Investors’ Guide to the Supercommittee Failure

It is difficult to forge effective policy solutions during the political "silly season."  We would all like to see less time spent on elections and more on solving problems.

The failure of the Supercommittee, which I originally thought had a fair chance to succeed, illustrates the dangers of extreme partisanship.  Some are suggesting that people vote against all incumbents.  In fact, we have three political parties — extreme Democrats, extreme Republicans, and those willing to compromise.

As an investor, I would like to support those in the Compromise Party, since that is the only way we can expect any solutions.

As usual, I am trying to emphasize the investment issues at hand, remaining politically agnostic.  I like candidates who favor market-friendly policies, but I urge you to exercise your own preferences.  Meanwhile, what does today's news mean for investors?

I will briefly discuss the direct consequences, the psychological effects, future prospects for deficit reduction, and whether this can be combined with effective, growth-oriented tax policy.  Finally, I'll look at some winners, losers, and investment themes.

I think I have found some excellent sources, covering the key points you need to know.

A downgrade of US debt is unlikely — at least not soon.  The ratings agencies have all commented on the process and the result.  The automatic cuts are as large as the committee goal.  For the sequestration to be overturned would require action by both Houses of Congress and a signature from the President.  That is not going to happen.  Here is a good story from The Hill on the "downgrade watch."

The failure still mattered for financial markets.  As I noted in my weekly preview, where I gave my "Ugly" award to the Supercommittee, the important effects are mostly psychological.  Most people are not stopping to analyze the exact effects, but are reacting to the failure of leadership.  Perhaps the most prominent example was noted market strategist and now hedge fund manager Barton Biggs, who upped his recession forecast and reduced his stock position, partly for this reason.

β€œI'm very disappointed,” Biggs said of the U.S. deficit- cutting congressional supercommittee's failure to agree on $1.2 trillion in federal budget savings. β€œIt's pathetic that they haven't come to a deal. It shows our political system is really dysfunctional. I've been wrong in being too optimistic about the outcome in the U.S.”

Whether you agree with him or not, it illustrates how some people are thinking.  For a variety of reasons, I think that today's selling was more about Europe, the dollar, and fallout from MF Global.  When so many things happen at the same time, it is difficult to pinpoint causation.  (For those interested in this theme, I expanded on it in my new investment diary).

There is still a chance….

Part of the reason for the failure was the evolving disregard for the sequestration consequences.  Various observers were offering opinions that failure was not so bad.  Matt Yglesias captures this sentiment.  His article is also the single best explanation of the incentives for action.  The new reality is that the Bush-era tax cuts will expire before the election without some compromise.  Matt discusses how this is interpreted by both parties, and the implications for future action.

Putting the deficit in perspective

Much of the coverage you see on financial television has a big political tinge.  Each night I set the TiVo for both Kudlow and the PBS Newshour.  Both programs include guests of various political persuasions, but the tone is quite different.  Tonight the PBS discussion was really first-rate.


The entire segment is worth your time, but Henry Aaron of Brookings makes a point that is frequently overlooked:

Well, I think there are three things wrong with the way in which the discussion has been proceeding so far.

The first is that we are discussing the second most important problem the nation faces, not the most important problem. The most important problem is the fact that 20 million Americans are either unemployed or out of the labor force because there are no job opportunities.

Job number one should be to stimulate the economy today. We do face a serious longer-term budget problem. And Maya is exactly right that what was under discussion is not large enough to deal with that problem. So, what I feared from this discussion and the kind of deal that was on the table here was that, even if they had reached agreement, and everybody celebrated the success of dealing with the deficit problem, just two years from now, we are going to face budget projections just as bad as those we face today, if that's all they do.

In what seems like a permanent political season, this issue is a matter of partisan politics.  As investors we should be interested in the economic recovery as well as the deficit.

Public Opinion

Congressional leaders will now head home for the Thanksgiving recess.  They will carry their message to their districts, and also listen to reactions.  Polls have consistently shown that more people hold the GOP to be responsible for the failure to reach debt reduction targets.  They also believe that some tax increases are necessary as part of a solution.  (Here is a good summary of poll results.  Here is one showing which solutions people favor, and the role of revenue increases.)

This is not a complete answer, of course.  Part of politics is trying to change public opinion.

Winners and Losers

The Hill's coverage also includes a nice summary of winners and losers.  Most of these are political, but some are stocks.  Bob Cusack cites pharma and agriculture as sector winners.  I already have been working some pharma positions in my enhanced yield program (dividends plus covered calls), and the prospects now look even better.