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Debt supercommittee: the Grinch that stole the Christmas stock rally

Europe’s continuing debt problemsand the inability of congressional leaders to reach an agreement on ways to cut the U.S. budget deficit are causing angst on Wall Street.

Europe’s continuing debt problemsand the inability of congressional leaders to reach an agreement on ways to cut the U.S. budget deficit are causing angst on Wall Street.

In a holiday-shortened week, many investors have decided the safest place for their money is someplace other than the stock market. Through midday Monday, the widely watched Dow Jones Industrial Average was off 300 points, the largest drop since Nov. 9. It finished the day down nearly 249 points.

Although it is no surprise that the so-called supercommittee of legislative leaders cannot reach an agreement on cutting $1.2 trillion from the budget over 10 years, some investors say it shows that partisan gridlock is still alive and well.

“It sets the mood,” says Mark Lamkin, CEO of Lamkin Wealth Management in Louisville, Ky. “The supercommittee is the grinch that stole the Christmas rally.”

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At the same time, European leaders are having difficulty reaching agreement on how to resolve their own debt problems. Germans are resisting the idea of some sort of pan-European issuance of bonds to replace those sold by individual countries. As a result, like the U.S., German policymakers are deadlocked.

Without some agreement, investors are focused on the weakest European countries.

“The concern continues to be about what to do about Italy and Greece,” says Sam Stovall, chief equity strategist for S&P Capital IQ in New York. “But, France is also a concern — if France is downgraded it would be a blow because it would in essence weaken one of the two pillars of Europe holding up the rest of it.”

However, some investors are already anticipating France’s credit will be dropped from AAA to AA by the rating agencies.

“It’s not a question of if but a question of when S&P downgrades France,” says Anthony Valeri, market strategist for LPL Financial in Los Angeles. “In all reality, back in August there was more cause to downgrade France than the U.S. because its debt-to-GDP [ratio] is worse than [that of] the U.S.”

Concern over the twin debt problems in the U.S. and Europe is so strong that investors are even ignoring some signs the U.S. economy is improving somewhat. On Monday, the National Association of Realtors reported existing home sales in October were up 1.4 percent — better than expected by Wall Street economists. However, home prices fell 4.7 percent year over year.

“The economic data was pretty good, and it did not have any impact at all,” says Valeri. “The market just ignored it.”

With the supercommittee unable to reach agreement, the law provides for automatic cuts in the federal budget starting in January 2013. However, many on Wall Street doubt this will actually happen.

“Congress is the one that enacted the penalty, and they can absolve themselves of the penalty,” says Stovall. “They still have 13-1/2 months to find a way out of this.”

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If Congress can’t find a solution, the possible cuts are of concern to investors because they might imply slower growth in the U.S. economy.

Across-the-board cuts starting in 2013 would reduce growth prospects, writes the brokerage house Canaccord in an analysis on Monday. The Vancouver-based firm expects the prospect of a steep cut in defense spending will spur Republicans to look for some kind of a deal while Democrats could be moved to act to prevent automatic cuts to Medicare.

Investors will be watching the debate closely with important ramifications for stock portfolios.

“With the advent of instantaneous news, now everyone is supersensitive — any time there is any bad news, the markets are reacting instantly,” says Frank Fantozzi, president of Planned Financial Services in Cleveland. “It’s amazing the amount of 2 percent to 3 percent swings in the averages.”

Ron Scherer is a staff writer for the Christian Science Monitor.