Debt Crisis Delayed. Now What?

The S&P500 jumped 2.4% last week in a knee-jerk reaction to the temporary lifting of the debt ceiling for the US federal government. Volatility promptly dropped back down close to the summer lows. And while one would think that investors would start rushing back into the stock market, driving the strong price increase, one would be wrong. Volume did not surge; it remained moderately low, continuing a long-term trend of gradually falling participation in the US stock markets by the average retail investor. In other words, Main Street isn’t buying this rally.

Technically, the S&P has re-entered into an uptrend, but because it started very close to the all-time highs, this uptrend looks especially risky. As of Friday, the S&P is already extremely over-bought on the daily charts, and very much stretched on the weekly charts.

Valuations, meanwhile, are hovering near historic highs. Whether one looks at the Shiller PE ratio, or price to sales, or price to GDP, the S&P is trading at levels that above 100 year highs, with the exception of the massive 2000 tech bubble, which as we all know, blew up in a spectacular fashion.

So stocks keep rising in the face of technical and massive valuation headwinds. And history shows—-very convincingly and very repetitively—that this is always a recipe for disaster. Even though the Fed’s easy money policy is embraced as a “can’t lose” boost to stock prices in the short-term, reality has always brought the stock market back down to earth in the past, and there’s no reason to believe that this time will be any different.

Meanwhile the US economic data flow will be resuming its normal release schedule soon, and all the missed reports will be release over the next couple of weeks. Even so the few reports that were released last week, despite the partial government shutdown, were mostly disappointing. The Empire State manufacturing survey missed badly. Mortgage applications continued to disappoint. The housing market index missed. Initial jobless claims were much worse than expected. The sole bright spot was the Philly Fed survey with beat expectations, even though it came in below the previous month’s level.

Finally, the big news of the week was the resolution of the debt ceiling crisis, enabling the US government to pay all of its bills by additional borrowing by the US Treasury (much of which will be funded by the Fed’s QE money printing program).

But the catch is that this is merely a short-term deferment. In only a few months, the same debate, and possibly crisis, will rear its ugly head once again. So in the short-term, equity prices may continue to firm, Treasuries could continue to strengthen, corporate bonds may also rise in price, and gold ought to continue to climb—-all at the expense of the US dollar which could be under pressure as the spending & printing spree continues.

So nothing has been fixed. Nothing has been solved. And very soon, the same pressures and stresses will likely return to the front page news.

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