Government Shutdown Looms
On Thursday, the chances of a government shutdown increased, so stocks sold off again. This has always been a confusing issue for me because I think the government will shutdown, but I also think stocks shouldn’t selloff because of it. The conclusion that thought process brings me to is that the shutdown will be a buying opportunity because it causes little damage to the economy, but causes stocks to decline. In October 2013, there was a 16 day government shutdown and 4th quarter GDP growth was 4%. That shutdown caused the S&P 500 to fall 2% in the aftermath, before rising 1.8% when the stop gap bill was signed.
Many government employees in nonessential departments are put on furlough and then paid for the time after the stop gap is signed. Obviously, essential services aren’t affected. The media likes to make the shutdown into a big deal as it loves to make any story sound bigger than it is to get people watching. The countdown clocks are added in the corner for effect. The reality is a shutdown of 1 week won’t matter much the in long run. I’m discussing it because stocks are affected by it in the short run. The chart below shows the S&P 500 versus the search popularity of the term “government shutdown.” The market has kept on rallying despite the government tempting fate many times. Because the government is on its 4th potential stop gap in a row, the market is becoming desensitized. However, the risk still exists as stocks showed they care on Tuesday and Thursday.
The stock market is telling you the odds of a shutdown increased, but if you need the exact percentage, the PredictIt betting market shows there’s a 45% chance of a shutdown which is up 13% from the day before. The House is probably going to pass the stop gap measure because it doesn’t need Democratic support. However, it’s all showmanship until the Senate votes because it needs Democratic support because it needs 60 votes to pass. The news on Thursday was that President Trump said CHIP should be part of a long term solution not a short term extension. That goes against the bargaining situation which has CHIP in the short term solution as it is expected to be extended for 6 years. Since the White House supports the stop gap solution, this adds to the confusion. Since the situation is in flux, any comment can cause a shutdown.
The situation is very fluid, but as of Thursday there are 2 Republican Senators who will vote no on the plan. There are 3 Republican Senators who are undecided. There’s 1 Democratic Senator who will vote yes. There are 12 Democrats who are undecided and 36 who will vote no or are likely to vote no. That’s a very bad situation because it means in the perfect world (assuming John McCain can’t vote because of health reasons) there will be 60 votes. That’s assuming the uncertain Republicans and Democrats vote yes. At some point, whether it’s this week or a week into the shutdown, the stopgap will be passed as some will change their minds because of tweaks to the bill.
The worst case scenario would be if the Dems require a DACA solution before passing the bill. That’s a reasonable possibility because many of the GOP members agree with them. The issue is that’s a complex topic which was expected to take a couple more weeks to work on. That would mean the government shutdown could last a few weeks. While the 16 day shutdown in 2013 didn’t do damage to the economy, I doubt anyone wants to tempt fate with a longer shutdown.
Now Is The Best Time To Buy Stocks
I don’t want this article to sound too negative since the market looks like it will have a great year. One misnomer is that the yield curve is a negative catalyst for the stock market. The reality is it is good news until it inverts. As you can see from the chart below, since 1976 when the yield curve is in between being flat and positive 50 basis points, the average forward returns are 13.4% per year. The fact that the Fed is raising rates means the economy is doing well. The only negative is when the Fed gets too hawkish. That won’t happen this year if the Fed’s QE unwind remains at the same pace and it raises rates 75 basis points. The only monetary policy risk factor is if the Fed decides to surprise the market with an extra 25 basis point hike to prevent the market from turning into a bubble. It depends on what type of Fed chair Powell becomes. While some investors assume Powell will go on with the policy path laid out for him, watching his decisions and reading his statements will help us determine if he’d ever do a surprise hike or accelerate the QE unwind.
The chart below is the conventional wisdom on rate hikes. When you buy stocks after the first rate hike and sell them after the last rate hike, you have done well. Obviously, I can’t refute the effectiveness of this strategy. However, I think it’s oversimplified. It’s not that easy to determine when the Fed will stop raising rates. After the last rate hike, it sometimes looks like the Fed will raise rates, but then the economy falters causing it to cease the contractionary policy.
Instead of using this chart, you should look at which policies are contractionary, and which are expansionary. I think the Fed is far from done with rate hikes because it’s policy is still expansionary. The indicators line up now, but the differentiating factor will be in 2019 or 2020 when the analysis tells you the policy is contractionary, but the chart below doesn’t say when the Fed will be done hiking. There’s no need to try to perfectly time the market. Simply raise cash each month the Fed is in a contractionary stance. I define this as when the Fed funds rate is above the core CPI. Keep in mind, the Fed funds rate often gets 2% above core CPI before recessions occur, so don’t sell too much too soon.
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