We Have a Deal, But…

To the surprise of almost no one, Congressional leaders FINALLY came to an agreement with the White House on Sunday for a plan to increase the debt ceiling and to “cut spending” going forward. The plan is bipartisan in nature and has some interesting tidbits such as a balanced budget amendment provision, no new taxes, the formation of a special committee to find spending cuts, and a penalty if Congress dinks around with approving the committee’s cuts before Christmas. But now the fun really starts. And by “fun,” I mean the market reaction.

As expected, S&P stock futures surged by more than 17 points on the news and the Nikkei leapt by nearly 2%. However, there are a couple of sticky little details that remain. First, the agreed upon plan needs to be developed into a bill and voted on in both the House of Representatives and the Senate by tomorrow. Second, and perhaps more importantly, total spending cuts of $900 billion is shy of the hurdle Standard & Poor’s has been talking about. And when you add in the additional $1.5 trillion or so of spending cuts the special committee is supposed to come up with, my calculator says that total cuts would be $2.4 trillion. Again, this is short of S&P’s stated target.

So, problem number one for the markets may be the worry that one of the “D’s” in the 4-D debate (debt, deficit, default, and downgrade) would appear to still be on the table. To put the spending cuts in perspective, the U.S. is currently running an annual deficit of something on the order of $1.6 trillion a year. So, cutting $900 billion now and another $1.5 trillion later – all over the next 10 years – may not be terribly impressive to almighty ratings agencies. (But then again, these guys couldn’t figure out that million-dollar mortgages from bricklayers in California weren’t exactly Triple-A!)

Problem number two is the simple fact that both houses of Congress must now approve this agreement. In light of the fact that this debate has been cantankerous (at best) and that there are some factions that will not be at all pleased with the plan, there is still time for some political grandstanding before the final votes are cast. In short, now is the time for politicians to stand up and voice their disapproval – right before they vote for the bill, of course.

The other teeny, tiny problem is that with the prospect for a U.S. default apparently out of the way, traders may turn their attention back to such minor matters as the economy and earnings. While the latter have been coming in above expectations with 78% of the 329 S&P 500 companies that have reported so far beating EPS estimates and 74% beating top line revenue projections, the data on the economy may produce some angst as well as some additional de-risking.

Make no mistake about it folks; Friday’s GDP report was abysmal. After all the numbers came in, first quarter economic growth was cut to just +0.4% and the second quarter’s rate was initially pegged at +1.3%. In addition, there is a fair amount of talk about the possibility of the Q2 number being a bit high. The bottom line here is that with growth at these levels, any difficulty going forward will put the prospects for a double-dip back on the front burner.

It may be for this reason that the futures have backed off from their initial highs. Don’t forget, we’ve got a big batch of very important data coming out this week, including the ISM reports and the Big Kahuna – the jobs report – on Friday. And don’t look now fans, but the yield on the 10-year T-Bond is diving again and currently trading at 2.80%.

So, just because we’ve got a deal this morning does not necessarily mean that happy days are here again for investors in the stock market. Let’s remember to be careful out there because this does not appear to be 1982 revisited.

Turning to this morning… Although off their highs, stock futures and foreign markets all sport green screens at the present time in response to the prospects for a U.S. debt default being taken off the table.

On the Economic front… There is no economic data due out before the bell. But we will get ISM Manufacturing and Construction Spending at 10:00 am eastern.

David Moenning
Editor:  The Daily Decision