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Will a Debt Ceiling Deal Precede a Sell-Off?


Looking through the looking glass.

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

Optimism surrounding a potential solution to the debt-ceiling deadline and government shutdown rallied stocks yesterday as Senate leaders craft their latest proposal. While this is believed to be the best chance yet at ending the embarrassing and potentially disruptive event, the measure would still need to be passed in the entirely more onerous House before being signed by President Obama.

We recently touched on the social mood surrounding this stalemate and offered that the acrimony in Washington is symptomatic of a broader and sweeping societal shift. This particular disagreement happens to be transpiring on the world stage, and the players involved are using our economic and financial well-being as chips when they call each other's bluff.

There has been a lot written about what would happen if the debt ceiling limit is missed-such as "prioritization," which I think is a recipe for disaster-including but not limited to the chain reaction that would evolve if the US somehow defaulted, which remains an extremely low, albeit not absent likelihood.

There has been decidedly less time spent on mapping the potential scenarios if and when an eleventh-hour accord is struck. Due in large part to the price action in the stock market last week, conventional wisdom dictates that stocks will continue higher into year-end, creating a "long squeeze" as underinvested fund managers chase performance.

Late yesterday, I received the chart below from Minyanville reader Eric, with the subject header, "History doesn't always repeat but it often rhymes." You will note the parallels between the S&P (INDEXSP:.INX) in August 2011-when the last debt ceiling crisis occurred-and today's tape.

Back then, an agreement was reached on July 31 (a Sunday), passed by the House on August 1, and signed by President Obama on August 2-and the S&P proceeded to fall 15% the next week. Of course, there were other elements impacting stocks back then-the eurozone crisis and the US credit downgrade, to name a few-so this isn't an apples-to-apples comparison.

There are enough parallels-be them technical, or the midcaps trying to bust out to all-time highs in both cases-that warrant a mention, however, as we piece together the puzzle that has become our financial fabric. With earnings coming out fast and furious and the bears having all but tossed the towel, toss this on your radar for schnitz and giggles.

Random Thoughts:
  • I will again note the breakdown in gold, as well as the historic correlation between gold and equities, represented by the S&P in the below chart. Gold 1275 is the "right shoulder" of a head-and-shoulders pattern that "works" in a technical vacuum to the summer lows, in and around gold 1180. While stocks have thus far "paid no mind" to the gold scold, we would be wise to respect the correlation, charted below from the liftoff in March 2009.
  • A few charts floating around are worthy of sharing through the lens of social mood and risk appetite, which have traditionally shaped financial assets in a free market. Source: Gallup, with a hat tip to Zero Hedge and Dougie Kass.
  • We'll see more bank numbers today with Citigroup (NYSE:C) and Charles Schwab (NYSE:SCHW), Bank of America (NYSE:BAC) on Wednesday, and Goldman Sachs (NYSE:GS) Thursday. Financials reacted well to JPMorgan's (NYSE:JPM) and Wells Fargo's (NYSE:WFC) mixed numbers due to muted expectations. Given how important financial stock performance is during bull markets, let's watch these upcoming reports closely.
  • We'll also have some big tech names. This afternoon, Intel (NASDAQ:INTC) will deliver its report, giving investors some forward-looking information on PC demand, which has been sluggish to say the least. On Thursday, Google (NASDAQ:GOOG) will report, and as always, it should set the tone for tech the following day.

Twitter: @todd_harrison

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