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Default Countdown: Don’t Let Fear Control Your Money, Says Lutz

Jeff Macke
Breakout

The countdown to default is down to three days. Little progress was made over the weekend in the debt ceiling negotiations. The only noticeable difference was a slight calming of the rhetoric as leaders retreated to their back offices, presumably in hopes of striking at least a short-term deal. If no compromise is reached the U.S. is set to breach its $16.7 trillion debt ceiling on Thursday, thereby losing its borrowing authority.

The pressure is mounting not just from voters but abroad. On Friday World Bank president Jim Yong Kim implored the U.S. to strike a deal saying foreign economies were already showing signs of disruption, often at the expense of the poor. "We urge policymakers here in Washington to come to a resolution as quickly as possible to avoid what could be catastrophic impacts from a default," he said. "Uncertainty and volatility make it more difficult for developing countries to access needed finance, and this would both slow investment and negatively impact growth. And the poor and vulnerable would suffer the most."

David Lutz, Head of ETF trading and strategy for Stifel Nicolaus, says investors are getting nervous as the October 17th debt ceiling deadline nears. With the rhetoric getting heated, active market participants are more comfortable missing a potential rally than putting new money to work.

Lutz understands the concerns but hiding out isn't a productive way to go about investing. In the attached clip Lutz walks through some of the investing headwinds to take some of the emotion out of the money management process and hopefully get one step ahead of the herd.

Concern 1: The Government Shutdown

Now entering its third week, the government shutdown is almost becoming old hat. As a negotiating point the shutdown has become part of the debt ceiling debate. There have been suggestions that some sort of temporary deal could be struck but the damage is largely done economically.

From a cynical, glass-is-half full perspective Lutz says that could be a good thing. The government officials seem to be under the impression that the shutdown can be ended at the drop of a hat, but economists know better. "We just had ISI take down GDP forecasts for the United States by 1% just because of the shutdown. Not because of the debt default but because of the shutdown." Lutz notes. "It doesn't look like the Fed is going to taper anytime this year."

Love it or hate it, quantitative easing is bullish.

Concern 2: The Debt Ceiling

Based on action in the Treasury market, which happens to be closed on Monday for Columbus Day, Lutz says the odds-on bet is that the debt ceiling issue gets pushed back into November through some temporary deal making. At least as far as the bond market is concerned, default remains a long-shot. Again, it's a travesty but it gives the markets a chance to reprice slowly. It also reflects an enormous amount of pessimism among investors.

Related: Stocks Fast Tracked to Profit After Government Shutdown

Yes the government is playing a lunatic game of chicken but if we learned one thing from the fiscal cliff it's this: There are no real "deadlines" when it comes to DC. There is zero chance of a default on October 17th and any deal prior to that will constitute an upside surprise.

The worst case scenario in which the cost of our debt skyrockets as foreign creditors lose faith in our bond market is still a catastrophic possibility but unlikely. As is usually the case with worst-case scenarios, the smarter money is on a more positive outcome.

In this case, almost anything other that default would be an upside surprise.

Lutz' Best Guess

Lutz is a buyer. His bullish theory, such as it is, relies on the investing public having almost no confidence in government officials. If our representatives do nothing other than perform the jobs for which they were hired it will constitute a major upside surprise. They just have to get out of the way of the market.

"We've got the shutdown, we've got the debt ceiling and now we have the Fed chairmanship," Lutz notes. "As long as DC capitulates on these three items and gets out of the way... we're going to be off to the races on the way to new nominal highs in the S&P going into the end of the year."

When simply not screwing things up any worse is a bullish catalyst, the odds-on bet is the money on the sidelines is going to be forced to chase stocks higher, like it or not.

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