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Taking Stock

Tony Crowell

Tony Crowell

Playing Political Poker

A week ago, I wrote this column on the third day of the shutdown of much of the U.S. government. Sadly, a week later, there has been very little real progress toward overall resolution. While the market warmly greeted recent news of a possible short postponement of the debt ceiling crisis, the situation could get much worse.

Closing down the government is an embarrassment more typically associated with banana republics. It is irresponsible, like ignoring paying household bills, which sometimes leads to further disgrace like having a home go into foreclosure. Shutting down is damaging, eroding the health of our economy even though the country has always rebounded in good order from prior shutdowns.

This is the first government shutdown since the Clinton Administration.  The particulars of the budget quarreling that brought that on are now lost to history; the most lasting memory comes from employee layoffs requiring White House staff to pick up pizzas using an intern named Monica Lewinsky.

Each day that the shutdown persists has a minor rippling effect on the overall economy. If resolved soon, these losses can probably be made up during the first quarter of 2014. The stock market produced a 300-point rally on news that the more immediately serious debt ceiling deadline might be deferred for a few weeks. A big upside move on such little evidence shows substantial underlying buying strength. (The move would be more convincing if trading volume had not declined.)

The stakes are catastrophically higher on the debt ceiling. Default on the debt of the United States would be a cataclysmic blow, not only to our economy but also to the world’s. Japan and China, each a holder of more than a trillion dollars of U.S. Treasuries, have already expressed formal concern.

Even the mere prospect of default is costly. Two years ago, the debt ceiling crisis came down to a deadline of a single day before the doomsday sequester legislation was approved. This did nothing to relieve mounting anxieties in financial markets and Standard & Poors, after months of prior warnings, stripped the United States of its AAA credit rating.

The debt ceiling dates back to America’s entry into World War I, where it was introduced not as any spending limit but as a measure to make government funding less cumbersome as the nation geared up for war. It had and still has nothing to do with spending; Congress does this through normal legislation.

It has been raised 78 times since 1960, including 18 times under President Reagan. Occasionally, members of both parties, including then-Senator Obama, have voted against it as symbolic gestures to highlight some issue. Such symbolism has mutated into today’s extortionate demands. It is obsolete and should be abolished.

This is not a political column but focuses on stocks and the economy. I try to give specific advice on how to play the cards dealt to us. In this case, I believe the potential market losses would be so severe in the event of debt default that I initiated a partial buffer against a market decline by purchasing ProShares Ultra Short S&P500 (SDS-$36), an exchange traded “short’ fund. It is structured to rise (or fall) twice the daily loss (or gain) in the S&P 500 index.

This particular Exchange Traded Fund (“ETF”) trades over 10 million shares daily, providing trading liquidity. SDS is a short-term buffer that I plan to close out before the coming weekend. I continue to hope that rational political solutions will emerge and would be quite content to accept a small loss on this hedge, much like paying an insurance premium.

By Thanksgiving, I expect the political situation to be more stable, although probably falling short of what could be achieved. This would support the market continuing its uptrend. Volatility may increase, exaggerating the usual contests between fear and greed, and dips will provide opportunities for timely buys of quality positions. Next week, I’ll name a few candidates.

Tony Crowell manages stock portfolios for individuals and their trust and retirement accounts with CROWELL•ROBERTS Investment Counsel, a registered investment advisor in Laguna Beach since 1993. [email protected] 949.494.1376/

800.697.2622 www.crowellroberts.com

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