Last week’s economic calendar continued to provide foundational support to the thesis that our economy’s growth is accelerating. Industrial Production for December came in at a stunning 0.9% versus Bloomberg consensus calling for a more modest gain of 0.4%. November’s revised reading was -0.1%. The Housing Market Index for this month remained elevated at 72. Weekly Jobless Claims reflected a sharp decline coming in at 220k versus the prior week’s reading of 261k. The Philadelphia Fed Business Outlook Survey remained in channel for January coming in at 22.2. Not at all surprisingly, Consumer Sentiment for January was a solid 94.4 versus December’s 95.9.
This week’s economic calendar, outlined below should provide further evidence of economic expansion. The Chicago Fed National Activity Index is expected to reflect a gain of 0.25. The Richmond Fed Manufacturing Index for January, due out Tuesday, is expected to come in at 18. Weekly housing data aside, investors will watch closely as the Weekly Jobless Claims hit the tape, on Thursday, as well as advance reports on wholesale and retail inventories. The three most important data releases of the week will be Leading Indicators Thursday, Durable Goods Orders and GDP on Friday.
What is the data showing?
With all of this economic data providing a constructive backdrop for markets and with Q4 earnings providing a lift for equity prices; the question in everyone’s minds involves Washington DC. What impact will the Federal Government shutdown have on our rally? Will it act as a hard stop on the price appreciation investors have become accustomed to?
Earnings are backward looking. Guidance is forward-looking. Purely from the perspective of earnings, equity markets are in the midst of a leg-up in prices. Though it is early in the earnings season, if financials are any indication of what to expect from the broader market, we should see a rising tide continue to take shape in the form of rising equity prices. However, this week, we may begin to see forward-looking guidance informed by the dysfunction in Washington DC. The shutdown that has emerged in Washington has a unique complexion to it this time around. It would appear as though the divide that has spurred this budgetary logger jam has more to do with ideology than it does finances. That difference could well mean that the shutdown will last longer than those we have experienced in the past.
To date, investors have not priced in a protracted shutdown as is evidenced by the continuation of our run-up in prices. The run-up in prices that we have witnessed over the past 52-weeks has left the S&P with a gain of 26.31% and a P/E of 23.41. Over the same period, the Dow Industrials have risen a stunning 34.65% while currently sporting a P/E of 21.61.
Let’s face it, markets should hypothetically be due for a pause in their march higher if not a constructive pullback of sorts. They “should” hypothetically, but will they?
Credits markets are reflecting the same bullish sentiment. The closely watched 10-year T-Note, for example, yields 2.64%. Friday’s 10-year closing yield was a 52-week high. It could be argued that, in recent months, interest rates across the board have risen at a rate faster than can be justified given the current economic landscape. There “should” be a degree of modest retracement, but will it materialize?
The VIX
The complacency currently priced into markets is a concern. Volatility, as measured by the CBOE Volatility Index (VIX), closed on Friday at 11.27. Though well above the lows of the first week of January (9.15), it is still not reflecting any meaningful concern on the part of investors.
This Federal Government shutdown is the most potentially disruptive theme that investors will have faced over the past 52-weeks as it may last longer than investors are anticipating. It could potentially take a degree of “risk-off” mentality off the table and as a result take some momentum out of the equity market melt-up. It could also drive risk aversion into credit markets, slow rising interest rates and trigger yield curve inversion. As a result we could potentially see a meaningful tick higher in the VIX. The reason is simple. The divide in Washington is philosophical. The Democrat and Republican parties have a fundamental difference over a policy first put into place by President Trump’s predecessor, President Obama– a policy that President Trump is attempting to redefine in ways that are in direct opposition to his predecessor and the leadership of the Democrat party. The differences in approach have the potential of not only lasting longer than previous budget battles, but also have the additional potential of accumulating with them tangentially related issues.
In the event the shutdown becomes a protracted philosophical battle, there could be an impact for investors. The last Federal Government shutdown trimmed 0.3% off Q4 GDP in 2013. That shutdown was, to a degree, also a philosophical battle in that the GOP was attempting to defund the Affordable Care Act. Ironically that landmark legislation is being currently dismantled in stages by the current administration and GOP incrementally and in stages. That shutdown lasted 16 days and cost the US economy roughly 6.6 million in lost work days according to Investors Business Daily. In the event this shutdown lasts longer than the one we had in 2013, it could well act to slow the rate of GDP expansion in a meaningful way.
Image: courtesy of Yahoo Finance
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