Despite so much anger, we've only just begun to see fear creep into the stock market. There has been an enormous divergence between investor sentiment (which has become exceptionally negative) and market prices (which have stayed relatively flat).
THE TECH BULL
Part of the reason for flat prices is that more than 80% of the companies reporting 2Q earnings this season have beaten their analyst consensus estimates. That's incredibly bullish. Furthermore, there is a party going on in Silicon Valley. Start-up tech companies are being routinely valued over $10 million, even without a working product. It feels good to be in coastal California right now.
THE PSYCHOLOGICAL TERRAIN
Psychologically speaking, here is what we are facing:
(long term, psychologically speaking, this situation is all bad, but more on that in a later post).
3. There is little that can be done to prepare for a negative outcome.
U.S. IS LIKELY TO MISS THE DEADLINE
Unfortunately the negative outcome is also the most likely, and the debt ceiling will not be raised by August 2nd. If this negative event occurs, there are likely to be band-aids applied - an executive order raising the debt ceiling, social security check IOUs redeemable at most banks (as California issued each of the past three years), and interest payments to bond holders that will be paid.
What if there us a ratings downgrade of U.S. Treasuries to AA?
- Based on the regulations for pension funds, banks, etc... to hold AAA Tier 1 assets in part of their portfolio, there simply won't be enough liquid assets for all that money to move into.
- This would necessitate a change in the rules governing "secure" assets. So fundamentally, very little would happen except a lot of confusion and panic in obscure derivatives markets that we haven't yet heard about.
In terms of the negotiations themselves, the psychology has played out such that neither side can back down. If either backs down, they will lose face with their constituents. If they both go through with the default, then they can both claim victory (of sorts). Recall that Tea Partiers were elected to throw perfectly drinkable tea into the ocean - to cause short term pain (refuse a debt ceiling increase) for longer term gain (better fiscal management). And we're currently seeing Obama's (necessary) second "stand" - healthcare reform was first. See that graph of Anger above? Anger causes people to become LESS flexible, not more.
GAME OF CHICKEN
SAFE HAVENS FOR $$