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Making Sense of a Senseless Shutdown 

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Our experts, Peter Lefkin and Kristina Hooper, share their insights on the latest budget battle in Washington including what it means for the upcoming debt-ceiling debate, the Fed’s tapering strategy and investors’ allocation decisions.
The shutdown continues as few strides have been made toward passing a stopgap spending bill to fund federal government operations. Republican and Democratic leaders met with President Obama for 90 minutes Wednesday evening, but neither side budged on demands.

Meanwhile, the shutdown has furloughed 800,000 employees, affected millions of Americans, damaged investor confidence and raised doubts about an already fragile economic recovery. The big questions now: When and how will this stalemate end, and what does it mean for investors and the public at large? Our experts weigh in:

Peter Lefkin Peter Lefkin
Head of Government and External Affairs
Allianz of America
The shutdown has real consequences… [but] the debt limit will have far more dire consequences—potential default and recession.”

A tempest from the Tea Party. Most Americans are appalled by the shutdown not only because it’s an inconvenience, but also because it reveals that we have an unhealthy democracy. Some members of the Tea Party believe the risk to government service has been overstated. They cite the sequester, which reduced discretionary spending by about 5% without any noticeable impact. However, the shutdown has real consequences—lost wages, suspended medical treatment, suspended benefits for veterans and economic uncertainty—and the debt limit will have far more dire consequences— potential default and recession.

The president knows Republicans will take political blame for the shutdown, at least for now, and will let them stew over it. It’s stirred up a divisive battle between the Tea Party activists and traditional Republicans. But public pressure will intensify for congressional action to reopen the government with both political parties pointing fingers at the other side and Americans disgusted with both. I think the president needs to show leadership, rise above the squabbling and stop publicly refusing to negotiate.

Average Quarterly GDP Growth
Since 4Q 1964 During periods impacted by shutdown
3.08% 2.15%

Suicide, no solution. By incurring such a visible and public loss on the stopgap spending bill, Republicans significantly weakened their hand for the important debt-ceiling debate that will begin in October. President Obama and Senate Democrats, not very popular themselves, may find that simply letting the Republicans beat themselves will give them the upper hand. And the Republican Party can’t afford to have another brinkmanship fight. In my 35 years of experience, I have never witnessed the political suicide that I’ve seen in the last few weeks. What is sometimes lost in the debate are genuine concerns that President Obama’s brand of health care may not work as intended and this attitude is not limited to Republicans.

The upside of a shutdown. I expect the shutdown to last about 10 days, as public outrage reaches a fever pitch. At that point, the president, perhaps realizing that public opinion is beginning to turn against him, will begin offering some solutions that will allow both sides to go home and save face. While the president has no desire to help Republicans dig out of a hole right now, he may soon realize that he needs their cooperation on the debt ceiling. The silver lining in the government shutdown is that it could be the wake-up call that both political parties need, realizing that it has real ramifications, and that they can’t play politics with something as serious as the debt ceiling.

Kristina Hooper Kristina Hooper,
US Head of Investment and Client Strategies
Allianz Global Investors
Without timely employment numbers, questionable accuracy and a higher potential for revision, how will the Fed apply its data-driven approach to dialing down QE?”

Volatility poses a buying opportunity. Think of this period of uncertainty as a buying opportunity for investors who are under-allocated to equities and have a long time horizon. Historically, shutdown selloffs have been short-lived. Indeed, stocks have proven resilient in past shutdowns, averaging a 0.6% loss on the S&P 500 during shutdown periods while showing flat returns on the Dow Jones Industrial Average. But even if it does drag on and bleed into the debt-ceiling debate, investors shouldn’t get scared. Despite the deadlock over the debt limit and ensuing downgrade in 2011, which sent stocks plummeting, stocks soon recouped their losses and rallied further.

Government Shutdown History

The Fed’s timeline for tapering could be jeopardized. The monthly employment report will be delayed due to the government shutdown. An estimated 80% of employees at the Bureau of Labor Statistics have been furloughed. Without timely employment numbers, questionable accuracy and a higher potential for revision, how will the Fed apply its data-driven approach to dialing down QE? In addition, if this shutdown lasts longer than a few weeks, then it could have a significant impact on economic growth. Therefore, monetary policy would likely remain accommodative for a longer period of time. Further, if investors’ psyches are severely damaged by these fiscal fights, then the Fed pulling away the punchbowl in October or November may send the stock market into a tailspin—something the Fed wants to avoid.

Financial repression remains a long-term theme. Despite taper talk, developed nations will keep interest rates low until they see steady growth. Amid low rates, investors should invest in risk assets offering positive real returns, particularly dividend-paying stocks and select emerging-market sovereign bonds. Treasuries and core bonds will not provide investors with the inflation-adjusted returns needed to rise above financial repression.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



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