Week Ahead: Why This Government Shut Down Threat Is Different
As a rule, it is best if traders and investors essentially ignore politics. Time and again the market has proven that political “crises” are, in economic terms and in the grand scheme of things, complete non-events. That is part of the beauty of the American economy. It is strong enough to not just survive but even thrive despite what at times seem like the best efforts of politicians.
Even when the government commits economic suicide and shuts down due to the failure to fund itself, the market usually just shrugs and continues to focus on more important things.
This week we face that prospect again, but this time, if we do see another shut down, the reaction could easily be different.
The last time a funding gap occurred was in 2013, but you would be hard pressed to determine when that happened by looking at the above chart for the S&P 500 during the second half of that year.
The actual shut down started on September 30th and ended on October 17th. The market lost some ground in anticipation of the event, but by mid-October had recovered, and actually added around 50 points during the closure. That may suggest that investors should not be worried that we face the prospect of a repeat this week, but the current threat comes in very different circumstances.
Firstly, the political situation itself is different. In 2013 the shut down came as the result of opposition to the President’s agenda by the opposing party. It could easily be argued that that was simply a case of an opposition doing its job and applying checks and balances to the executive branch of government. An opposition is there to oppose, but the market worked on the assumption that there would be an agreement at some point and that there would be no long term damage.
What is different this time is that the Presidency, the House and the Senate are all Republican controlled. That has resulted in certain policy expectations being priced into stocks, but if the government fails in the most basic task of funding itself in those circumstances, some of those assumptions and expectations would have to be questioned.
Following on the failure of healthcare reform, it would indicate a basic inability to govern effectively, and for a market based on policy assumptions, that could prove to be a big concern.
That worry could still easily be overcome over time if it weren’t for another consideration: valuation. Back in 2013, stocks were essentially at the beginning of a long, slow recovery from a devastating recession. Earnings multiples were still well below average and the Fed were doing everything possible to inflate asset prices.
With zero interest rates and money being pumped into the system every day, historically undervalued stocks had nowhere to go but up.
Incidentally, if you think that is just 20/20 hindsight I said as much in 2013, as you can see here.
Back then we had a market that was rising despite political and fiscal concerns, and as the result of undervaluation and accommodative monetary policy.
What we have now is the exact opposite.
The market is convinced that there will be political and fiscal stimulus for stocks while the Fed is raising rates and talking about reducing the size of their balance sheet, or actually taking money out of the system.
History would suggest that this week will once again see some brinkmanship and a lot of posturing, but that an agreement of some kind will be reached before any real economic damage is done. That is the way these things tend to play out.
This time, however, with a market that has risen around twenty percent based on the assumption that the White House and Congress would actually help rather than hurt business, there is a real danger that if an agreement is not reached that failure will be seen to have seriously negative implications for the future. This time is different, and traders and investors should be paying close attention to the political machinations this week.