A Question Of Politics

10/7/2013


Even during football season, politics may be this country's most popular spectator sport.

While Americans thrive on headlines, political issues tend to have less of an effect on the stock market than individual investors expect. Of course, if political problems expand to the point that they could affect the economy, and thus the results of American companies, the market effects may last awhile. With those facts in mind, let's analyze the risk of four political land mines.

Q What does the government shutdown mean for investors?

A This issue could affect the average American if the shutdown drags on. But for now, it's more smoke than fire.

On Oct. 1, the government partially shut down, cutting many services and preparing to furlough more than 800,000 workers. Senate Democrats rejected a bill passed by the Republican-controlled House that would have continued funding the government through mid-December. The bill would also have delayed implementation of the Affordable Care Act, or Obamacare, for a year, which explains Democratic opposition. As of press time Wednesday, the government remained shut down. However, negotiations continue, and a compromise could come at any time. Few of the 17 government shutdowns since 1977 have lasted more than three days, with the longest lasting 21 days.

Since the Republicans see the budget impasse as their best chance to stop Obamacare and the Democrats believe Republicans will take the brunt of the public's blame for an extended shutdown, neither side seems ready to back down. Some moderate Republicans have criticized their party's hard-line stance on tying the spending authorization to repeal of the Affordable Care Act, but so far the GOP wall remains firm.

The word "shutdown" overstates the situation. Mandatory expenditures will continue, and essential employees will report to work as usual. Most individuals will feel the impact of the shutdown mostly through a reduction in services such as customer interaction at federal agencies or staffing at national parks.

Previous shutdowns have had little long-term effect on financial markets. Unless the shutdown lingers for a number of weeks — with more and more services cut — it shouldn't crimp the operations of most companies beyond delayed payments to federal contractors.

The biggest risk is that uncertainty over the budget will make both businesses and consumers more skittish. Consumer and business confidence have declined in recent weeks, and in a survey CEOs acknowledged that the budget impasse has driven them to reduce hiring.

Q Is the fight over the federal government's debt ceiling connected to the budget battle?

A Not directly. But the same combatants will fight both wars, arguing over the same issues.

The government will reach its maximum borrowing limit in the middle of this month, and the Treasury can probably balance on the head of a pin for another month before technically defaulting on U.S. debt.

For a government that spends more than it brings in, the debt ceiling is more than a paper tiger. Congress must take action, either by raising the debt ceiling or reducing spending — thus the indirect connection to the budget battle.

Democrats are expected to support the president's request for additional borrowing, but Republicans have vowed to demand concessions on taxes and spending. The specter of a partisan spending struggle potentially occurring during a government shutdown could pressure stocks.

In 2011, a last-minute deal avoided a default on U.S. government debt but prompted a Standard & Poor's downgrade of the U.S. Treasury to AA+ from AAA. Yet yields on 10-year Treasury notes actually fell on news of the downgrade. Stocks staggered for a couple months after the debt deal, then began an uptrend that continues today.

Nearly all experts expect lawmakers to dodge the default bullet again. But the potential combination of a government shutdown and a debate over the debt ceiling could make for a chaotic October.

The biggest risk here isn't from a debt default, but from the spending cuts needed to avoid a default if Republicans dig in their heels. Would we see the level of economic sluggishness that accompanied fiscal austerity in Europe? Doubtful. But massive, quickly enacted cuts could impact corporate profits.

Q When will the Fed upset the applecart by shutting off the easy-money spigot?

A After the Federal Reserve decided not to taper its bond purchases of $85 billion per month in September — a development that surprised the market, in part because the Fed has been telegraphing a cutback for nearly half a year — stocks moved to new highs.

Through its actions, the Fed showed that it doesn't fear inflation as much as it longs to boost growth, an attitude friendly to stocks. But the euphoria didn't linger long. By the next Fed meeting at the end of this month, investors may start to see good news as bad, since continued economic advances might spur the Fed to cut back on its bond buying.

The problem is that since the September surprise, nobody knows when the Fed will taper — only that it will happen. Central bankers said they wanted more evidence that the economic recovery has staying power before they'll slow the pace of bond purchases. Such a stance opens the door for criticism and second-guessing with every piece of economic data.

The Fed's September meeting minutes, slated for release Oct. 9, could provide more specifics about what the Fed wants to see before it starts the tapering process. After watching bond yields mostly rise since the Fed first brought up the topic of tapering in May, investors would welcome some clarity. While yields have declined since the Fed's nonaction last month, the 10-year Treasury still yields 2.6%, up from 1.9% in mid-May. And there's another wild card; at some point President Obama will nominate Fed Chairman Ben Bernanke's successor.

Barring another surprise — like a dark-horse candidate, a decision to hold off tapering until next spring, or a specific comment about the economy that spooks investors — near-term Fed action shouldn't do much beyond sparking a short-term market move.

Q  Should we worry about the war in Syria?

A This war isn't new, as protests against the current regime began in March 2011. Not until the U.S. concluded in June 2013 that the government had used chemical weapons, with President Obama authorizing military support for the rebels, did the conflict directly affect financial markets.

Per-barrel oil prices rose more than $15 in the next two-and-a-half months, while the S&P 500 Index rose 1%. Then, on Aug. 27, the day Obama said he would consider a strike against Syria, oil prices rose 3.1% and the S&P 500 Index fell 1.6% — notable moves but not exactly disasters. Since that date, fears of U.S. involvement in the conflict have faded, with oil prices dipping 6% and the S&P 500 Index rising 4%.

The United Nations Security Council has resolved to destroy the Syrian government's chemical-weapons arsenal without acting directly against al-Assad, who has the support of Russia. Syria, while denying that it used chemical weapons, has said it will cooperate with the U.N. Tension in the Middle East could help keep oil prices high for the foreseeable future. But barring direct U.S. intervention or a widening in the conflict beyond Syria, headlines related to the uprising should only have a transitory effect on stocks.


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