The Endgames of Autumn

 | Sep 04, 2013 | 1:00 PM EDT  | Comments
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Stock quotes in this article:

rtn

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lmt

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noc

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ctsh

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infy

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wit

My favorite economist, Dr. Ed Yardeni, recently observed that the equity markets have more than doubled since early 2009 by evading worst-case expectations in one "endgame" scenario after another.

Almost as soon as Dr. Ed noted that this fall's endgame worries, numerous as they are, might not be sufficiently scary or disheartening to continue the trend, the White House: 1) began signaling its intentions to launch a strike on Syria for its use of chemical weapons against its citizenry, then 2) walked back the timing of any such strike by announcing that it will ask for Congress' approval first.

What's an investor to think?

My partners and I assume that both the House and Senate will eventually approve such a strike, but only in late September or early October and after a close and contentious vote. There will no doubt be a limit on the administration's time allowance for such operations, if not weapons or forces authorized for use in the region -- perhaps green-lighting what the White House has been inclined to do all along, i.e., use cruise missiles and other standoff weapons to degrade the Syrian government's military capabilities.

Raytheon (RTN) remains the most leveraged to a serious shootout, although, like fellow defense primes Lockheed Martin (LMT) and Northrop Grumman (NOC), Raytheon is already up more than 40% this year. And the entire defense group could be at risk to another round of budget cuts if a dust-up fails to materialize or if Congress fails to stop a second $54 billion sequestration on Oct. 1.

In any event, I believe that the president's calculating decision to engage Congress will suck the political oxygen (and headlines) away from other "endgame" stories involving everything from government funding after Sept. 30 and debt-ceiling extension in October-November to immigration reform and Hill Democrats' opposition to the president's evolving choice to head the Federal Reserve board, Larry Summers.

To repeat my earlier comments in this space, my partners and I are betting against immigration reform -- that's a contrarian view that's gaining more respect each week. House Republicans are showing no panic in their deliberate speed toward passing several limited bills instead of anything close to the Senate's "Gang of Eight" measure. They know they have to fix a brand-identification problem with Hispanic voters, but not perhaps until 2016, and certainly not at the expense of a primary challenge (from another Republican) next spring.

Meanwhile, if I'm right, IT outsourcers such as Cognizant (CTSH), Infosys (INFY) and Wipro (WIT) could be winners (as negative provisions in the Senate bill fall to the cutting-room floor). And consider another play, with heretofore positive expectations for tax preparer H&R Block (HRB) likely to be reversed as well.

As for the Fed call, I expect President Obama, later this month, to nominate former National Economic Council Director Larry Summers to replace Federal Reserve Board Chairman Ben Bernanke. I also expect Summers to win Senate confirmation, albeit by an underwhelming margin, perhaps reminiscent of the historically low 70 votes that Bernanke garnered for a second term in early 2010.

Media reports have focused on how a Summers-led Fed might prove a monetary policy wild card. As the New York Times' Binyamin Applebaum has noted, Summers, in a 2012 thesis co-authored with UC-Berkley economist Brad DeLong, has questioned the "efficaciousness" of quantitative easing and also raised concerns about attendant asset bubbles.

In any event, by far the most important reason President Obama may pick Summers is that he knows him well and trusts him. And a choice of Summers would show that the White House now sees the mix of skills and loyalty Summers would bring to the table in managing the Fed's "dismount" from the quantitative-easing, net-zero-interest-rate policy high wire as well worth any short-term economic risks or political brushback that it might engender.

The markets have arguably already begun to adjust to the notion of a Summers Fed less wedded to quantitative easing after January. Specifically, the Dow and S&P 500 have lost 4.7% and 3.1% respectively since The Wall Street Journal on July 18 reported that 70% of economists anticipated that Fed Vice Chairman Janet Yellen might get the nod, ensuring a continuation of Bernanke's current policies. Since then, Yellen's prospects have been seen as plummeting -- all as the bond markets, also eyeing Fed tapering, have driven up the 10-year Treasury yield from 2.56% to a high of 2.90% on Aug. 22, before more recently receding to 2.78%.

I believe that further signals will be sent that Summers will continue to hew to dovish monetary policies designed to curb unemployment as well as inflation. This should soften political resistance from labor groups, just as other September-October narratives regarding Syria and fiscal policy face-offs compete for daily headlines (also diluting the negative attention paid to criticisms of Summers' past statements at Harvard and the pro-deregulation role he played during the Clinton era).

As a sidebar, I'd expect preoccupation with Syria in both the House and Senate to suck the political oxygen out of the congressional discussion, helping to boost party loyalty or otherwise curb defections against an Obama call for his choice at the Fed. Others disagree, however, and believe that the president's need to secure Syria votes from wavering Democrats will only compound his difficulty in seeking to charm or goad them into embracing Summers, whom many have formally opposed. We shall see.

I also believe the high-stakes national security card now being played by the White House will delay any suspense over the fiscal 2014 budget and debt ceiling, perhaps past late September and into the window of time between Halloween (Oct. 31) and Thanksgiving (Nov. 26). What that spells for the next two months -- which have typically produced among the weakest returns and scariest volatility in any given year -- seems hardly worth donning a mask over. But it could nevertheless merit caution.

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