When the markets start fixating on a particular event or news, it can get extremely myopic with critical tunnel vision issues. In the last few weeks, Wall St. obsessed about the tapering. We, at Wall St. Analyst, had concluded that either the Fed would look at the inflation and unemployment data and not taper (which is what happened) or that the tapering had already been priced in. The markets, which have been extremely sensitive of late, went up sharply as the news of the Fed not lowering its bond buying hit the tapes. However, as we had warned on that day, the markets completely ignored the twin storms of a potential government shutdown and the debt ceiling crisis, which has as much, if not more, potential to churn the markets. Despite the imminent disasters, the markets continued to remain short sighted. Since the day after the Fed’s announcement on the 18th of last month, the S&P 500 is down 2.55%, a sharp contrast to the 5.23% rise in the previous two weeks (from the 3rd to the 18th of September).
We have seen such market myopia even during the early days of the financial crisis. Bear Stearns collapsed in March 2008 and was subsequently taken over by JP Morgan Chase (NYSE: JPM) with support from the Fed. The toxic assets and their far-reaching effects should have been visible to regular market participants and yet, the market mostly shrugged off the news and the S&P 500 reached its then all-time highs of 1,565.15 on October 9th, 2008. Myopic investors paid dearly by ignoring the early warning signs – the index did not reach those levels for four and a half years, surpassing it finally in April 2013.
Currently, the S&P 500 is trading close to its all-time highs at 1,682.55. A 3-week shutdown can cost as much as one percentage point of real GDP growth. The last time the US saw a shutdown was in 1995-1996, when the total three-week shutdown was said to have cost the US economy $1.5 billion. Simply adjusting for inflation and the current size of the government sector, the effect can be as large as $4 to $5 billion for a similar period, according to estimates by the Wall St. Analyst research team.
With political debates on the budget, the debt ceiling and the government shutdown, together with the S&P 500 trading at extremely high multiples, we see markets taking a downward trajectory in October – at least till the political will to solve this current crisis emerges. S&P, the largest of the ratings agencies that downgraded US debt from its pristine AAA rating during the last debt-ceiling crisis in 2011, may have a similar reason to go down that path again in the next few months, although it has announced that it is not taking any steps on this yet.
The Dow was down 128.57 points, or 0.84%, and ended the day at 15,129.67, while the technology-heavy NASDAQ was down 0.27% and finished the day at 3,771.48.