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Down to the Wire, Of Course

Investors are focused on three concerns: the financial situation in Greece and the risk of contagion, the pace of growth of the U.S. economy, and the risk of a default by the U.S. Treasury. It appears that Europe is getting control over its sovereign debt problem. The economic data is looking a bit better. Unfortunately, we have every reason to expect politicians to continue to squabble over budget issues until the very last minute, no matter how uncomfortable we might be over these negotiating tactics. Keep your helmets on and remain prepared.
 
The only comfort we can have in watching Washington battle over the budget is that we have known all along it would go down to the wire and their public comments suggest they recognize that a default on the U.S. debt would be very problematical for the economy and their own reputations. Therefore, it seems likely that they will not mindlessly allow the U.S.A. to default, as if this would be a minor event. Unfortunately, Washington’s decision making over the past few years inspires little confidence they will behave competently or responsibly. This is the group that allowed Lehman to fail, couldn’t past TARP the first time, and did pass Dodd-Frank as the “fix” for the credit crisis, even though the bill doesn’t even address most of the real problems that enabled the crisis to unfold. Moreover, while the legislation passed, few of the rules to implement the legislation have been approved and Congress is still fighting over whether to fund the agencies charged with implementing the rules. It would be difficult to choose between the Keystone Cops and Congress using competence as the criteria.
 
It is notable that equity prices have held up surprisingly well, considering the prevailing high level of uncertainty and the ongoing shift in retail investor money from stocks to bonds, despite record low interest rates. Weak economic growth, which people consider worrisome, has been sufficient to enable corporate profits to rise at a solid pace. Indeed, about 75% of all firms are reporting sales and profits above market forecasts. Profits are now at record levels, as are corporate cash holdings. Reluctantly, strategists have been raising their profit estimates. Moreover, valuations are cheap. So stocks should perform quite well, if only these uncertainties could be resolved. But until Congress does resolve the budget dispute, markets will remain on the roller coaster.