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Gold Digger started his career in financial services with Bloomberg LP in New York. He played a key role in fixed income analysis for Bloomberg professional services with specific focus on corporate and municipal bond markets. Currently he is the Chief Investment Officer of a private wealth... More
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  • US Debt deal and stock market implications 0 comments
    Aug 3, 2011 3:29 PM | about stocks: UUP, UDN
    US Congress finally voted on a debt deal as expected on the eleventh hour and debt ceiling increase was promptly signed into law by the President. That puts an end to the first chapter of this long debate that has just started and hopefully will bring out some intelligent choices for the nation going forward.
    However, association of debt deal with debt downgrade fears was totally uncalled for. Though rating agencies jumped into the debate to gain some political clout, we don't believe that US debt downgrade is imminent. In fact, it will be a major failure for rating agencies if they downgrade US debt at this point. The reason is very simple: with all said and done, US still generates almost 5 times the tax revenue than the outstanding bond interest liabilities in any given month.
    We don't understand how the bond holder interest and principal payments are affected if US government is able to reduce the pension, Medicare, Medicaid and other liabilities. The job of rating agencies is to make sure that bond holders are made whole and not to make sure how a country is run unless they can establish a reason why some policies will have a negative impact on the repayment commitment to bond holders.
    As of now, reneging or skimping on the social entitlements like social security, Medicaid etc. does not seem to affect the revenue generation power of US. This is mainly by design as the beneficiaries of these social programs make very small or absolutely zero contribution to the economy as a whole. Now this may sound little insensitive as a person but that is the truth and reality for an investor.
    So rating agencies should not have linked together these issues as a basis for credit rating of US treasury bonds unless they have a good model to show us how reduction of government liabilities for social entitlements will have a negative impact on government's revenues.
    Let us consider an analogy from corporate bond market: if a corporation decides to lay off some employees or reduce its pension liabilities to balance its budget then it will be considered as a positive event for both bond holders and equity holders rather than a negative event. And ratings get a positive boost unless rating agencies are convinced that laying off those workers would significantly reduce the profitability and revenue generation capabilities of the company.
    In fact, if congress successfully implements a plan to reduce the liabilities in the social entitlements then we would advise investors to go long US dollar. Now that debate will not be clear until at least November so a decisive direction is hard to predict until then. But if we see dollar weakness then it is time to start building some long positions in US Dollar (NYSEARCA:UUP).
    Another big positive for UUP might come if Congress is able to identify some measures for increasing the revenue itself. We can see immense opportunities in that area when we thoughtfully analyze just the foreign trade structure of the country. We should evaluate imports and their sources to start with.
    Though one negative overhang on US dollar might be Federal Reserve actions. And if we get any indication of another round of quantitative easing of some sort then this will be a catastrophe for US economy due to its big negative impact on small businesses. So before I advise my investors to start building position in US Dollar I would at least wait till end of August as it was this time last year that a panicked Fed chairman announced QE2 without any due diligence of its impact on small businesses. If that turns out to be the case again this year then an opposite trade is warranted of shorting the US Dollar by buying UDN ETF. That is why I would advise investors to wait till the end of August to take a decisive position in UUP or UDN.
    Strengthening dollar will help small businesses and big businesses equally. Because most big US business do not compete globally on prices rather they compete on quality and innovation. So while weaker dollar inflates their profits in the short term but on the other hand it hampers their longer term investment capacity. Also higher dollar keeps significant fuel costs under control for both corporations and individual consumer.
    Overall debt deal and closure of fed programs is a big positive for US stocks as well.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Stocks: UUP, UDN
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