Why This Time is Different
At the end of a week that saw China hopes fade, Brexit hopes rise, generally strong earnings, and reports that the Fed may end balance sheet reduction, President Trump announced an end to the longest US Government Shutdown in history. A week that touched on the major theme of 2018 and particularly year end: a slowing of earnings led growth due to the Trade War and US tightening but finished with possibly good but uncertain news. A week that could easily be a trailer for our Index / Commodity Outlook for 2019 and invokes much of the analysis we presented in a series of articles on how to trade news.
The impact of the US Government Shutdown typifies what appeared happened to the market in 2018 with the Trade War and Fed tightening and indeed FITS neatly with our now very clear and confident outlook for global indices 2019 to be published this week. Negative news (shutdown, trade war, tightening) initially dents stocks and USD but, until it is resolved, is generally underestimated and allows the market to recover until the real effects are seen later causing an equally if not greater negative reaction. An expansion.
For much of the last 10 years we outlined and monitored how the US economy and stock market (and consequently yields, USD and other indices) were following historical and conceptual milestones into a 1929 and 1987 style crash. Now the US market has retraced 20% and arguably entered a new phase, INDEX 2019 will explain forecast and help monitor how a new FITS template will see us beyond 2019 based on different historical and conceptual templates.
This week’s newsletter shows how the US Government shutdown forms part of the longer term outlook but also serves as a useful example—a microcosm—of a continuing pattern into a market top turn and ultimately recession.
This has been the 19th shutdown in 44 years.
Although each has invoked fears of a political economic and therefore market collapse, we have now become so used to this politically divisive and manipulated event appearing to be little more than a storm in a teacup, that we discount its significance and effect.. particularly once it is resolved.
But it is dangerous this time to ignore the positive and negative impact of the longest ever shutdown.
Fundamentally, the effect of a government shutdown has been difficult to measure primarily because they the impact hasn’t been large enough to stand out in a stream of other economic variables and news. Economists guesstimate a shutdown loses around 0.1% from GDP each week due to the loss of earnings and expenditure. And yet the 16 day shutdown in 2013 according to Standard & Poors, cost the US economy 0.6%, that is 0.26% per week.
Certainly the effect on NFP would argue for a greater than marginal effect. Standad & Poors estimated 120,000 jobs were lost for ever in the 2013 shutdown.
This may seem semantics, but at 35 days this time is significant as it (7 x 0.26 =1.84%) firstly threatens to wipe out Q1 GDP growth(which has averaged 1.7% since 2010 compared to 3% Q2, 2.3% Q3 and 2.2% Q4).
Even Kevin Hassett, President Trump’s top economic adviser said economic growth could be ‘very close to zero’ if the shutdown didn’t end soon. But secondly it creates both an investment gap that needs to be filled at some point to prevent a later dent to GDP and also threatens to undermine an already fragile economic outlook. And this is the important point. Last year’s shutdown was probably disguised by the uplifting effect of Donald Trump’s tax cuts (and most pundits/traders base their analysis on the last not necessarily average or historical or real current circumstances). With no sure resolution to the Trade War in sight, there appears to be little to offset the dent economically. Indeed the market largely shrugged off the adverse effect of the protectionism for nine months until the Fed overtly flagged concern. A possible premature end to Balance Sheet reduction could ultimately but not necessarily immediately be a mixed blessing because of the signals it would send.
Intermarket: How other markets than stocks reacts may be a better guide to how other markets and particularly the stock market will perform in the longer term. After all, yields and a persistently not strong USDJPY was a tip for late 2018 risk aversion (the 10 year differential led and still leads USDJPY by 315 hours in November and 100 hours now). Similarly the Dollar Yields and Gold will probably be strong to stable in the short-near term but should lead a later fundamentally driven downturn in stocks.
Technically, the Shutdown affects markets in a similar way to the Trade War and a slowing of inflationary growth expectations.
Following a sentiment expectation driven market where technicals are weak and largely ignore (or rather fail to detect) a deterioration in the fundamentals, the first leg down is a technical sentiment driven market.
As this moves wipes out sentiment and positions, fundamentals do not improve but sentiment does. In this instance, the anticipation of the shutdown into Xmas helped fuel the stock sell off but the actuality saw the market recover (sell the rumour buy the fact) a technical adjustment that can only be sustained by fundamentals. In other words the post shutdown recovery will only be sustained once it is seen to have little adverse impact. In more general terms, an anticipated later recovery in stocks can only be sustained if the fundamentals and not expectations actually improve. But that will not stop sentiment driving what is likely to remain a technical sentiment driven market for the first quarter if not half.
And this is where sentiment and the shutdown combine to provide a key driver for the first half of 2019. The delay in corporate buybacks. The SEC, like many government departments has worked on an skeleton basis and been unable to progress IPOs, (such as energy company New Fortress which is scheduled to trade this week). Although stocks are unlikely to sustain a shutdown resolution rally as these IPOs come on stream in the second quarter they should act support if not a driver of a still sentiment but not fundamentally driven market. The market may feel it is back in uptrend but unless it is clear that the shutdown hasn’t had an adverse effect on the economy and investment (ie unless the data shows a significant improvement) then we can expect yields and the USD to drag stocks back down and beyond.
Here’s to making the very best.
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