Sunday, July 31, 2011

Today's Major Market Move - U.S. Equity Futures Up 1.5% On News of Debt Deal

The over-dramatized and over-hyped debt deal is finally here and in pavlovian fashion, futures in the U.S., Australia, Japan, and the U.K. have all surged. The Dow Jones is up 1.5% and the All Ordinaries is up even more at +2.4%. I suppose the logic is as follows: Continued U.S. Deficit Spending=Continued Demand for Chinese Goods=Continued Demand for Australian Commodities. Here's the most recent table of global equity index futures:

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Click here for the most recent version of the table.

Details on the deal are still emerging but here are some of the numbers that are being reported (from The Globe and Mail):
Under the agreement, a congressional committee would have to come up with a 10-year, $1.5-trillion deficit reduction plan by November. And Mr. Obama could increase the borrowing limit by $2.1-trillion, enough to avoid having to ask Congress for more before the 2012 election.
The $1.5 trillion in long term cuts is on top of an immediate $1 trillion in deficit reduction. That ends up being $2.5 trillion in cuts over 10 years while we are current running an annual deficit of over $1.6 trillion. Even if we wound the wars down completely today (a logistical impossibility), that $2.5 trillion in cuts wouldn't last for more than 3 or 4 years in terms of balancing the budget. In essence the government, and this applies to both parties, is betting the farm on rising revenues. Politicians are desperately hoping that tax revenue will pick up and subsequently the pressure to make further cuts will dissipate. In light of the current macro trends: continued high unemployment, weakening housing market, declining gdp numbers, I find that outcome highly unlikely.

According to the US debt clock, the U.S. federal government is spending 63% more than what it takes in (3.6 trillion vs 2.2 trillion). Over the next 5 years, according to the IMF, GDP is expected to grow 23%. This number is extremely optimistic considering that the poor GDP numbers from Friday's release haven't been factored in yet (they still have an estimate of 3.6% growth for 2011 and we'll be lucky if we see even half of that).

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Without a change in the tax rate, which the Republicans so far have been dead set against, I don't see how tax revenue growth can outpace GDP growth by much. If revenues only increase by 23% over the next 5 years, there are going to have to be very significant spending reductions to bring the budget into balance.

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