Political Bickering Continues

The futures were tame this morning until the U.S. Treasury issued a statement warning of "a large, adverse, and persistent financial shock" if the U.S. were to default on its debt obligations. The ominous statement did little to break the stalemate between the major political parties. From Bloomberg:

Obama said today there is only "one way out" of the shutdown -- for House Speaker John Boehner to allow a vote on a stopgap spending bill without conditions. The speaker urged Democrats to negotiate a settlement, blaming them for causing the stoppage. The S&P 500 fell as much as 1.4 percent before trimming its decline. The paring accelerated after Boehner's spokesman said the speaker would not let the government default on its debt. Boehner "has always said that the United States will not default on its debt, but if we're going to raise the debt limit, we need to deal with the drivers of our debt and deficits," spokesman Michael Steel said.

Bullish Conviction Is Being Beaten Down

On October 2 we covered observable evidence of slowing economic conviction. The constant bickering between politicians in Washington, D.C. is pushing the stock market to the edge. Our market model uses numerous methods to track investors' tolerance for risk, including the 22-week moving average for the Dow Jones Industrial Average. The chart below shows the Dow before, during, and after the 2011 downgrade of U.S. debt. All things being equal, good things tend to happen when price is above the 22-week and the slope of the 22-week is positive (point A). When the Dow is below the 22-week moving average and the slope rolls over, the odds of bad things happening increase (point B).

Bulls and Bears Duke It Out

What does the 22-week moving average tell us about the market's tolerance for more shenanigans in our nation's capital? As shown in the chart below, the Dow is below the 22-week and the slope of the moving average is flat, meaning the margin of error is razor thin.

Services Below Expectations

We have been writing for months about the need for the economy to take the baton from the Fed, an institution that wants to give their money printers a much needed rest. With today's ISM number, the money printers may have to postpone their vacations. From Bloomberg:

Data today showed service industries in the U.S. expanded in September at a slower pace than forecast, indicating a pause in the momentum of the biggest part of the economy before the federal government closed. The Institute for Supply Management's non-manufacturing index fell to 54.4 in September from 58.6 the prior month. The median forecast in a Bloomberg survey called for a drop to 57. The figure includes industries that range from utilities and retail to health care, housing and finance and make up almost 90 percent of the economy.

Glass Half Full Approach

Is it all gloom and doom? No, not yet. The Dow is the worst of the three major U.S. indexes from a bullish conviction perspective. The chart below shows the S&P 500's 22-week moving average before, during, and after the 2011 waterfall plunge in stocks.

The same chart is much healthier today, which means the market's economic conviction is stronger than it was in early August 2011.

Tech Stocks: Then and Now

The snapshot below was taken in 2011, where bullish economic conviction was showing observable signs of deterioration (slope goes flat, then turns down).

The present day portrait of the battle between the bulls and bears shows more confidence in the technology sector's ability to deliver on their earnings promises.

Investment Implications - Concerned, But Patient

We have taken two incremental steps away from stocks, which tells you something about the observable deterioration that has occurred in the market's pricing mechanism. However, the market is not yet suggesting it is time to swap our stocks (VTI) for bonds or inverse stock (SH) ETFs. The Treasury ETF (TLT) has beaten the S&P 500 ETF (SPY) by only 0.21% this week, which does not make a convincing case for bonds (at least yet). We will keep an open mind and make further adjustments as the political ping pong continues.