US Government Shutdown?

The S&P500 lost a little over one percent las week, on modest volume. S&P volatility jumped almost 20%, yet remained at the low end of its 20 year historical range.

Technically, the S&P is rolling over on the daily charts. Another weekly close lower would confirm a new short-term downtrend. On the weekly charts, the topping formation that took shape in late summer is still in effect, and even more so after last week’s decline. Market internals are also weakening. The new highs minus new lows, for example is fast approaching negative figures. Also, the percent of stocks above their 50 day moving averages is not only falling, but the peaks in this index, since the first half of this year, have been successively lower and lower. To sum up market internals, the market advance since the mid-summer months has been led by fewer and fewer stocks. This is not a sign of market strength.

In US macro news, the quarter ended on a weak note. Flash manufacturing PMI disappointed. So did the Case Shiller home price index which is not recording a rapid slowdown in the pace of home price increases. Both consumer confidence and consumer sentiment missed. The Richmond Fed manufacturing index missed. Headline durable goods beat expectations, but the more important ex-transportation figure missed. New home sales missed; and the median price of new homes continues to decline. GDP for the 2nd quarter missed. Pending home sales missed and the Kansas City Fed manufacturing survey plunged. Some of the best results of the week came from personal spending and personal income, which did not beat expectations–they both merely met them.

The big story of the upcoming week is the imminent US federal government shutdown, and the possible repercussion to the US economy and the US capital markets.

The last time this happened (in 1996), it was a short-term event during an otherwise booming period of economic growth. This time, US economic growth is anemic and has been anemic ever since the so-called recovery began in 2009. So the possible impact to the economy if the shutdown actually happens and if it becomes in any way protracted, could be more damaging.

The impact on US markets could be even stronger. Wall Street hates uncertainty and instability and if the shutdown happens, historical analogies may provide a clue to the immediate future.

Back in 2011, when a crisis over the US debt ceiling was boiling over, equities and high yield credit were hit the hardest. Interestingly, and perhaps counter-intuitively, US Treasuries soared. And precious metals soared.

So it seems very possible that something similar might happen with this fiscal crisis. Expect a general risk-off atmosphere where stocks and risky credit gets sold. Money exiting these markets might run short-term and medium-term US Treasuries for a safe harbor. And it may also look to leave the US entirely, in which case the US dollar could get sold off causing other developed market currencies to jump.

Regardless of the exact outcome, there’s a good chance that some asset classes will drop in price, causing them to become more attractive in terms of prospective returns. In other words, this showdown could offer savvy investors a chance to ‘buy low’.

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