The T-Report: America, the Land of the Slogan

Posted by on Dec 28, 2012 in The T-Report | No Comments

Land of the Free, Home of the Brave?

That seems more like a fairytale than reality. I cannot believe that I am sitting here the second last trading day of the year and having to guess what Washington will do. What will the senate pass? What will congress do with it? I’m not even sure I have the terms right, because frankly, it rarely matters that much to the market. I just can’t believe we have come to this. We are waiting for a Sunday night session to determine the fate of America, or at least the fate of America until whatever can kicking compromise they come up with is reached.

The U.S. is Not [insert other country here]

For at least the past two years the U.S. has happily said who they aren’t. It actually started before that. First we weren’t Japan, and yet 4 years later we look a lot like Japan did after the initial Nikkei crash. Then we weren’t Greece or we weren’t Spain. Yes, nothing like 4 am press conferences to announce some hastily thrashed out deal to kick the can without solving anything. At least we have the dignity to do it on a Sunday night?

In the context of what has gone on over the past 2 years, it is simply shocking Europe has accomplished anything. Think about what they have done, and there they have 17 different countries, different languages, different economies, different philosophies, and are used to battling it out for football supremacy and Eurovision song contests. In the light of what has gone on in Europe, we should be even more ashamed at what our politicians have done.

Maybe it isn’t a co-incidence that the economy that is doing best with the least amount of support from politicians or central banks is Germany and they are run by someone trained in hard science (rather than politics) and may not be at the high end of the photogenic spectrum. Maybe a country of photogenic lawyers who need to work a couple of years to get pensions for life, while finger pointing at the “graft” in Greece is exactly what we deserve.

A quick though on AA America

There is growing expectation that the U.S. will be downgraded by at least one more rating agency. That would leave the USA with possibly a AA+ rating. I am struggling with what that would mean. My first reaction is totally dismissive.

It is dismissive because no one thinks the U.S. would default on its debt. The rating agencies are NOT going to impact that view. They could call it BBB+ and it wouldn’t change the view that the U.S. will pay its debt.

The Fed owns a lot of debt (almost a third of bonds maturing in 2018 and beyond) and they aren’t selling.

So the only question is “will there be forced sellers”? Would a downgrade from AAA to AA+ force sellers? I am digging deeper, but from what I have seen, many investor guidelines specifically include treasuries. It is often written as treasuries or AAA securities, or something along those lines, so I don’t think there would be many forced sellers, and with the Fed gobbling up $45 billion a month, and investors flushed with cash who don’t care about the rating, I don’t think we see a meaningful sell-off in treasuries on a downgrade.

Without a meaningful sell-off in bonds, I don’t see a meaningful sell-off in stocks, so I would be a buyer of that reaction. Having said that, so many seem to feel so strongly that a downgrade would be extremely bad, that I would pause and hold off on getting involved, because even if the others are “wrong” they might drive price much deeper than I would believe is deserved.

All the Reasons to be Long at 1,440 Still Apply

I am trying to type this, but it is a little difficult with my eyes closed and one hand plugging my nose, but here goes, time to get a little long.

I just felt shivers run down my spine, but the reality is not much has changed in the past two weeks, other than valuation. The outcome of fiscal cliff is still about the same. Some chance of a simplistic solution that pushes it into the early part of next year. Some chance we go over, only to see it pushed into the latter half of next year with some emergency bill.

Do I want to be long if we go over the cliff? No. But for now, small long makes sense to me.

My preferred long is HY19. That is the CDS version of high yield. It is offered at 100.25 today and traded above 102 just a couple of weeks ago. As I wrote in the “Paradox of CDS” a few days ago, HY19 is the cheapest way to play the high yield market, but because of its use as a hedge, it would initially underperform. So that is my best idea here, small long in that.

If you can’t or don’t use that, then I would look to European Stocks, EM stocks, Asian stocks, followed by U.S. stocks, followed, and finally U.S. high yield bonds (yes, the CDS is that much more attractive to me than the bonds here).

I would want room to add risk if we sell off, but as much as it seems to be dangerous I think it is finally the right trade. The Fed is still pumping money into the system. Yields will remain low. The economy, while not great, is going okay. Japan, and possibly all of Asia, seems to be reviving. Europe is getting fixed. So add some longs, but again, my focus would in CDS or outside of the U.S., as the “dirtiest shirt” saga plays out.

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