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What D.C.’s Folly Means for Investors 

 

The Upshot 

10/21/2013 

The fiscal crisis in Washington has ended, albeit temporarily, but there are clear implications for markets, the economic recovery and monetary policy. Kristina Hooper highlights the key takeaways—some good, some bad.
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Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

When it comes to dealing with dysfunction in Washington, we’re all suffering from fatigue. Fortunately, the crisis finally ended last week, and investors breathed a sigh of relief. While the stock market climbed to new highs and Treasuries rallied in the wake of a short-term resolution, the economy reportedly took a $24 billion hit, according to Standard & Poor’s.

So how do we make sense of this unfortunate chapter in US history? There are some clear implications, both good and bad.

Let’s start with the bad:
The economy is in worse shape than when the shutdown started. Standard & Poor’s now projects that the US economy will grow 2.4% in the fourth quarter, which is a downward revision from the roughly 3% growth rate predicted prior to the shutdown.

Shutting Down Growth Chart


The deal is a very short-term fix. The temporary continuing resolution means the government has reopened and will be funded at current levels until Jan. 15, 2014. The debt ceiling has been raised through Feb. 7, 2014, and the Treasury has permission to use “extraordinary measures” to borrow money after that date, if necessary. The deadlines are not far apart, suggesting one issue could bleed into the other again.

Americans have lost even more confidence in their government and the economic recovery. Indeed, 47% of American consumers polled by Bloomberg believe the economy is getting worse, a dramatic increase from last month’s reading of 34%.

US debt could still be downgraded. Keep in mind that US debt wasn’t downgraded in the summer of 2011 until after the debt ceiling issue was resolved.

And now for the good takeaways:
Chances are growing that tapering will be postponed until 2014. A hit to the economy is a double-edged sword. While it would be unfortunate to see economic growth decrease in the fourth quarter due to the shutdown, it means there’s a better chance that the Fed won’t begin paring its bond purchases until early 2014. And with a new, more dovish Fed Chairman, Janet Yellen, in place, the odds increase even more that tapering will happen next year.

While last week’s fiscal pact was only a stopgap, it’s unlikely that we’ll see another crisis like the one we just lived through. First, top Republicans are promising that there won’t be another shutdown. In addition, business leaders are outraged by the negative impact on the economy and blame the Tea Party. Corporate executives are already discussing plans to support GOP candidates who challenge Tea Party members in Republican primaries. This atmosphere should create a velvet fist that compels cooperation.

You can count on the Fed. Think of the Federal Reserve as the fourth branch of government, one that’s far more functional and activist than some of the other chambers of government. The Fed, fearful that there would be a government shutdown, decided not to taper in September. In fact, since the Great Recession began, the Fed has shouldered much of the burden for trying to stimulate the economy. It has assumed the role of protector, a mantle that it’s unlikely to give up any time soon.

It could have been worse. Keep in mind that we weren’t actually going to run out of money on Oct. 17. However, there was a sense of urgency among most lawmakers that the issue had to be resolved before we hit that date. That sense of responsibility provides a glimmer of hope that, when it’s really needed, a majority of leaders willcome together for what’s best for the nation. Most importantly, now that the crisis is over, these distractions are also over. It’s time to refocus on what’s important: fundamentals and meeting our long-term financial goals.

Bottom line: While budget battles and debt debates can cramp our investing styles, we’ve got to have the stomach to stay the course.

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Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
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.

 

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585, us.allianzgi.com, 1-800-926-4456.

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