Will The Deficit Super Committee Failure Lead to Another Meltdown?

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SAN DIEGO (ETFguide.com)  According to various news reports, the 'super committee' has shifted its focus from discussing deficit reduction options to how to best admit their failure to reach a conclusion.

Why can't the 12 members of the Deficit Super Committee agree on the needed cuts? Perhaps the 12 egos are even bigger than the actual deficit, or there's just no solution if 12 'smart' committee members can't solve the problem.

The bigger question for investors is how stocks will react to their expected failure?  Look at today's ticker and you may be reminded of August when Congress almost failed to solve the deficit.

A last minute deal in August averted a government shutdown but advertised the government's inability to manage its finance to the entire world. S&P withdrew the coveted AAA rating and stocks tumbled relentlessly for days.

How Big is the Deficit Problem?

The super committee was created by the Budget Control Act of 2011 on August 2, with the assignment to identify ways to reduce the deficit by at least $1.2 trillion over ten years.

To put this 'massive' task into perspective consider this: The 2011 federal budget is $3.7 trillion. I know the budget is fluid, but let's just multiply 3.7 by ten to get the full ten-year scope - $37 trillion. The committee's job is to eliminate $1.2 of $37 trillion -that's 3.2%.

How many American households have had to deal with a 3.2% income reduction (or better who hasn't)? Assuming a family makes $5,000 per month it would have to find a way to cut $160. If families can do it, why can't Congress?

The Big, Fat, Ugly Ripple Effect

It's easy (and probably correct) to point fingers at Congress for creating a financial stalemate, but the sad reality is that America's 'average Joes' will end up paying for it (financially and emotionally).

The government has become a huge part of the U.S. economy and accounts for nearly 40% of Gross Domestic Product ( GDP ).

The first chart below shows how the government has become more and more intertwined with the U.S. economy.

The second chart illustrates how the government's share of GDP has outmuscled (and probably stifled) the private share of GDP.

The third chart is an outright admission of failure. It plots government expenditures (including QE) against the only thing that matters - unemployment and the stock market (charts courtesy of the November 2011 ETF Profit Strategy Newsletter).

>> click here to view charts

     

    

    
 

In addition to damaging the domestic stock market (NYSEArca: VTI), a failure of the super committee has the very real threat of de-railing global markets (NYSEArca: EFA), which include emerging markets (NYSEArca: EEM) and already weak European stocks (NYSEArca: VGK). The U.S. won't recover without the help of its international trading partners.

It's A Lose-Lose Situation

If the super committee fails to come up with a deficit reduction plan before the deadline, the so-called 'trigger' will be activated; resulting in $1.2 trillion worth of deficit reduction measures and the world will once again see how ineffective U.S. government is.

Regardless of how the deficit is reduced, there are only two possibilities: 1) Increase taxes and 2) Decrease spending. Pick your poison, either will 'kill' the economy along with the Dow (DJI: ^DJI), S&P (SNP: ^GSPC), Nasdaq (Nasdaq: ^IXIC) and Russell 2000 (NYSEArca: IWM).

Tune In to the Noise That Matters

I usually trust my technicals and don't make or recommend making investment decisions based on news events. But I can't help but noticing everything that's going on.

- The super committee deadline is approaching.
- The perception about the eurozone debacle is moving away from denial towards a realistic assessment. Needless to say, the realistic assessment is bleak.
- The S&P is in the initial stages of a giant head-and shoulders or M-pattern decline.
- Dividends are close to an all-time low (a sign of over-valuation).

Putting the Decline Into Perspective

Today's decline is a small piece of the puzzle that fits perfectly in the larger mosaic. The stock market has adhered to a well-defined roadmap outlined by a composite of technical/sentiment/seasonal indicators.

As per the roadmap, the ETF Profit Strategy Newsletter expected a major market top in April/May 2010. Below is an excerpt from the April 3 ETF Profit Strategy update:

'Even though odds do not favor bearish bets the first half of April, I believe a major market top is forming. The S&P is forming a giant head-and shoulders top where the down sloping upper trend line runs parallel to the trend line that connects the October 2002 and March 2009 lows. For the month of April this trend line will traverse through 1,377. The 78.6% Fibonacci retracement is at 1,381.5. There is a fairly strong Fibonacci projection resistance at 1,369. In terms of resistance levels, the 1,369 - 1,382 range is a strong candidate for a reversal of potentially historic proportions.'

Just a few trading days before the October low, the September 23 ETF Profit Strategy Newsletter predicted that: 'From its May high at 1,370 to its eventual low, the S&P will likely have lost about 300 points (22%). This kind of move validates a counter trend rally. The plan is to square short positions and buy long positions in around S&P 1,088. The rally, once underway, will probably re-inspire a certain degree of confidence into the market before it runs out of steam. The most likely target for this rally is S&P 1,266 - 1,282.'

Why Change A Winning Formula

As soon as the 1,266 - 1,282 target was met the rally stalled and stocks turned back down again. The Newsletter recommended to go short at 1,270, temporarily took profits at 1,235 (to allow for a potential bullish triangle formation) and as per yesterday's update went short at 1,205.

When it comes to market forecasting there is always room for error, but as long as the market adheres to a reliable forecasting formula there is no reason to abandon it. According to the formula the down side potential is simply massive.

The ETF Profit Strategy Newsletter provides a short, mid and long-term outlook along with easy-to-follow buy/sell recommendations. 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: GDP

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