35% Chance Of A Debt Ceiling Crisis

Debt Ceiling Resolved Soon?

Goldman Sachs lowered its odds of a government shutdown, caused by the debt ceiling not being raised, from 50% to 35%. These numbers are somewhat arbitrary because there’s no way of knowing the precise odds of a shutdown. This situation is like when analysts come up with price targets which include the cents. They are mocked because it’s unlikely their price target can be accurate down to the penny. The reasoning behind Goldman’s odds change is more important than the precise number. Goldman says the government shutdown would look bad as the relief efforts are still going on to help the people affected by hurricane Harvey.

Given how bad the storm was and how many people were affected, relief efforts will still be going in 30-45 days when the debt ceiling will be breached. The chart below shows the estimated property damage in various historical storms. Lately, the betting market has been pushing the expectations for the ceiling being raised to an earlier date. The expectation is for something to get done between September 23rd and October 6th. That wouldn’t create much volatility in the stock market. The volatility will be determined by when it’s raised and the expectations for when it’s raised. If investors are confident a deal will get done, there won’t be a selloff even if it takes until October 6th. If the deal is uncertain until the last minute, the market can start declining in mid-September. Another weather-related aspect to this political scenario is that hurricane Irma looks like it might make a landfall in about 7-10 days. If that storm causes damage to any part of America, it will only bring more momentum to Congress to get a deal done. The parties aren’t on amicable terms, but even they can put partisanship aside to get something done to make sure the affected people get the help they need.

Bullish Charts

In a previous article, I discussed the bearish arguments which were gaining steam. Now let’s look at the trending bullish arguments. The chart below shows the fundamental stock market indicator compared to the S&P 500. The fundamental stock market indicator uses consumer comfort and the CRB raw industrials spot price index divided by the initial unemployment claims. As you can see, this isn’t a predictive metric, so it’s not saying the stock market will do well in the next year. All it does is confirm the latest movement in stocks. Personally, I wouldn’t say this is a great indicator because consumer comfort isn’t the best economic metric. I would use retail sales instead.

The chart below is another bullish chart which compares the consumer comfort index to the market’s forward PE. I don’t think this chart makes a great case for being bullish because the higher the consumer comfort index, the more bearish you should be. There’s likely a little more runway to the upside as we’re slightly above the 2007 peak and much below the 1999 peak. I think these two charts are relatively weak when it comes to making the bull case. The FactSet earnings charts do a better job because of how great this year’s earnings have been. I think the next FactSet report is coming out soon after a two-week break.

Economic Reports

There were many economic reports this week. The chart below shows the Challenger Job Cut report which is an advanced statistic showing the number of announced job cuts. Surprisingly, the report showed 33,825 job cuts which was an increase from the 28,307 job cuts last week. This is one of the few reports not signaling the BLS labor report on Friday will be great. I’m going with the majority of data, meaning I expect another solid report. As per usual analysts will be more focused on the wage growth in the BLS report than the headline number since wage growth tells us how long this recovery can last before inflation starts to pick up and the Fed needs to raise rates. It’s interesting to see the market not expecting any rate hikes in 2018 because I don’t think the low inflation will be here to stay for all of 2018. With the increased demand for commodities as the global economy accelerates, there should be more inflation at some point in 2018, forcing the Fed to raise rates.

As I said, the other indicators of the labor market were strong. The jobless claims report showed claims increased by 1,000 to 237,000. This report showed data for the week ending August 26th so it wasn’t effected by hurricane Harvey. Next week’s report will be the first report which is effected by the hurricane. It will be interesting to see the scope of the impact. If the claims were to increase by 20,000, the market wouldn’t go crazy because it would know this is a temporary blip.

The final report we’ll look at is the Chicago PMI. As you can see in the chart below, the barometer was unchanged at 58.9. The chart shows the Chicago PMI in relation to the ISM manufacturing PMI. They are somewhat correlated which means a decent ISM report should come out, but there’s no guarantee. Weirdly, the one disappointing aspect of this report was the employment indicator which fell for the 6th time in the last 12 months. It fell below 50 for the first time since March. In other reports, we’ve seen manufacturing jobs are being created too fast for the labor market to keep up. This report runs counter to that narrative.

Conclusion

If the debt ceiling issue gets resolved in September stocks should have a good month. That would be surprising in terms of the calendar effect because September is the worst month of the year for stock returns on average. The biggest risk might end up being hurricane Irma because a major storm coming after the historic flooding caused by Harvey would be devastating. I’ll be focusing more on that storm after the Labor Day break when it gets closer.