Drama in Washington weighed on stocks this week. Through the close Friday, the Dow fell 1.2%, the S&P was slightly lower by 0.1%, while the Nasdaq notched a gain of 0.7%. We thought gold would have risen on the shutdown in Washington, but instead moved lower by 2.1%. Oil moved higher, rising 0.9% to $104 per barrel. The international oil, Brent, closed at $108.46.
Source: Yahoo Finance
It’s no surprise that the government shutdown was the topic of the week. The threat of a closure greeted us Monday morning and the two sides were no closer to a deal by the weeks end.
In reality, this shutdown has little impact on the economy. JPMorgan economists analyzed past shutdowns and found that each week the government is closed results in a 0.12% hit to GDP (although it’s often forgotten that the money spent by the government is pulled from the private sector, which could have been used in other more productive ways). Federal employees are likely to get back pay, anyway, so the impact will be even less than advertised. Plus they receive a vacation paid for by the taxpayers.
This did give a lack of confidence to the markets, though, as stocks sold off much of the week. Stocks did rise strongly on the day of the shutdown, but this was likely more due to it being the first of the month and quarter, when new money tends to flow into the market.
The big concern is further down the road with the debt ceiling. A divided government on this issue will probably result in an even larger reaction in the markets.
On the subject of the debt ceiling, we are already hearing threats of default if the ceiling is not raised. The rhetoric has reached a new level, where even the highest members of this administration are warning the markets of an approaching calamity (LINK). We can’t say we’ve ever heard a sitting President issue threats like this to investors before.
A default on the debt is not possible. If the debt ceiling is not raised, the Treasury can prioritize payments so that creditors can get paid. If a default were to occur, it will have been entirely self-inflicted and highly irresponsible.
A casualty of the shutdown was several economic data reports provided by the government. In particular, the important monthly jobs report was not released Friday morning due to the closure. This report is a key metric for the Fed and their stimulus program, since an improving employment picture would indicate less stimulus needed. Therefore, it looks even less likely that the Fed will announce a reduction on the stimulus at its meeting later this month.
A substitute to the government jobs report was the employment figures from data processor ADP. It uses a different methodology, but give or take it tends to resemble the government jobs report, so this report received the attention this week. It showed a gain of 166,000 jobs, a weak number, and the last two months figures were revised lower. The employment picture appears remains poor.
On the positive side, other economic reports this week were mostly positive. Business activity in the southern and mid-west regions showed signs of growth. Manufacturing in the U.S. expanded over the last month to the highest level since April, 2011. However, the service sector saw a significant slowing over the last month.
Next Week
Next week looks to be fairly quiet for economic data. We will get reports on the trade balance, retail sales, and inflation at the producer level. There will again be several regional Fed presidents making speeches, so that might give us some additional insight to the future of the stimulus program.
The real issue moving markets next week will again be Washington. Movement closer to or further from a resolution – especially on the debt ceiling – will be the big driver of the markets.
Investment Strategy
We’re still cautious on the markets due to the drama surrounding Washington, though it is highly likely that stocks will jump if a resolution is announced. However, the debt ceiling fight is just up the road and we could see another volatile period at that time (unless this issue is resolved during the current shutdown).
In the longer run we see reason for caution, too. The momentum of this bull market is slowing as stock prices become more expensive. Additionally, even though the Fed is still active in their stimulus measures and are unlikely to pull back soon, they are doing operations to pull some liquidity out of the economy. They cite these operations simply as tests, but there has to be a reason for the testing.
While we are hesitant to add any new money into stock market indexes at this point, we would instead look for undervalued individual names to invest in. Fundamental analysis tells us how good a company is while the technical (chart) side gives us a good idea of when to buy. We would avoid stocks in sectors with a strong correlation to the broader stock market and interest rates. Our timeframe is shorter (looking out a couple weeks or months), so we can keep one foot out the door in case the market turns abruptly.
Gold continues to have a rocky road. It may move higher if a continuation in stimulus is expected, but eventually that stimulus will be removed. If the market begins to anticipate a pullback, gold could move lower again like it did the last several weeks. It’s good for a hedge here, but caution is warranted.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth seems to be weighing on commodity prices here, so buying on the dips may work with a longer time horizon.
As for bonds, this area continues to receive much attention as yields keep rising (so prices are falling). A short position (bet on the decline in prices) has done well recently but serves only as a nice hedge. It isn’t intended to be a loner term investment.
TIPs have performed poorly recently, but are an important hedge as we still expect inflation to increase down the road. Municipal bonds are in the same boat, but will work for the right client. We keep a longer term focus with these investments.
Finally, in international stocks, we are still not interested in developed markets and not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
In reality, this shutdown has little impact on the economy. JPMorgan economists analyzed past shutdowns and found that each week the government is closed results in a 0.12% hit to GDP (although it’s often forgotten that the money spent by the government is pulled from the private sector, which could have been used in other more productive ways). Federal employees are likely to get back pay, anyway, so the impact will be even less than advertised. Plus they receive a vacation paid for by the taxpayers.
This did give a lack of confidence to the markets, though, as stocks sold off much of the week. Stocks did rise strongly on the day of the shutdown, but this was likely more due to it being the first of the month and quarter, when new money tends to flow into the market.
The big concern is further down the road with the debt ceiling. A divided government on this issue will probably result in an even larger reaction in the markets.
On the subject of the debt ceiling, we are already hearing threats of default if the ceiling is not raised. The rhetoric has reached a new level, where even the highest members of this administration are warning the markets of an approaching calamity (LINK). We can’t say we’ve ever heard a sitting President issue threats like this to investors before.
A default on the debt is not possible. If the debt ceiling is not raised, the Treasury can prioritize payments so that creditors can get paid. If a default were to occur, it will have been entirely self-inflicted and highly irresponsible.
A casualty of the shutdown was several economic data reports provided by the government. In particular, the important monthly jobs report was not released Friday morning due to the closure. This report is a key metric for the Fed and their stimulus program, since an improving employment picture would indicate less stimulus needed. Therefore, it looks even less likely that the Fed will announce a reduction on the stimulus at its meeting later this month.
A substitute to the government jobs report was the employment figures from data processor ADP. It uses a different methodology, but give or take it tends to resemble the government jobs report, so this report received the attention this week. It showed a gain of 166,000 jobs, a weak number, and the last two months figures were revised lower. The employment picture appears remains poor.
On the positive side, other economic reports this week were mostly positive. Business activity in the southern and mid-west regions showed signs of growth. Manufacturing in the U.S. expanded over the last month to the highest level since April, 2011. However, the service sector saw a significant slowing over the last month.
Next Week
Next week looks to be fairly quiet for economic data. We will get reports on the trade balance, retail sales, and inflation at the producer level. There will again be several regional Fed presidents making speeches, so that might give us some additional insight to the future of the stimulus program.
The real issue moving markets next week will again be Washington. Movement closer to or further from a resolution – especially on the debt ceiling – will be the big driver of the markets.
Investment Strategy
We’re still cautious on the markets due to the drama surrounding Washington, though it is highly likely that stocks will jump if a resolution is announced. However, the debt ceiling fight is just up the road and we could see another volatile period at that time (unless this issue is resolved during the current shutdown).
In the longer run we see reason for caution, too. The momentum of this bull market is slowing as stock prices become more expensive. Additionally, even though the Fed is still active in their stimulus measures and are unlikely to pull back soon, they are doing operations to pull some liquidity out of the economy. They cite these operations simply as tests, but there has to be a reason for the testing.
While we are hesitant to add any new money into stock market indexes at this point, we would instead look for undervalued individual names to invest in. Fundamental analysis tells us how good a company is while the technical (chart) side gives us a good idea of when to buy. We would avoid stocks in sectors with a strong correlation to the broader stock market and interest rates. Our timeframe is shorter (looking out a couple weeks or months), so we can keep one foot out the door in case the market turns abruptly.
Gold continues to have a rocky road. It may move higher if a continuation in stimulus is expected, but eventually that stimulus will be removed. If the market begins to anticipate a pullback, gold could move lower again like it did the last several weeks. It’s good for a hedge here, but caution is warranted.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth seems to be weighing on commodity prices here, so buying on the dips may work with a longer time horizon.
As for bonds, this area continues to receive much attention as yields keep rising (so prices are falling). A short position (bet on the decline in prices) has done well recently but serves only as a nice hedge. It isn’t intended to be a loner term investment.
TIPs have performed poorly recently, but are an important hedge as we still expect inflation to increase down the road. Municipal bonds are in the same boat, but will work for the right client. We keep a longer term focus with these investments.
Finally, in international stocks, we are still not interested in developed markets and not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
