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DC deadlock threatens 'largest tax increase in US history'
And a government shutdown, again
Markets are rallying sharply this morning overseas for three reasons. First, European leaders issued statements over the
weekend acknowledging that they are creeping in the direction of fiscal unity. Markets are casting a vote on direction, not any
actual steps that will shore up Italian debt. But any step forward is a positive. Second, U.S. retail sales over the weekend serve
as a reminder that our economy so far is doing just fine. Not great, but OK. We have learned over the years not to read too
much into strong opening weekends. They often are head fakes for what is to follow. But good sales are certainly better than a
buyers’ strike so we will take it. Third, as I noted last week, hedge funds are always chasing momentum and performance and
they have gotten themselves into as short a position as any time since February 2009. That means a sharp rally this morning is
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likely to include massive short covering which will only serve to magnify the rally. If today’s strength is simply short covering,
it will be another one-day wonder in a bear market. We, unfortunately, have seen lots of those over the past 4 years. If it is real,
meaning markets believe the strength in the U.S. economy and are more confident that Europe can get its arms around its debt
problems, then the rally will carry through tomorrow and beyond.
So enjoy this morning and probably today. At the moment we remain in an 1100-1250 trading range and even with the rally in
futures this morning, we are smack in the middle of the range. I don’t see any reason that we should break out any time soon.
So far, I have spent most of the morning talking about Europe once again but I shouldn’t end without mentioning our own fiscal
mess. The supercommittee’s failure to attack fiscal irresponsibility isn’t the end of the story. Before year end, there are two
issues to address. Congress at the moment is operating under a continuing resolution that runs out on December 6. That means,
without another extension or passage of the necessary appropriations bills, the government will shut down then. An entity as
adept at kicking the can down the road as Congress ought to be able to pass yet another continuing resolution without much
bother but there is a fly in the ointment this time around. Last year, Congress passed a 2% cut in payroll taxes for employees as
well as one-year accelerated writeoffs for specific capital spending and an extension of unemployment benefits. All of these run
out on December 31 unless extended. In order to extend them, conservatives in Congress want offsetting tax cuts. The left
wing wants higher taxes on the wealthy. This is exactly what tied the supercommittee in knots. The right wanted no tax
increases whatsoever; the left wanted no plan that didn’t raise $1 billion from taxes on the wealthy. No compromise; no deal.
The debate over the payroll tax etcetera is a precursor to next year’s battle regarding the demise or extension of the Bush tax
cuts.
If the payroll tax cuts die, there is little question that growth forecasts for 2012 will have to be lowered. Take $1,000 out of the
pockets of every wage earner and clearly economic growth will be less. But letting the cuts expire will almost certainly shrink
the deficit a bit. Both sides have a point but neither is ready to move an inch. If they don’t and stay stubbornly in position for
another year, 2013 will witness the largest tax increase in U.S. history. I am not making any predictions. Politics has a way of
confounding the wisest of souls. But the storm cloud is out there and it likely won’t lift before the 2012 elections, if then.
But for now enjoy today. Maybe European leaders will heed the message of today’s rally or maybe it will simply buy them a
little more time. We’ll see.
Today, actor Ed Harris is 61. Paul Shaffer is 62.
James M. Meyer, CFA 610-260-2220