As quickly as the quantitative RISK MANAGEMENT signals told us to get defensive last Thursday, they were telling us to get offensive as of this Monday. Back in a Bullish Formation, the US equity market (SPX), likes what it sees with regards to this latest #KeynesianCliff compromise. Highlights include:
- The marginal tax rates for the wealthiest ~2% of Americans (i.e. individuals making more than $400k per year and households making more than $450k per year) have reverted back to the Clinton-era peak of 39.6%;
- These income thresholds will also be applied to an increase of the capital gains and dividend tax rates to 20% from 15%;
- The estate tax rate will rise +500bps to 40% while maintaining the existing threshold of $5 million;
- The AMT will be permanently fixed;
- Unemployment benefits will be extended by one full year; and
- The $110 billion sequester of spending cuts will be delayed for two months – just in time to be used as political leverage during pending debt ceiling “negotiations”.
Regarding the aforementioned “negotiations”, President Obama has repeatedly stated that he refuses to negotiate with Congressional Republicans on meaningful entitlement reform amid debt ceiling talks. Moreover, he continues to stress that further deficit reduction must come via his politically-compromised definition of a “balanced” approach. Having caved to some degree already, we highly doubt the GOP brass sees eye-to-eye with Obama on either stance.
As a result, you are officially invited to look forward to more political theater in t-minus ~8 weeks (on the off chance you didn’t get your fill this past holiday season). Only this time, the stakes are much, much higher – an unlikely, but potential US sovereign default.
Looking deeper into the latest fundamental RESEARCH signals, this deal to avert the full plunge of the Fiscal Cliff is positive for the US and global economy on an immediate-term TRADE and intermediate-term TREND basis – particularly relative to the now-moot fiscal doomsday scenario. This morning's sequential acceleration in the ISM Manufacturing PMI to 50.7 in DEC (from 49.5 prior) is also positive and supportive of our directionally-positive views on global growth.
On a long-term TAIL basis, however, this deal is likely to be viewed by many as explicitly bearish for the US dollar – particularly relative to expectations of meaningful fiscal reform. By some estimates, this latest deal is good for only $600 billion of deficit reduction over the next 10 years – a sharp decline from previous negotiations in the area code of $4 trillion.
As we have said time and time again, what’s bad for the US dollar is also bad for sustainable economic development, as well as the long-term prosperity of the US economy. Two critical factors that continue to register near-perfect inverse correlations to USD debauchery in our model are current POLICY volatility and uncertainty regarding future POLICY. The confluence of those factors tends to get manifested in two very distinct ways:
- Shortened economic cycles; and
- Amplified financial market volatility.
Prepare your proverbial “anchor” for both in about a couple of months. For now, enjoy the melt-up as we kick off what is sure to be an eventful 2013. Best of luck out there!