Monthly Letter December 2012
The markets and the economy seem to be dodging the bullets in the form of debt ceilings, budgets and other deadlines by an ever thinner margin each time. The fiscal cliff in the US was averted much later and the deal was less extensive than we had expected. We also get the feeling that the market has learned that the political game craves a late settling of these differences just to show the voters that you got the best possible deal (we commented on this in our November letter). Even though it is an exaggeration to say that the market was sanguine about the fiscal cliff, most investors had the same view that Madrague had; the Democrats and the Republicans would find middle ground and reach a deal. The tax issue was negotiated and settled, but the sequester (the automatic spending cuts) was merely postponed. So in the next few weeks we will have yet more political wrangling about the sequester, but this time combined with the debt ceiling. The politicians have solidified renewed interest from the markets if you are to look at it from a positive standpoint.
If the politicians push the boundaries even further we might be looking at a total deadlock in the upcoming discussions. However, this is not our base case scenario. We have previously mentioned that we currently believe option volatility looks cheap. S&P short term options trade below 14%. This implies less than 1 percentage point move a day.