a few weeks – they know that - it will default again late next year – they are ignoring that.

Italy is almost done as a crisis due to a new Prime Minister and a growing realization the problem is liquidity, not solvency, and a reduction in interest rates on Italian debt solves short term problems – namely the need to roll over 200 billion euros in debt in the next six months or so. Italy actually runs a primary budget surplus before interest payments. And traders are beginning to believe Italy is too big to fail and somehow, some way it will not fail. Crisis near over.

So where is the trade? The US and the erstwhile Congressional deficit reduction Super Committee. They need, by next week, to come up with $1.2 trillion in deficit reductions over a ten year period – something my cockapoo could do if he did not have to respond to insane wings, left and right, of the two political parties. This very small reduction – it is a little more than a rounding error over ten years – is simply a flash point for strife between Tea Party terrified, no new tax Republicans and the elderly terrified Democrats who want no meaningful changes in entitlement programs. Or so the headlines go.

At the voter level, the Super Committee’s problems stem from two impossible to reconcile sentiments expressed by Americans in recent polls – they want spending reduced and to leave Medicare untouched. Unless my second grade math was wrong, you cannot have both. Even those paragons of fiscal virtue (while campaigning), the Republicans do not want to go near health care. In reality, the Republicans are just as unwilling to touch entitlement programs for the elderly as the Dems. Just ask Republican Representative Paul Ryan, he of Medicare plan dead on arrival several months ago. Or Republican Senator Tom Coburn, his plan dead on arrival a few weeks ago.

At the political level, the problem is the Tea Party and John Boehner. He has lost control of the Republican caucus, worse, to eighty seven freshmen he should be able to bully the way a Speaker of the House is supposed to bully freshmen Representatives. Boehner does not believe in bullying – noble thought, that – making him the least effective Speaker of the House since Newt Gingrich. Funny, Gingrich rode to the leadership position based on conservative rejection of a health care plan as well. He also lost the House two years later.

Bottom line – without a manageable Republican caucus, there can be no meaningful compromise within the Super Committee and without that, we go to sequestration – automatic budget cuts in 2013 that Congress will, of course, overturn before 2013. None of this is news to any of us in Washington – I live here – but what is shocking is the number of people on Wall Street expecting some meaningful output by the Super Committee. Of course, they are defining meaningful as those irrelevant $1.2 trillion cuts over ten years, less than 3% of projected spending.

The issue for investors and traders to be prepared for is market reaction to a Super Committee failure. On the long side, think flight to safety and precious metals and gold and a great gold miner, Newmont Mining (NEM). Undervalued, good chart, modest dividend, well managed, huge reserves, my favorite in the sector, buy it and write come calls or just sell some puts. Or be more specific on the bearish side - who gets whacked with budget cuts and/or sequestration? The Pentagon. What is the most ridiculous program at the Pentagon, other than the $300 million spent on military bands (more than the State Department spends on all their personnel deployed overseas), likely to take a hit? The F-35 – a four-humped camel deigned to dance the waltz and drop bombs at the same time. The top brass agree, quietly, and just ordered a whole bunch of upgrades to existing airframes such as the F-18. Lockheed Martin (NYSE:LMT) makes the F-35, look at some puts, I disagree with many analysts who think F-35 cuts are already in the stock price. I may be wrong but you should be prepared.