Budget showdown, is there trouble ahead?

By |2018-01-22T19:00:19+00:00January 22nd, 2018|Uncategorized|

To date, investors have nShutdownot priced in a protracted shutdown as is evidenced by the continuation of our run-up in prices. The run-up in prices that we have witnessed over the past 52-weeks has left the S&P with a gain of 26.31% and a P/E of 23.41. Over the same period, the Dow Industrials have risen a stunning 34.65% while currently sporting a P/E of 21.61.

Let’s face it, markets should hypothetically be due for a pause in their march higher if not a constructive pullback of sorts. They “should” hypothetically, but will they?

Credits markets are reflecting the same bullish sentiment. The closely watched 10-year T-Note, for example, yields 2.64%. Friday’s 10-year closing yield was a 52-week high. It could be argued that, in recent months, interest rates across the board have risen at a rate faster than can be justified given the current economic landscape. There “should” be a degree of modest retracement, but will it materialize?

The VIX

The complacency currently priced into markets is a concern. Volatility, as measured by the CBOE Volatility Index (VIX), closed on Friday at 11.27. Though well above the lows of the first week of January (9.15), it is still not reflecting any meaningful concern on the part of investors.

This Federal Government shutdown is the most potentially disruptive theme that investors will have faced over the past 52-weeks as it may last longer than investors are anticipating. It could potentially take a degree of “risk-off” mentality off the table and as a result, take some momentum out of the equity market melt-up. It could also drive risk aversion into credit markets, slow rising interest rates and trigger yield curve inversion. As a result, we could potentially see a meaningful tick higher in the VIX. The reason is simple. The divide in Washington is philosophical. The Democrat and Republican parties have a fundamental difference over a policy first put into place by President Trump’s predecessor, President Obama– a policy that President Trump is attempting to redefine in ways that are in direct opposition to his predecessor and the leadership of the Democrat party. The differences in approach have the potential of not only lasting longer than previous budget battles but also have the additional potential of accumulating with them tangentially related issues.

In the event the shutdown becomes a protracted philosophical battle, there could be an impact for investors. The last Federal Government shutdown trimmed 0.3% off Q4 GDP in 2013. That shutdown was, to a degree, also a philosophical battle in that the GOP was attempting to defund the Affordable Care Act. Ironically that landmark legislation is being currently dismantled in stages by the current administration and GOP incrementally and in stages. That shutdown lasted 16 days and cost the US economy roughly 6.6 million in lost work days according to Investors Business Daily. In the event this shutdown lasts longer than the one we had in 2013, it could well act to slow the rate of GDP expansion in a meaningful way.

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