As Ronald Reagan said decades ago, “The nine scariest words in the English language are 'I’m from the Government and I’m here to help.'” David Lutz, managing director & head of ETF trading at Stifel Nicolaus, says the gang in DC is on the verge of helping U.S. markets crumble for the second time in three years.
It may not come as a complete shock to investors. Lutz sees evidence that money professionals are starting to buy options protection against the possibility of market declines in October and November. The major culprit sounds familiar: the debt ceiling.
The same fight that took stocks down nearly 17% in less than a month in 2011 is bubbling up again and it doesn't look like there's an easy solution.
On the one side Lutz says the GOP is “fragmented” in terms of what they want to ask for in negotiations. The same division between the centrist and extreme conservatives is creating a lack of focus that's deadly in negotiations. Democrats don’t seem inclined to care because they aren’t prepared to give an inch on entitlement reform.
Basically if the GOP doesn’t roll over completely it looks like we’ve got another mess on our hands. Here’s a spoiler alert: the GOP isn’t going to roll over completely if any of the members want to get reelected.
The biggest difference between now and 2011 is that the FOMC is less likely to be there as a backstop if the ratings agencies downgrade the U.S. debt again the way Standard & Poor's did in 2011.
The Democrats haven’t come around to putting a candidate up to replace Ben Bernanke who has all but said outright that he won’t return for another term. The fact that once presumptive nominee Janet Yellen is being downplayed in favor of the deeply controversial (read: widely loathed) Larry Summers introduces an enormous amount of uncertainty into the game.
As much as many monetary conservatives detest Ben Bernanke, they fear uncertainty is much worse.
Lutz has one key “tell” for investors trying to gauge the potential impact of the inevitable mess created by our elected officials: Housing. The iShares US Home Construction ETF (ITB) is down more than 16% in three months and nearing official bear market territory. If housing isn’t a black swan (it wouldn’t be a shocking event), it’s a canary in the coalmine. If housing fails the whole economy could die in mortal peril.
“As Alan Greenspan said years ago, ‘it begins and ends with housing,’” Lutz concludes. “If we start losing control of rates all of the sudden what we’re going to have is a collapse in the housing market, GDP is going to start falling apart, employment, and then the collateral damage of consumer spending because rates are going higher.”
Buckle up, America. We could be in for yet another bumpy ride.
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