US House Republicans Determined to Burn Country to the Ground (In Order to Save It!)

Whenever our financial markets commentary strays into the realm of politics, we're guaranteed to offend at least half of our clients and readers. So let us state up front that our job is NOT to choose sides but to evaluate how politics will affect the US economy and by extension corporate earnings, which are the bedrock of stock market performance. By that measure, the current tactics of House Republicans to shutdown the "non-essential" parts of the federal government and block raising the debt ceiling is an unmitigated disaster. Businesses crave predictability and reliability.   Just tell us the rules, and we'll figure out how to adapt. At present, businesses don't know if their invoices to the Federal Government will be paid, how the furlough of 800,000 workers will impact their sales, and how the political battle over providing healthcare will impact their cost structure.

Core to the functioning of the US political system is that the majority rules. The Patient Protection and Affordable Care Act was enacted by Congress in March 2010 and signed into  law by the President on March 23rd, 2010. The constitutionality of the law passed muster with the Supreme Court on June 28th, 2012. The law was tested again in November 2012. Governor Mitt Romney, whose Massachusetts Health Care Insurance Reform Law, was the model for the Affordable Care Act, campaigned aggressively on the repeal of "ObamaCare" (and lost.) By reasonable measure, the Affordable Care Act reflects the will of the people, even if the people don't quite understand the details and won't understand until January when the bugs are ironed out.

So on to implementation, right? Alas no. At present Republicans control 53.7% (232 out of 432) of the seats in Congress and have voted over 40 times to "repeal ObamaCare." Each time the Democrat controlled Senate has ignored the House bill. In 2013, conservative activists financed in large part by billionaires Charles and David Koch of Koch Industries devised a strategy to block passage of the 12 appropriations (spending) bills, which make up the budget of the United States Federal Government, unless Congress agreed to "defund ObamaCare." If Congress can't agree by October 1st of each year, then generally a "continuing resolution" is passed to fund the government at last year's funding levels.

This year, a micro-thin majority of 200 Democrats and 17 Republicans appear willing to support the continuing resolution, but House Speaker John Boehner refuses to put the bill to a vote until the President agrees to meet his demands to scuttle the Affordable Care Act. That is not going to happen ever, so 800,000 Federal workers were furloughed on October 1st. We'd love to know the impact of that furlough on the US unemployment situation, but the Labor department is now shut down and we have no information on this and dozens of economic statistics. In other words, we're in a 747 at 35,000 feet, but someone just ripped out the instrument panel.

The next pain point centers on raising the debt ceiling. By statute dating from 1939, Congress establishes the total amount of debt the government can have and leaves funding that debt to the US Treasury. This year the debt limit was reached in May, but the Treasury has used accounting gimmicks to postpone the day of reckoning until October 17th. If the debt ceiling is not raised later this week, then by Friday the US Government will be in default, yields on US Treasuries will soar as will the cost of borrowing for mortgages, corporate loans, student loans, credit cards. International borrowers will also be affected. The current economic recovery is fragile, so a surge in interest rates could push the US economy back into recession, and indeed the world economy. That would be bad for corporate earnings and also for stock prices.

At present, reaction in US markets has been muted - the S&P 500 hit an all-time high on September 18th, sold off 4%, then rallied back - currently only 1.3% off the all-time high. This performance reflects Wall Street's assumption that, "Surely the folks in Congress aren't so stupid as to actually allow us to default!" We may see, as a result, a pretty vicious sell-off later this week as investors realize, "Oh my god! Congress IS that stupid!" We have had numerous opportunities to tour through Congress in recent years in our participation with the Legislative Committee of the Investment Advisors Association, and we have met with Senators, Congressmen and their staffers. Representatives in particular react only to the phone calls and e-mails of their constituents. If the constituents are demanding shutdown of the government, then that's how their representative is going to vote - screw the greater good!

So what can we do as citizens, and as investors? If you live in a district represented by a Republican Representative, you can go to http://www.house.gov/, find your Representative's website, send them an e-mail, log a comment, make a phone call, telling him or her that you want the shutdown ended and the debt ceiling lifted. Or you can tell them to "stay strong" on the shutdown and the debt ceiling, and accept the reality that your business and community will suffer and your investments will plunge in value. But at least you will have made your voice heard. In November 2014, all members of Congress and 1/3 of US Senators are up for election. If you don't think your representative contributed to your economic well being and the health of your family, vote for someone else in the primary and general election.

As investment managers, we're struggling. If we conclude that no deal will be done, we should be dumping stocks right now, triggering massive capital gains taxes to our clients but at least protecting some of their capital. If we think that a deal will be worked out, then we should stand pat - stocks are reasonably valued right now, and we'd like to buy more. So we're sitting here reading the news out of the New York Times, Washington Post, Politco, and RealClearPolitics trying to glean insight as to what will actually happy later this week. As of Columbus Day, we don't know.