As the attention of markets and observers begins to focus on the forthcoming debate over the budget and debt limit, this time with a special guest appearance by Obamacare, I am reminded of an old trading room story. I have mentioned it before, but feel it bears repeating here. I was working on a Cable (GBP/USD) desk in London at the time when the Queen Mother, approaching 100 years old, was experiencing health problems and rumors of her demise were frequently heard. Of course, logically, the survival or death of the Queen’s mother could have no possible effect on the currency, but traders paid attention to the rumors regardless. On one occasion when, for the umpteenth time, such rumors surfaced, one voice could be heard clearly above the trading room buzz. One trader was heard to ask “What did we do last time she died? Did we buy it or sell it?”
So it is with the upcoming “crisis” in Washington. We have seen it all before. I don’t expect this time to be any different. Both sides will stake out an extreme position and refuse to compromise or negotiate until the last minute. We may even get to a deadline without passing a spending authorization or extending the debt limit. If we do, then, within a few days, a hastily cobbled together compromise will emerge that delays the need for tough decisions. I guess everybody knows the famous definition of insanity, but it doesn’t seem to prevent politicians from proving it regularly.
From the perspective of a trader or an investor, believing something will happen is one thing, but the important thing is assessing its possible effects on the market. If the Queen Mother dies again, should we buy it or sell it? The answer, if history is to be believed is “both”.
The debate and accompanying theatre has already begun, with Senator Cruz speaking for 21 hours in the Senate; an act that, depending on your own political position, can be seen as heroic or disruptive. Sensationalist news coverage of all of these events will make it seem as if the statements that congress members make and the intransigence they display will have lasting, devastating effects.
In the event that it all becomes too much for you, I urge you to look at the above chart for the S&P 500 tracking ETF SPY. In mid-2011, we had a similar situation. At that time the decision by S&P to downgrade US Government debt reflected fears that agreement was impossible, but it came nonetheless. The 15% drop to around 110 looks, with 20/20 hindsight like a great buying opportunity. The same could be said for individual stocks.
Both Exxon Mobil (XOM) and General Electric have seen ups and downs since the summer of 2011, but, with the same hindsight, the depths of the debt ceiling crisis presented great buying opportunities for both.
You would think that traders would, by now have learned, and that markets will hold up despite the brinkmanship that will be on display. This could be the case to some degree and the drop may be somewhat muted this time around, but the stakes are so high that some kind of reaction is almost inevitable.
My trading background compels me to follow any prediction with a question…how to play the expected move. I am tempted to suggest a calendar spread on SPY options; selling near dated calls and buying them further out. The problem is that I am not the only one who has seen this movie before. Placing that trade would work out to be pretty expensive. As is often the case, simple may be better.
Shorting the general market through SPY in the coming days would enable you to benefit from the uncertainty to come. If that works, then don’t be fooled by the feeling of impending disaster that causes the drop. An agreement will be reached at some point and the relief rally will come. Just in case this time is worse than others, buying back in through solid, relatively stable stocks such as XOM and GE should limit your downside somewhat if the crisis continues.
The feeling of Déjà vu that I referred to in the title is strong this time around. Not only have we seen this debate and this posturing before, but I also feel that I have pointed out the likely sequence of events and how to profit from it before. I am sure I have, but that doesn’t make it less likely to happen this time around. Sometimes, Déjà vu can be a blessing, not a curse.