Tuesday, September 03, 2013 - Welcome to September

Welcome to September

by Sinclair Noe

DOW + 23 = 14,833
SPX + 6 = 1639
NAS + 22 = 3612
10 YR YLD + .10 = 2.85%
OIL + .89 = 108.54
GOLD + 15.70 = 1413.20
SILV + .75 = 24.38

Well, we still haven't started the war, yet. Congressional leaders from both sides of the aisle lined up in support of military intervention. The Senate Foreign Relations Committee opened a hearing and grilled Secretaries Kerry and Hagel. Tomorrow, Kerry and Hagel are scheduled to appear before the House Foreign Affairs Committee. The debate is shifting away from “Did Assad use chemical weapons?” to “What should be done about it?”

Clarity of objectives seems to be a work in progress. Maybe all the talk will eventually consider the possible consequences of a military attack on Syria. Is it really possible to bomb a country and avoid deeper involvement? So far, the politicians are trying to work it out in a logical progression; if A, then B. That's not always how it happens in war. Logic gets thrown out the window.

At this time of crisis, it is worth remembering another time, 30 years ago in October, 1983 when US warships bombarded Lebanon, the country located next to Syria. Within weeks, the US Marine barracks in Beirut was blown up by a massive truck bomb that killed 241 American servicemen: 220 Marines, 18 sailors and three soldiers. The truck driver/suicide bomber was an Iranian national whose truck contained explosives that were the equivalent of 21,000 pounds of TNT. Two minutes later a second suicide bomber drove a truck filled with explosives into the French military compound in Beirut killing 58 French paratroopers. France is the only country standing with the Obama administration on a military strike on Syria, and they might put that support to a vote of parliament.

Mr. Obama has invited the Republican and Democratic leaders of the House and Senate defense, foreign affairs and intelligence committees to the White House this afternoon. Later, he'll fly to Russia for the previously scheduled G-20 economic summit, a forum that will put him across the table from Vladimir Putin of Russia.

August is finally behind us. No more excuses for the market. No more low-volume rallies and corrections. The Dow was red-hot at the beginning of the year. Its components were easily besting the broad market, delivering gains usually reserved for popular growth stocks. However, the summer was far from kind to the Dow. It began to slip in early July relative to the S&P 500. As of right now, the Dow has yet to find its footing. Even today's modest gains were well off session highs.

So, we head into September to the rhythm of the war drums. It promises to be an interesting month. If the major market indices can't catch a meaningful rally now, it is hard to imagine how the indices could sustain a meaningful rally later in the month. September has earned its reputation as the worst month of the year for the broader market, with the S&P down an average of 0.5% over the past 70 years. Not every year is negative; seven of the past ten years have seen positive September returns.

This Friday we get the monthly jobs report. Expectations are for a slight uptick from July's 162,000 headline result with no change to the unemployment rate from the prior reading of 7.4%. Remember good news is bad news for the markets, fearful of losing their spot at the trough of the Fed's easy money. This morning, the ISM report popped up to 55.7 as the manufacturing sector continued to expand for a third straight month; and the yield on the 10-year Treasuries popped to 2.88% In two weeks, the Fed FOMC will meet and consider slowing the flow of easy money, a cutback or taper of QE3. Toss in ongoing speculation about a replacement for Bernanke, and let the fireworks begin.

Congress will officially reconvene next Monday and they will be focused on the Syrian war, but don't forget the battles over taxes and spending, regulations and safety nets, and how to get the economy out of first gear. Which means more gridlock and continual showdowns over budget resolutions and the debt ceiling. They still haven't figured out exactly what is being cut as part of the sequester. Earlier this year, the House and the Senate passed spending bills for the 2014 fiscal year, which begins on Oct. 1, that were about $90 billion apart, but never settled on a final figure. Congress is expected to pass another stopgap bill, known as a continuing resolution, financing the government for a few more months, but it is unclear whether such funding will stay at current levels or shrink. This is actually important because if they fail to come to a deal before October, many parts of the federal government could shut down. Not a complete government shutdown, but death by a thousand cuts.

We're emerging from the depths of the worst downturn since the Great Depression but nothing fundamentally has changed. Corporate profits are up largely because payrolls are down. Cost cutting has limits, and we've started to see those limits in the revenue numbers from second quarter earnings reports. Businesses need customers, and the customers are holding tight to the purse.

While the debate rages over Syria, American workers have been taking to the streets to demand a bit more pay. So as Congress reconvenes and the battles resume, be clear about what's at stake. The only way back to a buoyant economy is through a productive system whose gains are more widely shared. One of the totally unanswered questions about Syrian military intervention is how we're going to pay for it. It's not cheap to park five destroyers in the Mediterranean; it's not cheap to lob a few hundred cruise missiles over the waves; it gets real expensive, real fast if anything goes slightly askew.

Where does the money come from? It won't be coming Detroit or San Bernardino. In July, Detroit filed for bankruptcy. Last week, San Bernardino filed for BK. Two of the biggest municipal bankruptcies in US history.

After kicking the can down the road, with increasing desperation, for many years, the end of the line has been reached. The city is finally admitting that far too many financial promises have been made, and that the majority of these simply cannot be kept. It does not matter whether the promise-holders have a good case for receiving services or needing payments, or even if they have legal protections. If the promises can be broken, they will.

Strange as it may seem, the bankruptcy filings don’t appear to have unnerved the $3.7 trillion municipal bond market. The momentum defies predictions that the muni market would go into a deep freeze following the Motor City’s financial collapse and Detroit Emergency Manager Kevyn Orr’s plan to impose losses on some bondholders. There’s not a lot of evidence to show this has been the death knell for GO [general obligation] bonds.

Everyone thinks it’s just Detroit, but Detroit is not unique. It’s the same in Chicago and New York and San Diego, San Jose, Stockton, and San Bernardino. It’s a lot of major cities in this country. They may not be as extreme as Detroit, but a lot of them face the same problems. Detroit is merely the first of many municipalities to hit the wall, where the realization dawns that far too many promises have been made, and nowhere near all of them can be kept. Different classes of stakeholders are still assuming that their claims will somehow be protected. They are typically thinking of those claims in isolation, without considering the implications for other groups whose rival claims would have to be subordinated. It has been clear for a long time that we would reach this crunch point

Investors in municipal bonds are typically looking for a dependable income, stable bond prices and shelter from taxes. They have generally come to regard these investments as risk-free, even as the obvious problems faced by municipalities have been mounting. The bankruptcy of three cities in California last year seems not to have been interpreted as the warning signs that they were, and so far, relatively speaking, neither does the bankruptcy of Detroit. This complacency is highly unlikely to last, however, as the extent of the inevitable losses in Detroit becomes clear. The clear risk is that bond prices will crash on spiking yield, and that this will precipitate a rush for the exits. A move in this direction has begun, and concern is rising, but as yet it remains a muted response.

Public pensions are also a major stumbling block; supposedly protected by Michigan state law; the law might not protect retirees. What and who will be protected by the law? Under both the Dodd-Frank Act and the 2005 Bankruptcy Act, derivative claims have super-priority over all other claims, secured and unsecured, insured and uninsured. In a major derivatives fiasco, derivative claimants could well grab all the collateral, leaving other claimants, public and private, holding the bag.

Welcome to September.