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All Eyes Remain on Washington

The Dow Jones Industrial Average (Dow) lost 1.22%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM)  rose 0.06%, the Standard & Poor’s 500® Index (S&P 500)  declined by 0.07% and the NASDAQ Composite Index (NASDAQ) tacked on ...

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October 07, 2013    |    By Mike Schwager

Performance for Week Ending 10/4/13:

The Dow Jones Industrial Average (Dow) lost 1.22%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM)  rose 0.06%, the Standard & Poor’s 500® Index (S&P 500)  declined by 0.07% and the NASDAQ Composite Index (NASDAQ) tacked on 0.69%. Sector breadth was negative as 7 of the 10 S&P sector groups finished lower. The Consumer Staples (-0.98%) led the way lower followed by Industrials (-0.91%) and Utilities (-0.65%). Healthcare was the best performing sector, closing up 0.94%.

 

Index* Closing Price 10/4/2013 Percentage Change for Week Ending 10/4/2013 Year-to-Date Percentage Change Through 10/4/2013

Dow

15072.58

-1.22%

+15.02%

Wilshire 5000

17676.85

+0.06%

+19.77%

S&P 500

1690.50

-0.07%

+18.53%

NASDAQ

3807.75

+0.69%

+26.10%

*See below for Index Definitions
 

MARKET OBSERVATIONS: 9/30/13 - 10/4/13

The major market indices finished the week mixed reflecting uncertainty surrounding the budget negotiations in Washington. The failure to come to terms by midnight Monday resulted in a partial shutdown of the government and politicians do not appear close to finding resolve. The concern is not so much over the government shutdown but how this impacts the exponentially more important decision to raise the debt limit by October 17. A failure to do so would result in a technical default and would likely send the equity markets reeling, interest rates higher, and potentially push the U.S. economy back into recession.

Despite this potential doomsday scenario, investors, for the most part, have remained fairly complacent. The CBOE Volatility Index (aka the VIX), although off its recent lows, remains far from panic levels. In addition, the American Association of Individual Investors (AAII) reported that bullish sentiment in the most recent week rose to 37.8% from 36.05% - the first uptick in 4 weeks. The lackadaisical attitude (“whistling past the graveyard”) likely reflects “crisis fatigue” and the fact that investors have become conditioned to expect an eleventh hour solution from politicians. Winston Churchill said it best – I paraphrase: “In the end politicians will do the right thing, but not before all alternatives are exhausted.”

While I believe that politicians will ultimately “blink” to avoid a default, the problem is that this view is overwhelmingly shared by most everyone, with many economists believing there is “zero” chance that politicians would let this situation play out. That leads to the question -- what if everyone is wrong? I don’t believe most investors are positioned for an adverse outcome, suggesting things could get very ugly in the event of a negative outcome. Using the debt ceiling debate during the summer of 2011 as a guideline,  the S&P 500 plunged by over 18% in a relatively short period of time. 

The fallout from the shutdown has also resulted in the delay of key economic reports.  Last week construction spending data was delayed as was the much anticipated August Payroll report. Remember, we are in an environment where the Federal Reserve (Fed) has adopted a “data dependent” game plan in deciding when to start paring back their bond buying program. The hiccup in data likely means any decision to taper would likely come later (December meeting) than sooner (October meeting). That’s the good news. The potential bad news is that investors rely heavily on the ongoing flow of economic data to confirm their investment outlooks and views on the economy. In other words, investors will suddenly be flying blind, an event that in and of itself could unnerve some investors.

Earnings season also kicks off in the upcoming week. It will be interesting to hear what companies have to say about the fiscal situation and how it could potentially impact current quarter results. Last week United Technologies said up to 5k employees could be furloughed due to the shutdown. The National Retail Federation said a prolonged government shutdown could hurt consumer sentiment and harm the holiday selling season. Boeing warned that deliveries of some jets could be postponed, as the FAA officials who need to approve the planes before they're handed over to customers have been furloughed.

Obviously news flow out of Washington will be the primary driver of the markets in the near term. The good news is that the stalemate in Washington will likely come to a head relatively soon which could result in a relief rally as the cloud of uncertainty is removed – stay tuned.

 

The Week Ahead
Third-quarter earnings season kicks off in earnest during the upcoming week with 10 members of the S&P 500 scheduled to report. The floodgates will open during the following two weeks with 221 scheduled to report during the two week window. According to Bloomberg, analysts are currently forecasting overall S&P earnings to post a very modest 1.7% gain during the quarter. Four Fed officials will make public appearances this week. Cleveland president Sandra Pianalto and Philadelphia president Charles Plosser will speak on Tuesday. St. Louis president James Bullard and San Francisco president John Williams will speak on Thursday. The economic calendar will be a wildcard in the upcoming week as much of the data could be delayed due to the shutdown. Also of note, the Fed will release the meeting minutes from the Sept. 17-18 policy meeting of the Federal Open Market Committee. The minutes are expected to shed more light on the debate behind the central bank’s decision to refrain from tapering $85 billion in monthly bond purchases.


Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm’s headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500© Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

VIX- CBOE Volatility Index is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge."

American Association of Individual Investors – AAII is a non-profit, membership-driven investor education organization. The American Association of Individual Investors (AAII) was founded in 1978 by James Cloonan. The AAII's mission is to teach individuals to manage their own portfolios and to beat average S&P 500 returns, while taking on lower-than-average levels of risk. AAII also publishes the results of its weekly investor confidence surveys that are based on its members' feelings about where the stock market is headed.

Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

Past performance is no guarantee of future results. Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no gua rantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.

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