In last week’s column, I discussed how the market was moving higher in anticipation of some sort of settlement of both the partial federal government shutdown and the raising of the debt ceiling. And sure enough, equities “correctly” anticipated that an agreement would be reached, as Congress last Wednesday approved an 11th-hour deal to end the shutdown and pull the world’s largest economy back from the brink of a potentially historic debt default that could have brought about worldwide financial calamity.
Ending weeks of political brinkmanship, the president signed the spending measure after Republicans gave up their efforts to force changes to the Affordable Care Act. This down-to-the-wire deal unfortunately only offers a temporary fix and really does not resolve the underlying issues of spending and deficits that divide the two political parties, as it funds the government until January 15 and raises the debt ceiling until February 7. This means it is possible that we will see another budget fight and shutdown once again early next year as well.
With the deadlock broken just a day before the Treasury said that it would have exhausted its ability to borrow additional funds, the stock market exploded once again to the upside last Wednesday with the Dow Jones Industrial Average higher by over 200 points, as the S&P, Russell 2000 Index of small stocks, the mid-cap indexes and the Dow Jones Transportation Average all reached new best-ever levels.
The Democratic-led Senate overwhelmingly passed the measure by 81 to 18 and the Republican- controlled House followed with a 285 to 144 approval as well. In addition to raising the federal debt limit, a House-Senate bipartisan commission was created to try to come up with long-term deficit reduction ideas that would have to be approved by the full Congress. Their work has to be completed by December 13, which is not going to be an easy task.
The agreement did include some income verification procedures for people seeking subsidies under the Affordable Care Act, but this was the only “victory” that Republicans could claim because they were not able to delay or dismantle the health-care act or make any major changes, such as the elimination of a medical device tax.
This political dysfunction has worried creditors such as China, which is the largest foreign holder of U.S. debt, at $1.3 trillion, and which said that they would seek to diversify into other currencies as this fiasco has hurt our country’s reputation as a safe haven and stable financial center. For instance, Fitch Ratings warned last Tuesday that it might cut the U.S. sovereign credit rating from AAA, citing the political brinkmanship over raising the debt ceiling. It could also hurt consumer spending as 800,000 federal workers were temporarily furloughed.
Hopefully, now that the political crisis has been put to rest for the time being, investors can once again concentrate on what they usually do in late October, namely, to analyze the third-quarter earnings reports that are being released every day. So far they have made for decent reading as, of the 108 S&P companies that have reported their numbers, the earnings advance has been 4.5 percent with the final projection now for a gain of 2.5 percent over last year. Revenues have increased by 2 percent and of the companies that have reported, 71 percent have beaten the earnings forecast, which is better than the traditional 63 percent that usually do better, while 54 percent have been ahead on the revenue side, which is less than the 61 percent average beat in this area.
There have been a number of spectacular advances after certain companies reported their numbers, with GOOG now joining PCLN as the second-ever S&P company to trade in four digits. In addition, Dow components AXP, GE and VZ have done well on their earnings, but there have also been some bad reactions as well, with Dow components GS, IBM and UNH all taking downside beatings after their reports. Some of the high-fliers have continued to fly further into the stratosphere after their earnings, with CMG and NFLX two prime examples of stocks that have not looked back for the time being.
Investors are also going to be hit with a plethora of economic reports at the present time, as several of them were delayed because of the government shutdown and the most important one of all, namely the September jobs report, was finally released yesterday after having been delayed from October 4. This one will be discussed in more detail in next week’s column. In addition to the jobs report, we will finally get August construction spending and September durable goods, in addition to the ones that will be released on time such as the August trade deficit, the September import price index and the final October U. of Michigan Consumer Sentiment Survey.
It is estimated that the shutdown will result in a subtraction of 0.5 percent from the fourth-quarter G.D.P., or $24 billion in lost production. Because of this slowdown, it is now widely assumed that the Federal Reserve will have no choice but to delay the start into next year of the long-awaited tapering of its current $85 billion a month in bond purchases whose purpose is to stimulate the economy by keeping interest rates at record low levels.
This has resulted not only in yields on the 10-year Treasury Note declining back to the lower end of their recent trading range at 2.59 percent, but it also resulted in yields on short-term T-bills returning back down to negligible interest rates close to zero from as much as .50 percent as nervous holders of this paper bailed out of those obligations that were to come due last Thursday, the day of the potential debt default, in addition to bills that were to mature next month.
While all of the political drama in Washington, D.C. has been commanding the headlines, let it be pointed out that crude oil prices have been declining to their lowest levels in three months. These cheaper gasoline prices are estimated to put an additional $40 billion of purchasing power into the hands of consumers with the approach of the holiday shopping season. This bit of good news might alleviate some of the anxiety that the political fiasco in Washington, D.C. has brought about in terms of potential year-end spending.
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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