Government shutdown in rear view mirror

I don’t make jokes. I just watch the government and report the facts. – Will Rogers

All’s well that ends well and in the latest political brinkmanship between the Republicans and the Democrats, it was the Republicans who blinked first as the government reopened last week and the U.S. avoided default by raising the debt ceiling. In what was no surprise to anyone who is familiar with how our government operates, a last-minute deal was struck before the deadline to avert a major calamity. But the deal only buys the participants a few months time before we are forced to endure the same exercise again. For all of their efforts to extract some concessions from the Democrats, the Republicans came up empty except in the public opinions polls, where they appeared to be the clear losers. The new agreement now calls for a continuing resolution to keep the government open until January 15^th and increases the borrowing capacity to February 7^th. In addition, a bipartisan conference committee was formed to develop a budget by mid-December that will address revenue and spending plans for the next 10 years. But don’t hold your breath. Lawmakers have shown no willingness to compromise on long-term fiscal matters in the past and expectations are very low this time, too. The clear winner last week was the stock market as the S&P 500 index set an all-time closing high and the Nasdaq Composite index closed at its highest level since 2000. Investors seemed to ignore the shenanigans taking place in Washington and, instead, focused on third quarter earnings, which so far have been better than expected.

Last Week

One could argue that the stock market never really feared a lengthy government shutdown or a failure to raise the debt ceiling as prices held up remarkably well. Instead, it was the Treasury-bill market of all places that experienced the most volatility as the yield of a two-week bill rose 60 basis points (0.60%) before it returned to earth after a deal was reached. It is hoped that the politicians in Washington have learned a lesson as both parties suffered in the polls. While there might be some damage from the shutdown to near-term economic growth, there should be no lasting effects.

While the release of economic data from the government has been one of the casualties from the government shutdown, there was no shortage of third quarter earnings reports last week. The biggest pleasant surprise was turned in by Google, the largest internet company, which reported strong results that easily surpassed analysts’ estimates. The price of its stock climbed to over $1,000 a share. General Electric also reported solid earnings along with Morgan Stanley and Bank of America in the financial sector.

For the week, the Dow Jones Industrial Average rose 1%, the S&P 500 Index climbed 2.4% and technology-laden Nasdaq jumped 3.2%.

This Week

With the government shutdown a thing of the past, the September employment report will be released on Tuesday. Most economists forecast an increase of about 180,000 in new jobs and no change in the unemployment rate, which is currently at 7.3%. If these numbers prove to be correct, they would be consistent with past data and certainly provide no reason for the Federal Reserve to alter its easy monetary policy. Other numbers due out this week include existing home sales, new home sales and durable goods orders, all of which are expected to show modest improvement and provide further evidence of a slowly growing economy.

This coming week will also be the peak in the third quarter earnings season and all of the major industry groups will be represented. Among the most notable of the companies due to report include McDonald’s, Microsoft, Texas Instruments, Du Pont, Ford Motor, Procter & Gamble and Bristol Myers Squibb. While there have been a few earnings disappointments for the quarter, namely IBM and Goldman Sachs, the results up until this point have largely exceeded expectations and this trend should likely continue.

Portfolio Strategy

The end of the government shutdown and the debt ceiling fiasco are the last apparent external events that the stock market has overcome since August. During this time, the market has dealt with Syrian chemical weapons, German elections, a government sequester, Fed Chairman Bernanke’s successor, unprecedented talks with Iran, the possibility of Fed tapering and an economic slowdown in China. Through it all, the stock market has climbed a wall of worry as each of these ‘macro’ events had the potential to derail stocks. The market’s resilience was never more evident than on Wednesday when IBM’s huge earnings miss did nothing to curb the overall strength of the stock market. With nothing on the near-term horizon that could have a negative impact, the path of least resistance for stocks appears to be higher; that is, at least until the deadlines approach again in approximately three months for the budget and the debt ceiling. With low interest rates, modest inflation, favorable earnings results and no threat of imminent Fed tapering, stocks would appear to have the wind at their back. If there is one cause for concern this earnings season, it is that revenue growth has been difficult to achieve for many companies. This reflects mostly on an economy whose growth has been sluggish as well as uncertainty with regard to government policy and its effect on future demand. But look for stocks to weather this storm, too, and continue their winning ways at least through year-end.