(MoneyWatch) "It coulda' been worse" was the explanation for last week's rally. Sure, Congress missed the technical "fiscal cliff" deadline of midnight 12/31/12 and yes, lawmakers delayed by two months the hard choices on government spending cuts, but all in all, the perceived disaster scenario of no deal was averted and investors were happy. Their pleasure was on display with a smart 4.6 percent gain in the S&P 500 to a five-year closing high. The broad index is now within just 99 points of nominal all-time high of 1,565, reached way back in October 2007, and the Russell 2000 index of small cap stocks hit an all-time record close of 879.
If this sounds too good to be true, it just may be. Investors consistently suffer from short-term mood swings. The newly-found optimism is a welcome break from the Scrooge-like tone seen just before the deal, but just as fast as you can say "debt ceiling," the tune may change. You remember the debt ceiling, right? It was the July 2011 Congressional debate over increasing the nation's borrowing limit, which spawned the automatic government spending cuts or "sequestration." Although lawmakers did reach a deal to raise the debt ceiling by the Aug. 2, 2011, deadline, Standard & Poor's noted that the process was not impressed and downgraded U.S. debt from AAA to AA+. U.S. stocks tumbled in the following weeks.
Fast forward 17 months and all of the sudden, investors could find themselves with a nasty case of déja vu, all over again. On New Year's Eve day, the Treasury Department notified Congress that the country hit its legal borrowing limit of $16.394 trillion. The Treasury can delay until late February or March the prospect of a full-blown debt crisis, which means that Congress has about 60 days to negotiate both the spending cuts and the debt ceiling.
Oh sure, President Barack Obama said "I will not compromise over ... whether or not Congress should pay the tab for a bill they've already racked up," but what's the alternative? The president will be forced to ask lawmakers to raise the debt ceiling and if House Republicans adhere to the view that their colleague Rep. Dave Camp of Michigan espoused ("We must identify responsible ways to tackle Washington's wasteful spending"), a battle and subsequent compromise will ensue.
Remember that without a deal to raise the debt ceiling, here's what's likely to occur:
- U.S. government bondholders will be paid
- Social Security checks could be delayed
- Non-essential government services will be shut-down
- Non-essential government workers will be furloughed
- U.S. economy would grind to a halt, increasing the odds for a recession
- Stocks will plunge
So enjoy the rally while it's here, but prepare for volatility over the next 60 days! The fun could begin this week, as the unofficial start to fourth-quarter earnings season kicks off on Tuesday, when Alcoa reports.
-- DJIA: 13,435, up 3.8 percent on week, up 2.5 percent on year
-- S&P 500: 1,466, up 4.6 percent on week, up 2.8 percent on year
-- NASDAQ: 3,101, up 4.8 percent on week, up 2.7 percent on year
-- February crude oil: $93.09, up 2.5 percent
-- February gold: $1,648.90, down 0.4 percent on week (6th weekly loss)
-- AAA nat'l average price for gallon of regular das: $3.30
THE WEEK AHEAD:
7:30 NFIB Small Business Optimism Index
3:00 Consumer Credit
8:30 Weekly Claims
10:00 Job Openings and Labor Turnover Survey (JOLTS)
8:30 International Trade
8:30 Import and Export Prices
2:00 Treasury Budget