Believe it or not, the stock market is currently following the historical pattern of actually rising during a federal government shutdown, something it has done more often than not in the past as well. I had pointed out in this column two weeks ago that investors should remember that “during the Clinton-era shutdowns of November and December 1995, the S&P actually rose by 1.3 percent and 0.1 percent respectively” and that hopefully history will repeat itself this time.
Guess what? As of Monday’s close, the S&P has risen by 1.7 percent since the shutdown started on October 1. One would have to assume that market participants believe that both the budget issues that caused the partial shutdown in the first place and the more important debt-ceiling limit that will be reached this Thursday will be successfully resolved, even if such a settlement involves kicking the can down the road, so to speak.
After all of the back-and-forth blame games between the president and the Republican leadership in the House of Representatives, the outlines for an agreement came into focus late on Monday afternoon. The debt limit will now be raised by enough to meet the country’s borrowing needs through February 7, 2014, the government would be funded through January 15, 2014, and there will be a House-Senate budget conference that will attempt to deal with these issues which will be convened by December 15 of this year. The across-the-board sequester cuts that took place in March would be kept in place.
The past two weeks had started out with markets selling off in anticipation of a reduction in G.D.P. to the tune of 0.1 percent for each week of the government shutdown. But by the end of each week, stocks had recovered on the belief that the consequences of a default for financial markets and world economies would be too grave to consider. Two weeks ago, the S&P managed to end the week with a loss of only one point, while both the Nasdaq and Russell 2000 Index of small stocks were able to eke out nominal gains. Only the Dow performed poorly with a weekly loss of 186 points. Last week, after another horrible start with consecutive triple-digit Dow declines, things stabilized as the week moved ahead and last Thursday saw the markets put in their best one-day performance since the first trading day of 2013 back in early January, with the Dow ahead by 323 points. As a result, the Dow ended the week higher by over one percent, the S&P gained 0.7 percent while the Nasdaq declined by 0.4 percent due to some profit taking in its high-flying components which have performed incredibly well this year, and this group includes FB, NFLX and TSLA, among others.
The market has become so obsessed with the political drama in Washington, D.C. that it has basically forgotten about economic reports that have not been released due to the government shutdown. These reports include the most important monthly release of all, namely, the September jobs report. In addition, August factory orders and construction spending, September retail sales and the August trade deficit have been put on hold. And this week September C.P.I. and September housing starts will have to wait for the government to re-open before being released as well.
The other big issue that investors face at this time of the year is the heart of the third-quarter earnings season, with expectations for profit growth already having been pared back to 1.8 percent. For the fourth quarter, there is the hope that earnings will advance by around nine percent, and it will be instructive to see how companies project these results in light of the anxiety that the shutdown has caused.
Of the 30 S&P companies that have reported so far, things are off to a less than auspicious start as only 55 percent of them have topped earnings forecasts, compared to the historical average of 63 percent that traditionally beat the numbers.
The credit markets have reacted to the potential of a government default later this week by raising the yield on the shorter-term maturities that come due at the various deadline times related to the debt ceiling. For instance, the yield on Treasury bills that mature on October 17 had gotten as high as .51 percent on fears of a default before settling back down to .20 percent as hopes for a settlement grew. This optimism can be seen by the fact that Treasury bills that come due on November 29 are only yielding .17 percent, suggesting that investors believe that the debt ceiling issue should be resolved by that time.
It would be too demoralizing to reiterate all that has gone on during this latest government fiasco, but as of Monday evening, senators said that they were closing in on a deal that would reopen the government and push back a possible default for several months, although there are still many obstacles to a settlement as the Thursday deadline draws closer.
This was ahead of a meeting between the president and vice president and the top leaders of both the House and Senate. But any deal would have to win approval in the House, where the tea party faction of the Republican Party has insisted that any continued government funding must include measures to undercut the Affordable Care Act, and this is a non-starter for Democrats.
It is unclear whether Congress can meet the November 1 deadline when the Treasury would not have enough tax revenue coming in to cover interest payments, retirement benefits and other obligations. Even if Republicans and Democrats in the Senate can meet that deadline, hard-liners might be able to delay a vote for several days using Senate rules. And then there is the tea party faction in the House that could try to delay things as well because they do not want to make concessions to the president.
If the crisis cannot be resolved by Thursday, the Treasury will be forced to pay a higher interest rate on new debt that has to be issued. Banks and money market funds are already shunning some government securities that are often used as collateral for short-term loans and to facilitate many other transactions. China, which is the largest holder of U.S. debt at $1.3 trillion, said that it was time for a “de-Americanized world.”
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
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