America’s Super Committee

Money managers remain undecided about what to do for the rest of the year. Their choices are obvious: Buy in the hopes of enhancing performance and earning their bonus, or lay low and go on holiday early. As economic news remains mixed, the end of the year promises to be exciting.

The markets remain skittish as the European sovereign-debt crisis continues to spread and many market participants are waiting for the next domino to fall. Hungary may be the next victim of the crisis, as many have realized that the country isn’t as strong as it was believed to be.

Consequently, the yield on Hungary’s 10-year bonds spiked to 8.78 percent at an auction today–61 basis points above the yields at the last auction two weeks prior. As a result, the Hungarian government announced that, “it has restarted talks with the International Monetary Fund.”

Meanwhile, on this side of the pond, the US Congress has set up a committee, better known as the “Super Committee,” that is tasked with trimming USD1.5 trillion in federal government spending over the next decade.

There’s a strong argument to be made that these savings can be achieved in a decade. But the Super Committee is supposed to have the bill ready for a vote by Nov. 23. Congress is supposed to vote on the bill, which is non-amendable, by Dec. 23. The bill is then supposed to be enacted by mid-January.   

Among the proposals that could materialize from the Super Committee are the withdrawal of US troops from Iraq and Afghanistan, decreasing itemized deductions and preferential tax treatment for wealthy Americans, cuts in agricultural subsidies, eliminating tax exemptions on the interest on municipal bonds and changing the Social Security cost of living index.

Given the gravity of the issue, it’s conceivable that Congress will take all the necessary steps to reach an agreement on this bill. But we’re less optimistic. The US is already in an election cycle and issues of debt, taxes and entitlements will be fertile ground for politicians as the campaign season picks up steam. However, if the Committee fails to reach an agreement, the current the plan calls for automatic across-the-board spending cuts of USD1.2 trillion over 10 years starting in January 2013.

Although this situation bears some resemblance to the August dispute over raising the US debt ceiling, the stakes are higher now and the outcome is more difficult to predict.

If the committee decides to delegate this task by ordering congressional committees to legislate these cuts at a later time, both sides of the aisle can avoid blame while kicking the can down the road. If this decision is pushed to next year, expect the debt ceiling to emerge as another topic of debate next year.

Troubles in the US and Europe support our view that Asia’s economies are among the strongest in the world. Although the region isn’t immune to the European sovereign-debt crisis, the region’s economies are well-positioned for a worst-case scenario. 

Furthermore, although the US economy will face daunting challenges for years to come, it’s in a stronger position to combat these problems than the EU, which paradoxically operates as a monetary union without a fiscal union.  

If the markets rally by the end of the year, expect a violent rally led by financials and technology stocks. Investors should position themselves accordingly. If the S&P 500 falls below 1,100, prepare for the worst. Anything above 1,300 signals a bull market. The territory in between these values is the playground for traders.