Can Markets Remain Resilient in Light of Political Dysfunction?
SPECIAL EDITION
Equities were mixed again last week, and the markets remain focused on the budget impasse in Washington, D.C., after the second week of the partial government shutdown. The S&P 500 closed the week in positive territory, increasing 0.8%.1 It is hard to ignore headlines and market volatility, but the real issues for markets are the debt ceiling debate and third quarter corporate earnings announcements.
Reopening Would Only Be the Beginning
As has been the case with the 17 prior occurrences of a U.S. government shutdown, we do not anticipate a lasting impact on the economy or markets. In the near term, however, there are several areas that need to be addressed.
U.S. Government Default is Not Likely
Our thesis is that the risk of a debt default by the United States is very close to zero. The threat of default on U.S. debt has motivated lawmakers to begin conversations, the outcomes of which are uncertain and unpredictable.
Political Posturing is Just That
Democrats and Republicans want to gain an advantage before the November 2014 elections. Polls indicate the Republicans will likely retain or increase their 18 seat lead in the House of Representatives and capture three or four additional seats in the Senate, a few seats short of control. Democrats are trying to create a plan that might reverse the debate and enable them to capture the House. In other words, we are witnessing U.S. political turmoil with potentially no change to the status quo.
Compromise Appears to be the Future Outcome
During last week, both parties may have realized they’ll agree to disagree. The health of the U.S. economy, financial markets and investors depends on passing a resolution that allows us to raise the debt ceiling and reopen the government. Republicans have stopped trying to block or postpone Obamacare because the White House has been clear that this is not a valid proposition. Alternative possibilities include softening or repealing the medical device tax, some entitlement reform or selective tax reform.
The Equity Bull Market Continues
Political themes aside, market fundamentals remain intact, and the S&P 500 is
up around 19% for the year. But bull markets don’t go straight up — the S&P 500 has been trading between roughly 1,550 and 1,700 over the last several months1 as U.S. equities digest strong gains. We maintain our view that in order to advance, equities will need visibility on stronger revenue and earnings growth.
A Delay of Certainty May Cause Uncertainty
We hope the consternation in Washington does not cause overall improving conditions to fade, reminding us of the muddle-through economic environment. Any delay in resolution may take its toll on investor confidence and could have eventual economic implications because of the fragility of the economic recovery.
The Big Picture
Despite continued political noise in Washington, we are convinced a fiscal agreement should allow the U.S. economy to stay on a gradually improving trend as consumer and business spending advances at a moderate pace. There have been signs in the last month of some improvement in leading economic indicators, both in the U.S. and abroad. We see setbacks as opportunities to add to favored positions given our conviction that ultimately a compromise will be reached.
Around the world, we hear less bad news out of Europe, Japan has begun to recover and we’re continuing to see some stabilization in China. We anticipate that improved discussions in Washington should support risk assets and thus reflect a potentially negative outcome for gold and Treasuries.
No outlook is complete without mentioning the obvious risks. A temporary deal is being discussed, but final fiscal resolution is further out in the future. Economic performance is tenuous, and we await further GDP growth, stronger earnings and improved expectations for the future.
IN OTHER NEWS
Fed Chairman Nominee: After a long and rancorous decision process, current Vice Chair Janet Yellen was selected as the logical choice for the next Chair of the Federal Reserve Board. Janet Yellen is arguably the most experienced incoming Chair in the central bank’s history and will enable continuity of policy.
Fed Tapering: The partial government shutdown should not cause damage to the economy (unless the timing becomes prolonged). But any potential for slightly lower growth and/or a disruption in economic data will probably cause the Fed to postpone tapering until at least December and more likely into 2014.
1 Source: Morningstar Direct, as of 10/11/13.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non- investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.
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