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Washington Politicians Play Russian Roulette With the Stock Market

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The countdown continues as hope springs eternal.

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Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

Ten days and counting; that's the only time folks are focused on as we fire up our systems for a fresh five-session set.

While high-profile players such as Bill Gross and Larry Fink assigned a "zero percent" chance of a US credit default -- the assumed result if politicians fail to reach an accord that would allow them to once again raise the debt ceiling -- the shadow of doubt is creeping into the mainstream mindset, as evidenced by the global price action Monday morning.

In a linear world, each and every second would be a ticking time bomb as markets discount the specter of default, an event so ominous that the first phase of the financial crisis would feel like a Dora the Explorer birthday party. Our world, however, is not linear, so we should expect nonstop posturing, rationalization, and compromise at some level, and if all else fails, legal intervention that would save the world as we know it.

On Friday, we wrote that Global Markets Are Pricing in the Unthinkable and walked through a back-of-the-envelope discounting mechanism that is the stock market. A 10% chance of a 50% loss should lead to a 5% decline, all else being equal, with both variables ever changing. That's not the only dynamic driving the near-term price action, but it's certainly the most notable -- and perception is reality in financial markets.

I have been admittedly cautious in my trading approach and I own that; I've made decisions that are consistent with my individual time horizon and risk profile. Regardless of what happens between here and year-end, there was money to be made betting on the Federal Reserve, and the bulls have benefited in kind. While bears continue to insist this market is The Grand Illusion, price is the ultimate arbiter of variant financial views.

What happens in this debt duel will be the exclamation point on what has been a wild year, and the government shutdown, along with whatever resolution we see surrounding the state of US credit, will dictate how the history books remember 2013. Most believe we'll avert the mother of all crises and this political hiccup will pave the way to a year-end rally higher (tapes that are strong all day year tend to end that way). But what if we don't?

I remember the first vote on TARP like it was yesterday; when it failed to pass on September 29, 2008, I walked down to the closest bank branch and withdrew a short stack of cash -- just in case. I was living alone in a rent-stabilized NYC apartment at the time but I wanted to take steps to safeguard myself in case the banking system browned out.

The stock market tanked 45% over the next six months -- even after the next iteration of TARP passed 10 days later -- but the system was saved, or perhaps reincarnated.

Fast-forward five years. I've got a wife, three kids, a home in the burbs -- and a potential disruption that would make 2008 look like child's play. And while many insist there is "100% chance" of a resolution, odds are increasing that it won't be amicable and unintended consequences will manifest stateside and abroad. Trading aside, I think we can agree that the implications of the prevailing direction of social mood are still sorting themselves out.

Through that lens, hoping for the best but covering our bases with three children, we're going to stock our basement with water and essentials. Worst case, we'll be prepared for the next hurricane (we had no power for two weeks following Sandy) and it's one less thing to think about as we edge through the next fortnight.

In the meantime, opportunists will attempt to "front" the resolution rally and the performance anxiety that will likely arrive in tandem. We're left to manage risk, monitor levels (S&P (INDEXSP:.INX) 1680 is the 50-day, S&P 1660 is the 11-month uptrend and S&P 1596 is the 200-day), ready for earnings (which begin tomorrow) and remain lucid as the world's wildest reality show continues to continue.

One step at a time as we continue to find our way.

R.P.

Twitter: @todd_harrison

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