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Global Markets Price In the Unthinkable

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Smart money says, "No shot," but at what cost?

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

It's a Freaky Friday, if only for the message that came across my economic screen this morning:

MOST GOVERNMENT DATA RELEASES DELAYED DUE TO PARTIAL SHUTDOWN

Of course, there's a difference between a "non-essential" government shutdown and the big bad wolf that is blowing in the distance -- all the way out on October 17. That is the line in the sand on a US debt default, although smart money is saying to pay it no mind.

Just yesterday, Bill Gross and Larry Fink assigned a "zero percent probability" that the US will default.

As a 23-year veteran of the derivatives market, I've been schooled to believe that there is no such thing as a 100% guarantee. Still, the fallout from a US debt default would be unfathomable; to borrow a passage from Minyanville's Michael Sedacca:

"A default would make 2008 look like a walk in the park and it's not just Treasuries that would be in jeopardy; agency MBS are an equal, if not larger part of the investment and financial world -- something to the order of $7 trillion, backed by the 'full faith and credit' of the US government. Plus another $11.5 trillion in Treasuries; Wall Street and the rest of the banking industry would cease to exist overnight; all markets could get cut by 50% with the lack of leverage, and that could prove conservative."

While the ramifications would be unprecedented and thus unknown, the results would indeed be catastrophic and one would have to think -- or at the very least hope -- that Mr. Gross and Mr. Fink have the types of golden Rolodexes that would steer the unthinkable outcome toward calmer heads, if in fact such heads are capable of rational thought.

That's the sliver of doubt that is currently being priced into the marketplace. To use a crude example, if there is a 10% chance at default and the result would be, say, a 50% loss in the market, it stands to reason that the market would discount the event by falling 5% (we're currently 3% off of all-time highs in the S&P (INDEXSP:.INX)). Those numbers are pure guesswork, but you get the gist; the market is navigating a period of price discovery.

I will note that the aforementioned correction has been decidedly orderly, almost as if some players are trying to front the reflex rally that would presumably occur upon bipartisan resolution. Given the short covering we saw after the decision not to taper -- and the posturing into this pullback -- we're left to wonder if that optimism will again reward the bulls, or if it is paving the path of denial.

Random Thoughts:
  • Time -- and price -- will tell the tale; S&P 1680, 1665, and 1595 are support below, while 1700, 1710, and 1730 (rough justice) are levels of lore if the tide should turn.

  • When we asked if Tesla (NASDAQ:TSLA) was a bubble last week, the stock was trading above $190. I don't profess to know if that was it, but I'm reminded of The Gold Scold when the yellow metal was at $1900.
  • BKX (INDEXCME:BKX) 62 is the August low; as the piggies typically lead the broader poke, that level should remain on your radar. Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), and Deutsche Bank (NYSE:DB) are my individual proxies in the space.
  • When I think of the government.com bubble, the pernicious social mood would seemingly provide an apropos pinprick.
  • Again, a default would be a tail event, which is a low probability event, but the unintended consequences of this embarrassing infighting remain to be seen.
  • Each and every time support (or resistance) is probed, a layer of demand (supply) is chewed through. Today is day five of the probe of the 50-day moving average in the S&P.

  • What do you get when you marry HFT and headline risk? Air pockets of volatility.
  • Remember when the market moved on fundamental data points, technical analysis, structural influences, and psychology? Ha ha, me too!
  • Does the Federal Reserve still control interest rates?
  • Will a third political party -- socially liberal, fiscally conservative -- emerge from this mess?
  • JPMorgan trades dry, eh?
  • A few more hours until our requisite respite; make it count, so we can enjoy the downtime. Good luck today.

R.P.

Twitter: @todd_harrison

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Position in SPY.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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