After a pair of stopgap funding measures, Washington is getting
ready to play hardball on the government budget. Both sides have
drawn clear lines in the sand, and April 8 looms as the day when
government buildings could be officially locked, government
employees told to stay home and all non-essential services could
grind to a halt. Whether the shutdown lasts a few days or a few
weeks, your portfolio will feel the impact. And you need to start
Too many uncertainties
Investors crave certainty. Yet this is an especially murky time.
Key questions need to be asked. Will Japan'seconomy go into
recession as its government tackles the economic effect of the
current crisis? How will the Middle East play out (and what will
happen to oil prices)? Will more European economies need a bailout?
How will the U.S. markets handle the end of the Federal Reserve's
second round of quantitative easing (QE2)? [I also wrote earlier
about how investors' record levels of borrowing onmargin could
bring the market crashing down...
The market has climbed a "wall of worry" in recent quarters, but
the wall keeps getting higher. A government shutdown, though, is
the most tangible of any of these threats and you need to assume a
worst-case scenario -- simply because that's what the large herd of
investors do in times of uncertainty.
What it means
The timing of a shutdown could not be worse -- from an investor's
perspective -- as it is scheduled to start just a few days before
first-quarterearnings season begins. You can expect any company
that derives a significant chunk of revenue from Uncle Sam to take
a cautious view, anticipating that a prolonged shutdown would keep
them from coming even close to second-quarter forecasts.
In the defense sector, this includes names like
Northrop Grumman (NYSE:
General Dynamics (NYSE:
. Major projects such as shipbuilding have already been slowed by
the temporary funding measures, and these defense contractors have
warned that any more stoppages would lead to missed deadlines and,
eventually, cost over-runs.
In the technology sector, companies such as
Computer Sciences (NYSE:
Cisco Systems (Nasdaq:
have always relied on the government for anywhere between 5% to 30%
of revenue. Even the auto makers rely on the government for a
decent portion of their fleet sales.
There are many small and
firms that have grown nicely in the past decade on the heels of an
increasing amount of outsourced government work. The list is far
too long to mention, but this is a good time to go over all of your
holdings to see how much of their business is derived from
This time is different
As the April 8 deadline looms, you may see reports in the financial
press that former Republican House Speaker Newt Gingrich's late
1995 showdown with then-President Bill Clinton, which led to two
work stoppages, barely nicked the market. That's because Gingrich
was generally seen to be playing a weak hand and could not hold out
for long. Indeed those two stoppages lasted only one and three
weeks, respectively, and the GOP eventually blinked. That was
partially due to the fact that the U.S. budget gap was already
shrinking and headed for surpluses on its own within a few years.
Yet the current crisis is far more significant, and major changes
are likely to occur to achieve an outcome. On one side, there is a
push to make major spending cuts that would
a smaller government. Deficits are indeed odious, but they have
been a stimulating force for the
as the government puts more money into the economy than it takes
On the other side is the view that taxes will need to be raised as
part of any long-term budget fix. Here again, the recent era of tax
cuts has been a real plus for the stock market, as they have put
more money into the hands of businesses and consumers. So no matter
the outcome -- less spending, higher taxes, or both -- this has to
be seen as a near-term negative for the economy and the market
(even though it is essential that we close the budget gap).
This is not about balancing a budget; it's about eventually paying
down massive debt. The only way to do that is to run budget
surpluses, as happened in the late 1990s. That era of surpluses
helped fuel a robust economic expansion (and an eventual market
bubble) as interest rates came tumbling down. Yet the size of the
deficit is now so much larger, rates are already at historic lows
and the remedies will be so much more severe that a happy repeat of
the late 1990s is no sure thing.
Action to Take -->
OK, off with the Chicken Little hat. The sky is not falling. The
U.S. economy has proven remarkably resilient to past crises, and in
a few months, the possible government work stoppage could be a
distant memory. But the next few weeks promise to bring plenty of
stomach churning as consumers and companies alike watch the
government possibly grind to a halt. That mood would hardly be a
positive backdrop for stocks.
-- David Sterman
P.S. -- Few investors realize that a 20-year energy agreement
between the United States and Russia is about to expire. This deal
supplies 10% of America's electricity. As broke as our government
is, the situation is so serious that President Obama is asking for
$36 billion to avert this crisis. And Republicans support him.
Here's what's going on…
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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