Blog : Penny Stock Week: The 500-year Storm

by Ed Zwirn on October 14th, 2013

Investors ought to get ready for another volatile ride this week, with the stock market executing large swings - as it did last week - based on the latest hopeful and/or discouraging perceptions of whether and when the debt and budget showdown will sort themselves out.

The 30 Dow Jones Industrial Average blue chip stocks closed Friday at 15,237.11 up 1.1% from the prior week's 15,072.58. But the market was extremely volatile, with the gap between DJIA highs and lows at 517.87.

Most of this ground was covered on Thursday and Friday, when the blue chip index rallied 434.13, or 2.9%, on the strength of hints by political leaders.

But the more speculative end of the stock market, including tech stocks and penny stocks, had been hit harder by the recent selloff and so had more ground to cover.

These stocks managed to claw back. The NASDAQ rose 3.1% over the two-day rally to finish down 0.4% for the week and the penny stock-rich Russell 2000 spiked 3.9% to finish the week up 0.5%.

This wide trading pattern will probably continue, at least through Thursday, the date U.S. Treasury officials say they will exhaust their ability to borrow to finance government operations and pay obligations.

Although there has been some anecdotal evidence of some selling of Treasury paper, with flows last week out of U.S. money market funds at their highest level since April, according to EPFR Global, there has been no big selloff of government debt. The yield on the 10-year Treasury stood at 2.68% as of Friday, after holding steady all last week.

It would be this number that would be the first one to watch in the event the debt ceiling gets breached, or serious fear erupts that this may happen. Selling pressure on U.S. debt, which is unprecedented, would force this yield up as the bonds get sold at a deep discount.

The open secret on Wall Street is that this scenario is so unlikely and at the same time so potentially catastrophic that none of the major investors are hedging themselves against a possible U.S. debt default, with parties ranging from the U.S. Federal Reserve Bank, the Chinese government, just about every pension fund, big banks and the Social Security Trust Fund poised to take hits on their holdings should the unthinkable happen.

But 500-year storms hardly ever happen. The likelihood is that worldwide financial markets will breathe a sigh of relief by Friday morning, after the debt ceiling gets raised, for however short a time. Beyond that, the devil will lie in the details, after we get a chance to figure out the mess our politicians have left us in going forward.