Shutdown Looms, But Retail Goes All In On Stocks

Shutdown Drama Dominates The Headlines

The latest news on the shutdown potential is President Trump met with Senate Minority Leader Chuck Schumer. It will be a close call if there’s a shutdown because they said they made some progress, but there was no explicit deal. This meeting is a good sign that something will get done soon either by Friday or next week. The odds of a shutdown have whipsawed from 30%-60% throughout the day on PredictIt. The latest I’ve seen is a 48% chance of a shutdown. One interesting factor which I didn’t realize is that the CHIP funding for some states will run out on January 19th. The CHIP program gives health care coverage to 9 million children in low income households that make too much money to qualify for Medicaid. The timing of the direct effect to these children will determine how much emphasis there is on getting a deal done before the deadline. I know it sounds heartless, but this is one of the issues in negotiation.

The battleground of this shutdown is DACA. It’s a weird disagreement that also makes sense. It’s all about game theory. The reason why I say it’s a weird disagreement is because the GOP and the Dems both mostly agree that there needs to be a fix to the situation, meaning DACA can’t expire on March 5th. It’s expiration would force 800,000 people to face potential deportation. The main disagreement is on the timing of that debate. The GOP says it needs a few more weeks to get the DACA agreement done, but the Dems are pressing ahead because they want to use the government shutdown as leverage to get a better deal.

I’m not sure of the specifics of what the Dems are pulling for with DACA, but part of it is just making sure some solution is agreed upon by the deadline. Some extreme Republicans don’t want anything to be passed. The GOP promised Republican Senator Flake a DACA fix when it was passing the previous stopgap budget, but it hasn’t delivered. The reason why I say it makes sense that the situation is weird is because if the GOP was directly against whatever the Democrats were proposing then the Dems wouldn’t bother using the leverage they have. The Dems know there’s an opening. They want to stand their ground on the Friday vote to get a DACA solution in the next few weeks.

The chart below shows where the biggest effect of the government shutdown will be felt. As you can see, the negative comments in consumer sentiment surveys increased when there was a shutdown in 2013. Essentially, this means almost nothing changes. The consumers don’t actually stop shopping like they would if there was a spike in oil prices or a recession. They just complain about the situation to a survey giver. The other interesting part of this chart is how explicitly optimistic respondents are. Keep in mind, both measurements are of respondents adding comments without being provoked. As I mentioned, Q4 GDP in 2013 was 4.0%; it doesn’t seem like these negative comments transfer to spending declines.

The charts below show examples of the trading in the previous government shutdowns. As I mentioned, the 2013 shutdown led to a 2% correction in the S&P 500. The 1990s shutdown also led to a minimal decline. The biggest risk to stocks is a shutdown encourages profit taking which then ends the momentum the market has built up. There’s no question the fundamentals are strong, but rising at a 4% per month pace shows the market is running on hot air. Therefore, the momentum ending is a bigger risk than the shutdown itself.

The FOMO Trade Is On

The latest update on the fear of missing out trade is $58 billion was put into ETFs and mutual funds in the past 4 weeks which is the biggest inflow ever as you can see from the chart below. This is in nominal terms, so the record isn’t too strong, but it shows retail investors are getting involved in the market. The fact that retail investors were spurning the market in the beginning of this bull market was a positive sign. Retail investors becoming more optimistic isn’t a death knell for the market, but it means the bull run is close to ending. It’s also disconcerting that the retail investors are responding to the recent positive action. Essentially, the retail investors are driving stocks higher and then the higher prices are encouraging them to put more money to work. That’s a great cycle when it’s working in the market’s favor, but retail investors are fickle. If their only reason for buying stocks is a rally which is increasing at an unsustainable pace, then they might sell out of stocks if a selloff occurs.

The market just passed the 1990s record for the longest streak without a 5% correction as the current streak is 395 days. I know the fundamentals behind earnings and the economy look good, but I’m nervous seeing the longest streak without a 3% and 5% selloff and what is about to be the 2nd longest expansion since 1854. As you can see from the chart below, the survey asking investors if they think stocks will rise in the next year is at an all-time high. It only goes back to 2001; unfortunately, we can’t see the data from the 1990s. However, the Investors Intelligence poll goes back to 1986. It shows the bulls outnumber the bears by the most ever. 66.7% of investors are bullish and 12.7% are bearish. The American Association of Independent Investors shows 54.1% of retail investors are bullish and 21.4% are bearish. To finish up on the point of the FOMO trade gaining popularity, the one week total inflow into equities was $23.9 billion which is the 7th best week ever. U.S. equities got $6.4 billion, Japan got $3.6 billion, emerging markets received $3.5 billion, and Europe received $2.2 billion. It makes sense to diversify out of U.S. stocks because it has the highest relative CAPE ratio (2 standard deviations above normal).

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