Empire Manufacturing Dives, DC Still Divided


The New York Empire Manufacturing Index is normally viewed as a secondary regional economic report, but given the lack of economic data issued by the government due to the shutdown over the past couple of weeks, it was in the forefront today. According to the report the index came in at 1.52, indicating a slight rate of growth in general conditions. That was a far miss from September’s reading of 6.29 and the consensus of 7 that most were expecting. Readings above zero indicate expansion while readings below zero indicate contraction. This report is specific to the New York region but you have to wonder if the national data we are not receiving may also be showing signs of weakness.

DC Still Divided
The rest of week is supposed to be full of economic data but I don’t expect to actually hear any of it. All we can do is wait for Washington to solve their differences, get with the program, and remove the uncertainty surrounding the debt limit and budget battle before we can resume some sort of normalcy in trading and analyzing the markets. Still, one has to wonder if reaching a deal will simply be a “sell the news” event.

At the moment the markets are being held hostage by politicians and as the October 17th deadline approaches the chances are this will be behind us, or at least professionally can kicked down the road so we can deal with it again in 2014. This is just another chapter in the long running government saga. After two weeks of declines that ended last week the Dow has rebounded more than +500 points and the S&P 500 more than +50 points on hopes a deal can be reached before the debt ceiling deadline on Thursday. If we get through Thursday without a deal the market may not be so forgiving.

Going beyond the Thursday deadline could lead to another debt rating downgrade and a sharp rise in interest rates. We are already the laughing stock of the world because foreigners don’t understand our system of government… and we can’t keep our government running.

Everyone should understand that a last minute deal in Washington is probably going to be short term in nature and we going to go down the shutdown/debt ceiling scenario again in the near future. A deal now is merely an agreement to negotiate again before the next deadline.

Despite all the press about the government shutdown this is the 18th since 1976. The debt ceiling has been raised 53 times during the same period and 77 times since 1962. Shutdowns happen regularly but in reality it is more accurately called a slim down. More than 83% of the government is still working. Only certain agencies are shutdown.

On 27 of debt ceiling hikes there were special conditions attached to the debt limit increase that had no relevance to the actual debt ceiling. In an analysis by The American Enterprise Institute they cited that 60% of the 77 debt limit increases since 1962 came with Democrats attaching conditions to the hike. Only 15% contained Republican led conditions and 25% were divided with joint conditions. There is no reason for President Obama to refuse to negotiate on the debt limit since it has been happening routinely since 1962. In a negotiation nobody ever gets 100% of what they want. The parties negotiate and both sides give up something… that is how government works.

This debt limit problem is going to be revisited over and over again in the years ahead. The government needs to borrow another $700 billion over the next 12 months. It will need to borrow another $7 trillion over the next ten years and probably more because of Obamacare. This is an unsustainable path… it is like getting a cash advance on your credit card to make the credit card payment every month. Every trillion in new debt is going to produce another debt ceiling fight until the country eventually crumbles under the insurmountable debt load… it is only a matter of when, not if. See these prior posts for some interesting statistics on scenarios of how this may play out in the years ahead: Government Shutdown & Too High to Buy, Too Strong to Sell

Markets
Everything we’ve learned about fundamental and technical analysis can be tossed out the window for now. The market is trading on emotion with the sole trigger being politics. Until it is resolved I don’t see any edge in being either bearish or bullish. What’s likely to happen is a short term debt ceiling increase and budget extension through January/February next year that allows the government to re-open and spend more money, and the politicians will start this whole process all over again in two or three months.

Taking a step back the S&P 500 is clearly in an upward trend. I suspect prices may break out higher on the announcement of a deal and there is overhead trend line resistance near 1735/1740. Our Fibonacci models indicate that a run into the 1757 to 1776 area could be in the cards. If a breakout higher comes to fruition it would represent further gains to S&P 500 in the neighborhood of +2% to +4.5%. If prices see these levels extreme caution would begin to set in for the equity markets.

On the other hand if prices reverse lower (below 1650ish) we could be looking at a bearish Head and Shoulders pattern playing out that I highlighted in this post: Another Head and Shoulders Pattern. If this scenario comes to fruition it signals a move down to 1480 or below may be in the cards. This seems unlikely but something keep an eye on. A close over 1707/1710 would negate the head and shoulders pattern.

Either way this market is in need of a breakout above 1707 or below 1674 to provide some direction. Until then we must stay nimble and would be comfortable turning more bearish on a quick move to the overhead resistance levels mentioned above.

Updated Chart of the ESZ3 (December S&P 500 Contract)

ES_10-15-13