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Equity market investors, be aware-- the short-term threat level has been raised to amber. While the big arguments over the outlook for stock markets have centred on President Donald Trump's ability to win ambitious tax reforms and infrastructure stimulus, a more immediate question is looming. Can Congress avoid a shutdown of the federal government at the end of next week?
Now, the odds of a budget agreement are good, but the way that lawmakers get to a deal is going to matter as much to investors as the details. And it's a safe bet that currently sanguine markets will be progressively more on edge as the April 28 funding deadline approaches. With Republicans, Democrats, and the White House all vying to keep their opponents' policy priorities out of a deal, there's still the risk that talks go wrong and federal employees are put on furlough, just like they were for 16 days back in 2013.
Now, economically speaking, a short shutdown is neither here nor there. Even the stock market has gone through previous periods of budgetary brinkmanship without exhibiting a clear pattern of distress. An analysis by LPL Financial of the shutdowns from the Ford administration onward found that the average market move was a fall of 0.6%. As you can see in the chart, of the longest five shutdowns, markets are just as likely to be up as to be down.
There are a couple of differences this time, though. This would be the first time in 40 years that the showdown is occurring in the spring rather than in the September to December time frame. And much more seriously, it would come at a time when political optimism is still baked into share prices.
For all this talk of the reversal of the Trump trade, the US equity market is off less than 2% from its high, and it's still up 10% since election day. Most forecasters have pushed out the date of the expected benefits from tax reforms, but few have reduced those expectations by very much.
Any evidence that Washington can't smoothly navigate even more mundane issues of funding the government-- well, that raises the spectre of clashes over items such as the debt ceiling later this year, all things that could derail Trump's agenda. And it risks disillusioning the business leaders on whose animal spirits equity bulls are relying.
