Market Consequences of D.C. Dysfunction
Over the past few weeks, whether writing commentary or presenting to some of our clients, I have argued that the optimal strategy for investors was to largely ignore the D.C. dysfunction. Within the Q4 Playbook “Two Plus Two Equals Four,” I wrote the following:
- “I have long maintained that it is nearly impossible to make accurate investment decisions based upon potential fiscal policy measures in Washington. Rather, an investor’s best defense against D.C. dysfunction is a strong understanding of the market’s technical formation and heeding when those technicals suggest neutralizing risk.”
Now that a temporary resolution has been approved, let’s review the market consequences.
First, the pristine bullish nature of the S&P 500® Index (SPX) technical formation (Figure 1) remains intact despite the 4.8% correction from the September 18 intraday high of 1729.44 to the October 9 intraday low of 1646.47. The October 9 low was traced out slightly above the previous correction’s low at 1627.47 on August 28. That keeps the incredibly bullish series of now seven consecutive higher lows for each of the modest corrections since last November intact. The price action of the past 365 days underscores the importance of understanding the technical formation in order to manage risk.
Figure 1 S&P 500 Index (SPX), October 2012 to October 18, 2013
Second, since the Wednesday night resolution was agreed upon, both equities and surprisingly bonds are appreciating. Also, the value of the U.S. dollar is declining. Within my Q4 Playbook, I offered my expectation that better economic news here in the U.S. would continue to place selling pressure on bonds, lifting yields toward 3%, and appreciate the U.S. dollar. My expectation that continued better economic data would report here in the U.S. has not changed. However, the market consequence of the resolution to the D.C. dysfunction must be acknowledged. Tapering of the FOMC asset purchase program now looks less likely to begin before the next FOMC meeting on March 18-19, 2014. Previously I expected the potential for December tapering.
Upcoming FOMC meetings
- 2013: October 29-30; December 17-18
- 2014: January 28-29; March 18-19
The consequence of the D.C. resolution is that the FOMC will be hamstrung with concern for fiscal risk at the next three meetings. Little reported in the media, but very important, is that the resolution allows for the Treasury to utilize “extraordinary” measures to service obligations. Therefore, February 7 is not the deadline to raise the debt limit. More likely the allowance of extraordinary measures pushes the deadline back 30 to 45 days from February 7. Also, what makes the debt limit deadline a moving target is the amount of revenue the Treasury receives over the next few months. Strong tax receipts or payments similar to 2013 from the government-sponsored entities could push the date back even further.
I suspect the recent price action for the U.S. dollar (Figure 2) and 10-year U.S. Treasury (Figure 3) are the market consequences of the FOMC maintaining a holding pattern because of the longer runway to raise the debt limit.
Figure 2 U.S. Dollar Index, October 1, 2013 to October 18, 2013
Figure 3 U.S. 10-year Treasury, October 1, 2013 to October 18, 2013
Finally, the government shutdown has distorted our October capital markets calendar. Let’s refresh the calendar with some tentative dates for when the data will now be released.
- Monday, October 21
- September Existing Home Sales
- August Construction Spending
- September Industrial Production
- September Retail Sales
- August Factory Orders
- August Trade Balance
- September Building Permits
- September Housing Starts
- Tuesday, October 22
- September Nonfarm Payroll report
- Richmond Fed Manufacturing Index
- Thursday, October 24
- September New Home Sales
- Friday, October 25
- September Durable Goods