As we enter a week when the world’s elite gather at Davos for the annual Economic Summit, US companies release their fourth quarter earnings and the ECB meets on Thursday, the backdrop of a US Government Shutdown looms large. An interesting and perhaps unfortunate coincidence that may well provide a template for increasing 2 way volatility throughout 2018.
Global leaders, US corporations and Mario Draghi will probably all paint a picture of economic and corporate expansion. And yet a Government Shutdown, however it is resolved, is likely be the trigger for, what we described in our INDEX 2018 outlook as, a technical expansion, where increasing volatility combines with a loss of upward momentum. It should also further confirm our 2002-2003 template for the US Dollar and do little for the US bond market that continues to follow the unique and bizarre 1987 intermarket template perfectly. We do not think this is a perfect storm. Rather, one of a series of scattered growing showers that will help define the outlook for the rest of 2018, which has so far been a one way street.
This week saw the SPX break the record for the longest run without a 5% correction.
The great thing about this weekend is that whether a continued shutdown leads to a sell off in stocks, USD and bonds or bond yields or a resolution provides a ramp, neither should be sustained.
Given the lack of agreement at the time of writing, indices have been marked down on IG Markets (a UK broker) weekend grey market as follows
They are now recovering and will inevitably reflect the state of discussions as Congress meets through the weekend.
There is plenty of history to this idiosyncrasy since the Budget Act of 1974 introduced the modern US funding process.
This will be the 18th such shutdown in 43 years and the first under a President whose party controlled both the House of Representatives and the Senate and indeed the first under single party control to place government employees on furlough. Although it is clearly disruptive to the provision of services and dents government revenue, its significance can be easily be overstated beyond the headline. It will be resolved but how and when is a variable feast. Most have been short-lived. 10 of the previous shutdowns lasted five days or fewer and 8 lasted three days or fewer. The last two were the longest, 21-days from December 1995 to January 1996 and 18-days from September to October 2013.
It is probably beyond our brief how the Government is reopened, through the granting of the Child Immigration Act to the Democrats or otherwise. It would be just one of a series of concessions that Donald Trump has and will continue to grant in order to proceed with his agenda with such a small majority in the Senate. However, the inevitable consequence of such compromise is another small dent to his authority and a watering down of the promised reform (particularly if it affects the Mexican Wall) that has help fuel the stock market uptrend. It also serves to undermine his and the country’s reputation abroad with knock on consequences on the US Dollar. Ironically such temperance may serve to bolster both in the longer run and may see a more forthright President Trump at Davos in a bid to deflect and re-establish his authority. Beyond that the only detail that is of concern is the duration as possibly the longer it goes on the larger the scale of potential reaction. Although markets do not really work that way as trading decisions are neither typically prolonged nor uniformly distributed they do have a habit of reacting in a similar fashion under Government shutdowns. On average they fall for 24 hours before recovering in contrast to an average shut down of 7 days (median 3, mode 1)
Again context is important as rarely have we seen a shutdown in such a strong overly long market. The consequence of continued shutdown or even resolution is therefore likely to be more exaggerated before markets return to current levels. More importantly it should help us define exactly where we are in our 2018 template for indices as reflected by this 2007 fractal comparison for AAPL.
In a week where AAPL announced a decision to pay 15.5% repatriation tax ($38 billion) so freeing over $200 billion of cash no longer trapped offshore, it will have plenty of scope to increase dividends or buy back more shares.. and according to this fractal plenty of future increasing dips over the course of the Trump Presidency. AAPL’s earnings on February 1st could well trigger one such dip.
As Andy McElroy our stock analyst said: “This is perfectly illustrated by our view on AAPL, which is unlikely to make an sustained break above its long term channel. By the time earnings season concludes we expect many equities to be correcting the early 2018 ramp. Tax benefits are not expected to show up in EPS until 1Q18, so any further rallies from this point will stretch valuations even further.”
Analysis on AAPL and other shares is freely available to anyone registered at Matrixtrade.com.