In a holiday-shortened week, many investors have decided the safest place for their money is someplace other than the stock market. Through the first half of trading, the widely watched Dow Jones Industrial Average is off 300 points, the largest drop since Nov. 9.
Although it is no surprise that the so-called "super committee" 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.
[Editor's note: The original version of this story reported that the super committee would need to find $1.5 trillion from the budget over 10 years.]
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 US, 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 US because its debt to GDP [ratio] is worse than [that of] the US.”
Concern over the twin debt problems in the US and Europe is so strong that investors are even ignoring some signs the US 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 Mr. Valeri. “The market just ignored it.”
If the super committee is unable to reach agreement by the end of Monday, 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 Mr. Stovall. “They still have 13-1/2 months to find a way out of this.”
If Congress can’t find a solution, the possible cuts are of concern to investors because they might imply slower growth in the US 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.”