Washington Driving the Market
We are once again in a situation where investors find themselves more concerned with what is occurring in Washington than what is occurring in the US economy. It started last week when the Federal Reserve decided to continue its bond buying to stimulate the economy instead of implementing its “tapering” program that it outlined in June. The markets’ initial reaction was very positive with new all-time highs being reached. But, after a week of the news settling in, the gains have been completed erased. The general assessment is that the Fed will begin reducing its bond buying this year. From a macro perspective, if the Fed has to continue to purchasing bonds at the current level, it is actually a negative indicator for the economy and the stock market. Our view has consistently been that although it may cause some short-term volatility, the equity markets have mostly priced in the Fed “tapering” and it is beneficial to have the Fed begin to remove its stimulus from the economy, especially at this point in the business cycle.
The second Washington based issue that is currently upon us is the approval of federal appropriation bills that need to be passed by the end of September in order to keep the federal government running. Based on the legislation that the House of Representatives passed last week, which defunds the Affordable Care Act, we will most certainly go up to the deadline of September 30th before a compromise is made to keep the federal government running. The federal government has not shutdown in recent years but in the past 40 years it has shutdown several times including six times between 1977 and 1980, and nine times between 1981 and 1996. On average the shutdowns have ranged from 3 – 21 days.
If the government were to shutdown, many essential services such as Social Security and Medicare administration would continue but many other agencies such as the Federal Parks and Courts would close and approximately 800,000 people would be furloughed. The economic impact of a government shutdown would certainly be negative and it would put downward pressure on stocks but using history as a guide, the effects would probably be short-term in nature. Also, given the publics’ frustration with the possibility of a government shutdown, there is a very good chance for a compromise to occur in Congress to avoid a shutdown.
The final Washington based issue is the need for Congress to raise the debt ceiling by mid-October. For this issue, the stakes are much higher to have a resolution before the mid-October deadline. As was evident during the debt ceiling discussion of 2011, pushing the deadline on this issue can have a much more dramatic impact on the markets and the overall confidence in the US economy. We may also see Congress push a compromise to the very last hour in this situation but after 2011, Congressional leaders understand there is limited value in pushing the debate over the brink.
With issues such as these, it is best not trying to outsmart or time the markets because it is easy to get it wrong. With that said, when we approach a potentially volatility time, it is best to evaluate your long-term asset allocation now versus when the market becomes more volatile.