Buying the Shutdown

Global CIO Commentary by Scott Minerd

The U.S. government has shut down 17 times since 1976, but the current brinksmanship unfolding in Washington has the potential to last longer and have a more pronounced effect on markets than previous examples. Uncertainty over the drama on Capitol Hill is leading to higher volatility, but weakness in asset prices likely represents a buying opportunity. There are also favorable investment options outside of the United States, which will benefit from ongoing loose monetary conditions. There is little incentive for either the Democrats or Republicans to agree to a budget deal before October 17th, the forecasted date when the debt ceiling will need to be raised. Because the U.S. government is no longer spending, there is also a chance that this date could move further out on the horizon. The consensus estimate is that each week of the shutdown will reduce 4Q GDP by 25 basis points, meaning that fourth quarter growth could be up to 75 basis points lower by the time the shutdown is over. This is especially significant given that the expectation for 4Q GDP is only currently around 2.5 percent. Having said this, there is no risk that the U.S. Treasury will default in the coming weeks. Importantly, these political headwinds represent relatively isolated shocks to GDP, and their effects will likely recede fairly quickly given the torque in the underlying economy. Leading indicators show no sign of a recession, and a resurgence in output growth could still occur during the first half of 2014. There are a number of ways for investors to take advantage of the political dysfunction in Washington. Historically, equities rally when uncertainty over a shutdown begins to subside, so there is a case for buying stocks, which have fallen in seven out of the last nine sessions. Stifled growth also means that interest rates have further room to leg down, which is supportive of fixed income assets. Finally, there are abundant opportunities for excess returns outside of the U.S. right now, with both European and emerging market equities offering attractive valuations and improving fundamental outlooks.

Gauging the Impact of Government Shutdowns

There have been 17 U.S. federal government shutdowns since 1976. Excluding drastic moves in commodity prices and bond yields in the late 1970s, analysis of eight occasions during the past 30 years reveals that U.S. equities and the dollar tend to decline during shutdown periods, while gold and commodities tend to perform well. Shutdown periods do not appear to have a significant effect on 10-year Treasury yields. Historically, when a shutdown ends, market performance reverses quickly, and Treasury yields fall by an average of 22 basis points over the following 10 days. The economic impact of a shutdown largely depends on its duration. According to consensus estimates, a week-long shutdown would cut annualized GDP growth by approximately 25 basis points in the fourth quarter.

AVERAGE PERFORMANCE OF SELECTED ASSETS DURING GOVERNMENT SHUTDOWN PERIODS (1983 - PRESENT)

Source: Bloomberg, Guggenheim Investments. Data as of 9/30/2013

Economic Data Releases

U.S. Manufacturing Outlook Improves, While Housing and Consumer Confidence Disappoint

• The ISM manufacturing index showed a faster pace of expansion in September, rising to 56.2, the highest level since April 2011.
• The ADP private payroll report showed U.S. private sector employment increasing by 166,000 in September, with August data revised down to 159,000.
• Personal income increased 0.4% in August, in line with expectations. The increase was the largest since February.
• Pending home sales fell for a third straight month, down 1.6% in August. Three consecutive decreases have not occurred since the end of 2007.
• Initial jobless claims decreased to 305,000 for the week ended September 21. The four-week moving average is now at the lowest level since June 2007.
• Second quarter GDP growth remained at 2.5% in the final revision.
• University of Michigan consumer confidence revised up to 77.5 from 76.8 in the second September reading, but remained at a five-month low.
• The Dallas Fed manufacturing activity index jumped to 12.8 in September, the best reading since February 2012.
• The Chicago PMI increased for a third straight month, rising to 55.7 in September.

Inflation Continued to Decline in the Euro Zone Despite Better Economic Confidence

• Economic confidence in the euro zone improved to 96.9 in September, the fifth consecutive monthly gain and the highest level in over two years.
• Consumer prices in the euro zone continued to head lower in September, reaching 1.1% year-over-year, the lowest since February 2010.
• German retail sales rebounded in August after two months of decline, but were below expectations at 0.5%.
• Unemployment in Germany rose 25,000 in September, the largest monthly increase since 2009.
• The HSBC China Manufacturing PMI was revised down in the final estimate, showing manufacturing activity inched up from 50.1 to 50.2 in September.
• China’s official manufacturing PMI accelerated to 51.1, rising for a third consecutive month in September.
• Japan’s CPI rose a more-than-expected 0.9% year-over-year in August, the highest amount since November 2008. Core prices, however, remained in deflation at -0.1%.
• The Tankan index of large manufacturers in Japan rose to 12 in the third quarter survey, the best reading since 2007.
• Japanese industrial production fell more than expected in August, down 0.7%.
• Retail sales in Japan rose 0.9% in August after falling for two months.

VIDEOS AND PODCASTS

 

2022’s Upside: The Fed Has Put the Income Back in Fixed Income

Anne Walsh, Chief Investment Officer for Fixed Income at Guggenheim Investments, joined Asset TV to discuss macroeconomic conditions, risk, and relative value in the bond market.

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2022’s Upside: The Fed Has Put the Income Back in Fixed Income

 

Macro Markets Podcast Episode 26: Mortgage-Backed Securities, Structured Credit, Market Liquidity

Karthik Narayanan, Head of Securitized for Guggenheim Investments, discusses value in the residential mortgage-backed securities market and other ABS sectors. Anne Walsh, Chief Investment Officer for Fixed Income, answers a listener question on liquidity. Jerry Cai, an economist in our Macroeconomic and Investment Research Group, brings the latest on the labor picture and an update on China.

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Macro Markets Podcast: Episode #26