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If you’re an investor, there’s an important date coming up. You’ve probably read about it, but everything you’ve read is wrong – including what the actual date is!
I’m talking about the coming debt ceiling drop dead date, which Treasury Secretary Mnuchin says is Sept. 29. Mnuchin also says that, unless Congress acts on that day, the government will run out of money. At the same time, the government will have lost its ability to borrow money from the public to finance its ongoing deficits.
As I have reported in my “Wall Street Examiner Pro Trader Federal Revenues” report, the Treasury appears to have enough cash to last until mid-October, not Sept. 29, as Mnuchin is threatening. There is some uncertainty, however, due to a large military pension fund payment that is legally required on Oct. 2.
And on that date you’ll see one headline that will be your signal to sell – fast.
In this column I’ll show you exactly what is going to happen and when. I’ll also show why the analysts are completely wrong about the market’s direction. As we get closer to the real drop dead day, I’ll show you how to position your portfolio for maximum profit during the crisis using my exclusive LAMPP indicator.
First, here’s what’s really happening (if you ignore the hype)…
The Government Has Scheduled a Phony Crisis for Sept. 29
Whether it’s Sept. 29 or a couple of weeks later in mid-October, market analysts and the mainstream media are saying that once the government loses its ability to borrow, the markets are going to tank.
But they’re wrong. On that date – Sept. 29, or within a couple of weeks – the markets are more likely to begin a powerful rally. I’ll explain that in a moment.
The truth is that the crisis for the markets will begin on the date that Congress finally fixes the problem, not the day the government runs out of money.
As you know, the government runs considerable financial deficits every year. And it finances those deficits by borrowing. It borrows mostly from the public through sales of notes and bonds. But it also “borrows” from itself by moving cash around among internal accounts such as the Social Security Trust Fund, various government pension programs, and the like.
The total amount of money the government may borrow is limited by Congress – and they set that limit in a separate process from which they authorize spending money. So from time to time the government gets in a position where it is spending money but does not yet have permission to borrow the cash to support the spending.
Imagine if you set your family’s budget for the coming year at 120% of your income but didn’t check to see if your credit cards had a high enough limit to cover the difference.
That’s what Congress and the Treasury do each and every year. Well, now is the time when they must get an increase in their credit limit. But unlike the rest of us, Congress gets to set its own credit limit. It’s a phony emergency which Washington brings on itself and which Congress can resolve in a 20-minute vote whenever it wants to.
But that time – when the money is being spent but the ability to borrow is running out – makes for great sport in Washington and on Wall Street. For Washington, it’s an opportunity to showboat and for various power players to display their feathers On Wall Street, of course, the opportunities are all about the money.
As investors, we’ll also focus on the money. But first let’s go over the political part, since that will inform our analysis of the investing part.
Washington loves a crisis, especially one where they have the power to end it whenever they want. It allows them to raise funds for reelection, to gain power, and to look important. In this case it will be the Trump administration asking for an increase in the debt ceiling – basically, asking for permission to borrow more money – and congressmen and senators making speeches about the importance of fiscal responsibility while trying to wheedle concessions from the administration in exchange for the votes to increase the limit. There will be all kinds of breathless press coverage, mostly focusing on two possibilities – a government “shutdown” and a default on the nation’s debt.
A shutdown is a real possibility here but it means nothing in the long run. Some parks will close, maybe some agencies will have enforced holidays, and there won’t be any garbage pickup in Washington. But the military will still be on the job, Social Security checks will be sent out, and the nation’s business will continue.
A debt default could be a disaster. Or it might not. Everyone knows that the U.S. will always pay its debts, and if it comes to that, whatever instability that results will be short-lived. If Greece can return to the debt markets, so can the United States.
But a default is also extremely unlikely. The government always has money coming in, and dedicating it entirely to debt repayments (at the cost of paying other bills like government wages and office supplies) would allow a default to be deferred indefinitely, perhaps for a year or more.
All of which is to say that we can ignore all those dire warnings we’ll be seeing in the press except as it affects our investment stance. Again, this is a phony “crisis” ginned up for political purposes.
That means if we want to profit, we have to tune it out completely.
What Will Spur the Actual Crisis
Secretary Mnuchin has now drawn a line in the sand on the date Sept. 29. He chose that date first because it is the end of the fiscal year. Secondly, a massive payment to a military pension fund is required by law on the next business day, Oct. 2, which is the first day of fiscal 2018.
As of Aug. 15, the government currently has $96 billion in cash in its coffers. It has a big payday coming on Sept. 15 when it collects quarterly estimated individual and corporate income taxes. That, plus withholding and other taxes it collects through the month, and the cash it currently has in the till, should be sufficient to last until mid-October, depending on how large the required military pension fund payment is.
I combed through the Daily Treasury Statement for the beginning of last October and found only a modest payment to military retirement. We assume that the information that a large payment is due is correct, but there’s no evidence either way to suggest that it would be sufficient to completely drain Treasury cash. It appears that the Treasury currently holds enough cash to last until approximately mid-October.
That’s where I think the drop dead date is. But what about the accounting games the government has been playing to allow it to continue issuing debt to the public at a normal pace? You see, those are voluntary.
The government has been using its cash to pay down internal debt instead of using it to directly pay its bills. Internal debt, such as the money owed to the Social Security Trust Fund, is counted under the debt ceiling. When the Treasury uses cash to pay down some internal debt, it creates sufficient headroom under the ceiling so that it may continue to issue debt to the public. We assume that it is doing that to maintain a semblance of a normal market.
But as it begins to run short of cash, the Treasury may decide at any time to stop that game. It could stop issuing new debt and use its cash to directly pay the bills instead.
That will generate hysterical headlines. They’ll scream that the U.S. government has hit the debt ceiling and can no longer raise cash to pay its bills. They’ll say that the government is now on the doorstep of shutting down and even defaulting.
If that happens, the other thing most Wall Street analysts will tell you is that the markets will decline. They’ll say that a government shutdown, the threat of default, and “uncertainty” in general is bad for markets.
But such threats and “uncertainty” do not control the direction of the stock market. Liquidity does. Contrary to what you’ll hear in the media, this “crisis” is actually going to generate more cash for the markets.
If the federal government is suddenly not absorbing $50-$80 billion in cash from the market, as it normally does every month, because it’s temporarily not allowed to borrow, primary dealers and other market participants will suddenly be flush with excess cash that they normally would have used to by regular Treasury issuance.
This has happened before, in 2015, the last time we had a debt ceiling “crisis.” The dealers and other investors found a place to put some of that cash. It was the stock market.
The stock market increased by 9.9% during the month that the Treasury was unable to borrow.
So, ignore the analysts and pay attention to history.
When will the market decline then? I can’t give you that exact date, but I can tell you how to know it when you see it.
Here’s the Headline You Actually Want to Watch For
When you see the headline “Trump, Congress Reach Debt Ceiling Deal,” it will be time to sell – a big decline is coming.
Why is that? When the government is allowed to borrow again, not only will it resume borrowing its normal amounts, it will do some extra borrowing to make up for all the “tricks” it had to pull to prevent debt default.
Pension funds that had been raided will have to be paid back, government workers may get some back wages, cash accounts that had been drained will be replenished. In addition, as I reported recently, the TBAC is recommending that the Treasury build up over $200 billion in excess cash. The Treasury virtually always follows TBAC recommendations. I have estimated that all together the Treasury would flood the market with roughly $500 billion in new debt within six to eight weeks after the debt ceiling is raised. That’s enough to crush both the stock and bond markets.
And that leads to the opposite of the excess liquidity available during the crisis. With the Fed creating money at a normal rate and the Treasury borrowing multiples more than it usually does, dealers will need to liquidate other holdings in order to fulfill their responsibility to buy Treasury offerings.
Again, look back to 2015. Once a deal was reached, the earlier 10% rally reversed, and the stock market declined by over 3.5% in a week. And it followed with a much bigger decline in January.
This time, if the Treasury follows the TBAC recommendation resulting in $500 billion in net new Treasury supply in a few short weeks, the outcome will be much worse for the market than in 2015.
Furthermore, the Fed is threatening to begin shrinking its balance sheet as early as October. We hope that the Fed isn’t that dumb, but dumb decisions have long been a feature of Fed policy. Shrinking the balance sheet at that point would withdraw additional funds from the market pool at the worst possible time. The combination of the massive hit of Treasury supply and the Fed beginning its program of balance sheet “normalization” (a euphemism for tightening or draining) would almost certainly trigger a bear market.
All the other things you’ll be reading about – the uncertainty, the direction of interest rates, the awful consequences to our nation – is noise. The signal comes from U.S. Treasury borrowing.
And the best part for investors is that none of this is a secret. All of the data – Treasury borrowing, Fed money creation, the cash that goes to the dealers – is public and available to anyone who wants it. It’s just that most analysts are asking the wrong questions. And then they wonder why they got the wrong answers!
My proprietary LAMPP model uses that public data and it will give us exact signals as we approach Sept. 29 and then plot our way methodically through the dance of the debt ceiling. It will give us clear buy and sell signals keyed around the events of the debt ceiling crisis.
— Lee Adler