BarroMetrics Views: The US Debt Crisis
Today’s post is a reproduction of this week’s weekly newsletter (the newsletter is currently closed to new subscriptions). I reproduce here because I see the events now occurring as possible harbingers that my long-held view (that we are repeating the 1966 to 1982 stagflation scenario) is incorrect. While I still think US default is not probable, the crisis has raised this occurrence to a possibility; the event occurs not because the politicians want it but because the polis miscalculate and/or a third party acts in an unforeseen manner.
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Normally I would produce a video for the week. But, I believe that, in the current environment in the US, the picture is better reflected by the written word.
I’ll start by providing a context. My view of technical analysis is:
1) History rhymes rather than repeats.
2) Technical Analysis is a visual reflection of the aggregate bias of the individual market participants.
3) Taking (1) and (2) together this means that:
* technical analysis identifies
* behavioural patterns that
* identify, sufficiently robustly, the probably direction of a market
* so that we can profit from it.
4) At any given time, there are three possible ‘events’ that may impact the market:
(a) Expected: this is likely to result in a trading range market i.e. have little impact on price.
(b) Surprise: an event that comes out of the blue e.g. an Act of God or an event that produces a surprise twist. Price is affected, usually sharply but then returns to the previous levels and structure.
(c) Unexpected: an event that is misinterpreted by the market. When the ‘correct’ effect is finally seen by a majority of the players, a new trend begins.
The ‘Debt Ceiling Crisis’ may prove to be an unusual one in that if the US defaults, we may have an event that started as an Expected event, progressed to a Surprise and terminated as an Unexpected.
When the current situation first reared its had, most traders believed (including yours truly) that after the ritualized posturing and grandstanding, before August 2, we’d see passed the increased debt ceiling. Now, we have a strong possibility that the Aug 2 deadline will not be met. Another view many seem to be holding is the one where we’ll have an extension that will avert the default. But what if that does not happen? What if, like World War I, when no one wanted or expected a war, events take on a life of their own, and the unforeseen happens?
I cannot imagine the consequences of a US Default or a downgrading of the US Credit Worthiness (to my mind, these two are almost the same). Clearly the S&P will dive; the US$ should dive thus breaking the current indirect correlation between the S&P and the US$. The operative word is ’should’. Let’s see if it does. At time of writing, the indirect correlation is just holding: the S&P is down 12 points and the US$ Index up 28. I see little reason for the US$ not to dive if the US defaults or has its debt downgraded.
That said, I believe we can identify with confidence, the secular trends of two instruments I trade:
*gold - up parabolically
*Interest rates - Yields up (prices down) for the start of a new bear market in Interest Rate Futures and CFDs.
For this week, for me, caution will be the watch word. I prefer to let the dust settle rather than take a trade (day or overnight) that is at the mercy of the politicians in Washington. Once the debt issue is settled, I can my normal trading plan to again be effective in producing profits.
Refer this blog post to a friend or colleague…
