01.14.19

Government dysfunction fails to shut down U.S. equities

Brian Nick

The last week’s market highlights:

Quote of the week:

“Remember that sometimes not getting what you want is a wonderful stroke of luck.”
– Dalai Lama
 
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2019 Outlook :
  • U.S. economy: A slowdown, not a recession
  • Global economy: Amid lower expectations, emerging markets could surprise to the upside
  • Policy watch: Fewer tailwinds, stronger headwinds
  • Fixed income: Rates likelier to rise than fall  
  • Equities: Late cycle but good value
  • Asset allocation: A neutral stock-bond view

Breakdown—It’s (not) all right

Due to a lapse in Congressional appropriations, the federal government has been partially shut down since December 22. On Saturday, January 12, this shutdown earned the dubious distinction of becoming the longest one ever, eclipsing the 21-day gap in government funding that occurred in December 1995 during Bill Clinton’s presidency. Affected workers have already missed one paycheck, and with President Trump still at loggerheads with Democrats over the funding of a border wall between the U.S. and Mexico, the stalemate could last far longer.
 
While there’s never a good time for such an impasse, this one is taking place against a backdrop of already high policy uncertainty. For instance, in contrast to its September plans for multiple rate hikes in 2019, the Federal Reserve now appears to be adopting a “wait and see” approach to raising interest rates. In so doing, the Fed has acknowledged the concerns of anxious markets and the potential impact of a slowing global economy. Also, the U.S. and China are in the midst of trade negotiations ahead of a rapidly approaching March 1 deadline. Trump has vowed to increase tariffs on $200 billion of Chinese imports unless a deal has been reached by that time. And just a few weeks ago, Defense Secretary James Mattis resigned, which raised alarm among U.S. allies.  
 
Policy uncertainty tends to spur equity market volatility, as we saw in December. Instead of a “Santa rally”—a jump in stock prices that often occurs between Christmas and New Year’s—investors were presented with a spike in the VIX, Wall Street’s “fear gauge,” which on December 24 hit its second-highest level in more than three years. Although the VIX fell last week in tandem with the S&P 500’s continued strong start to 2019, it remains elevated versus levels from earlier this year.  
In our view, as long as the shutdown is resolved fairly quickly, its economic impact should be manageable and temporary. In that case, personal consumption is unlikely to decline much given the relatively few workers affected (compared to the broad population) and the promise of their receiving back pay. Indeed, in past shutdowns, “essential” federal employees who were required to work without pay, as well as those placed on unpaid leave, were reimbursed once the government reopened. That’s why we think that if there are downturns in select data for January, including personal spending or the household savings rate, they’ll likely be recouped in February data. Of course, any small hit to the economy pales in comparison to the plight of the employees hurt by this political battle.
 

U.S. economy: Mind your business!

We expect the U.S. economy to slow in 2019 as the boost from last year’s tax cuts and fiscal stimulus begins to fade. Moreover, the longer the government shutdown persists, the greater the likelihood that it could erode consumer and business confidence, providing another economic headwind. Heading into the end of last year, however, business owners remained bullish despite the spike in equity market volatility. The NFIB Small Business Optimism Index stayed near historically elevated levels in December. Among the survey’s highlights:
  • Hiring strengthened significantly, and owners plan to add even more employees in 2019.
  • Capital investments have risen over the past few months. Encouragingly, respondents pointed to increasing their capital expenditures budget and boosting inventories.
  • The percentage of owners expecting better business conditions in six months is well above its long-term average.
At the same time, the net percentage of companies reporting difficulty finding qualified workers hit a fresh peak (39%) for this economic cycle. That measure never rose as high in either of the two previous cycles—even during the late-1990s expansion, in which wage growth topped 4%. Against this challenging backdrop, employers anticipate having to increase compensation to draw good candidates off the sidelines.   
To put this solid report in context, small businesses were exhibiting less confidence throughout the equity bull markets of the late 1990s and mid-to late-2000s. In other words, they appeared to be more optimistic in December—almost 10 years into this economic cycle—than they were at the end of the prior two cycles. Of course, we may find that they have changed their tune when January’s NFIB survey is released in about a month. That data will provide clues to the shutdown’s impact—real or perceived—on small business owners. For now, however, it’s steady as she goes on Main Street.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
 
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