October 1, 2013

All eyes on Washington

Government shuts down. However unlikely this outcome may have seemed, the US government furloughed workers and partially stopped operating on 1 October. As the media counted down the hours to this date, Congress had negotiated in three key areas:
  • changes to long-term entitlement costs (Medicare)
  • delays to implementing the Affordable Care Act
  • concessions on defense spending
Neither party wanted to be blamed for visas not being issued, parks being closed or bonds not being paid. Yet the politics were complicated by a power vacuum in the Republican House, disgruntled Democrats in the Senate and a president who has been adamant about not conceding on long- or short-term health care spending, which all raised the odds that an impasse would lead to a shutdown.

The key thing to remember is that the government has shut down in the past—in fact, 18 times over the 20-year period from 1976 to 1996—and the markets have not melted down in response. During many of those episodes, markets were choppy, but on average the S&P 500® Index was higher three months after the onset of a government shutdown.

Debt ceiling looms. Over the years, Congress has passed laws to limit its own spending by setting triggers on the mountain of debt owed by the federal government. A new trigger point will be reached in the next few weeks as spending continues to outpace the revenue stream.

What we expect

Past behavior is prelude to future behavior. Our view is that Congress is likely to "kick the can down the road." Other recent Washington crises, such as the 2012 tax increases, have resulted in something akin to "defer, demur and deflect." The rhetoric gets heated and the press covers the possibilities of crisis, but in the end, a compromise is reached and the worst case—default—is averted.

A Grand Bargain is very unlikely. The political will to settle the differences and put the US on a different debt trajectory for the next 20 years is not there this time. A grand victory is often suggested and would be a fantastic short-term elixir for the stock market, but don’t put money on it.

The markets don’t like uncertainty but aren't likely to disintegrate. Based on historical experience, what matters more to investors are cash flows and earnings supported by fundamentals.


Washington's battles are important. Citizens watch, take notes and form impressions to act on in the next election. But the markets care about growth, inflation and value.

Right now, steady US economic growth isn't threatened by recession or collapse. Growth outside the US is beginning to improve. Corporations, especially those that make up the major stock indices, are making money and being responsible about debt and spending. Consumers in the US and emerging market countries are spending, but not irresponsibly, nor with much debt, and no major bubbles cloud the picture.

Inflation is not an immediate threat as excess capacity exists around the world, wages remain subdued, oil prices are falling and productivity is holding up well. The basics are in decent—albeit not spectacular—shape. Once the spookiness of the October debt ceiling fades, the market is likely to rise in line with earnings and cash flows, which still look strong.

No forecasts can be guaranteed.

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.


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