First, let’s examine the prospects of any cuts at all coming from the supercommittee. We checked in with Hanover Investment Group, of suburban Washington, which monitors fiscal conditions at the national, state, and municipal levels. Hanover’s managers handicap the supercommittee this way:
A 60 percent probability of agreement on a puny $400 billion to $600 billion of cuts and small revenue increases. Congress passes that recommendation. Obama signs it. Stocks slump.
Or a 30 percent probability the supercommittee fails to reach agreement, and stocks sell off briskly through the end of the year.
Or a 10 percent probability of a $1 trillion package that pleases markets and shows that American lawmakers can make the politically and financially painful cuts necessary to deal with the growing national debt.
“If the supercommittee ‘goes big’ and agrees on $2 trillion to $4 trillion of deficit reduction over 10 years, it will get an A-plus from investors, and markets will soar,” Hanover adds. “Investors would finally have proof of Congress’ ability to tackle our burgeoning debt, and fears of crisis-driven tax increases and spending cuts would abate. Fiscal stimulus would be back on the table as an option to help economic recovery.”
If the committee cuts $1 trillion to $2 trillion, Hanover predicts, Congress will get a B-plus, and investors will still be contented.
But a mere $500 billion to $1 trillion reduction, “sprinkled with gimmicks,” would disappoint investors, result in a C or a D grade for the committee, and markets will stagnate or weaken.
Failure to reach any agreement would be seen as a complete failure, and the market reaction would resemble the bombshell that greeted the prospects of a Greek referendum on austerity measures. It would bring major near-term fiscal adjustments, and because sudden adjustments hurt company earnings and balance sheets, stocks would plummet.
So there you have it, at least from one market-watcher. If you’re looking to trade on the Nov. 23 supercommittee deadline, you can do so via exchange-traded funds. For example, Standard & Poor’s breaks down its S&P 500 index into sectors, with an exchange-traded fund for each sector: consumer discretionary (symbol: XLY), consumer staples (XLP), energy (XLE), financials (XLF), health care (XLV), industrials (XLI), technology (XLK), materials (XLB), and utilities (XLU).
Of the sectors most likely to be hurt by a trillion-dollar deficit cut are health-care companies – dependent, as they are, on Medicare and Medicaid dollars – and defense companies, part of the industrials sector.
What about the bond market?
Last time the United States faced a budget deadlock, back in August, U.S. sovereign bonds were downgraded from a historic AAA rating. And without further spending cuts, there is the possibility that other ratings agencies would downgrade the United States by the end of this year.
“There is a fairly good chance” of another downgrade, Zane Brown, fixed-income strategist at Lord Abbett & Co., told Bloomberg television Friday. “We had hopes the supercommittee would strike a grand deal. Now, the rumors we are hearing is there is no agreement at all. That kind of additional squabbling will spark responses [from] ratings agencies.”
Bondholders of U.S. debt might not enjoy the unexpected rally that came when the first downgrade happened. At that time, investors rushed to the very assets – U.S. Treasuries – that had just recently been downgraded. Frankly, U.S. Treasuries were the best house in a bad neighborhood.
“This time around,” Brown added, “you’re likely to see Treasuries fall somewhat in price and rise somewhat in yield.”