DEBT CEILING WALL OF WORRY IS ANOTHER REASON FOR U.S. INVESTING

Debt Ceiling Wall of Worry Is Another Reason for U.S. Investing

The U.S. congressional standoff that shut down the government for the first time in 17 years is a buying opportunity for stock investors, if history is any guide.

The Standard & Poor's 500 Index (SPX) has risen 11 percent on average in the 12 months following a government shutdown, according to data compiled by Bloomberg on the 12 instances since 1976. That compares with an average return of 9 percent over 12 months. In all the cases, the U.S. equity benchmark was higher by the end of the next two years.

While the S&P 500 has fallen seven of the past eight days on concern the political deadlock over the U.S. budget and debt limit will hurt the economy, investors at Raymond James & Associates and PNC Wealth Management say equities will recover as profits rise. Analysts' forecasts show earnings will increase at the fastest pace in two years during the fourth quarter. More than 300 companies in the S&P 500 are scheduled to report results this month, according to data compiled by Bloomberg.

"I'm a buyer on weakness," Jeff Saut, the St. Petersburg, Florida-based chief investment strategist at Raymond James, said in a phone interview. He helps oversee about $400 billion. "Once it's in the rearview mirror along with the debt ceiling, the market will start to focus again on the improving economic numbers and improving earnings."

The U.S. government will be partially closed today with Congress deadlocked over whether to tie any changes to the 2010 health-care bill to an extension of government funding. Even if the budget fight is resolved, lawmakers would immediately move to the next fiscal dispute over raising the $16.7 trillion debt ceiling.
Stocks Retreat

The S&P 500 slumped 0.6 percent to 1,681.55 yesterday, closing at a three-week low. The U.S. equity benchmark is still up 18 percent this year, on track for the biggest annual increase since 2009. Treasury 10-year note yields fell one basis point to 2.61 percent yesterday, trading at an almost seven-week low, and the dollar weakened against the majority of its most-traded peers.

The last time there was speculation about a U.S. government shutdown was in August 2011, when the S&P 500 fell more than 11 percent in three days. Stocks tumbled during the stalemate between President Barack Obama and Congress over whether to raise the debt ceiling and S&P stripped the U.S. of its AAA credit rating that month.

The losses were later reversed, as the Federal Reserve pledged to hold the benchmark interest rate near zero and maintain bond purchases to support the economy. The S&P 500 gained 25 percent in the 12 months through August 2012.
Government Shutdown

"If you go back to the 1990s and the last time we had a government shutdown, that was actually good for the stock market," said Martin Leclerc, founder of Barrack Yard Advisors LLC, in a phone interview from Bryn Mawr, Pennsylvania. His firm oversees $230 million. "It seems the market has climbed every wall of worry and every risk that's out there, the market has seemed to surpass."

In the last government shutdown that started in December 1995, the S&P 500 rallied 21 percent in the following year, according to data compiled by Bloomberg. The U.S. equity benchmark was up 36 percent in the 12 months after a one-day closure in 1982. That was the biggest advance of the 12 instances.

Stock swings will widen during the shutdown, according to Kristina Hooper, a U.S. investment strategist at Allianz Global Investors in New York. The firm oversees $409 billion. The S&P 500 has declined an average of 0.59 percent during government shutdowns since 1976, according to data compiled by Bloomberg.
Equity Volatility

"We'll definitely see more volatility if there is a shutdown, because the majority of the market wasn't anticipating it as late as last week," Hooper said in a telephone interview yesterday. "The longer-term picture is positive. We'll likely work through this relatively quickly."

The Chicago Board Options Exchange Volatility Index (VIX) jumped 7.4 percent to 16.60 yesterday, the highest level in a month. It is still 18 percent below its average since 1990.

Stocks need to fall further before they become bargains, according to Kevin Caron, a Florham Park, New Jersey-based market strategist at Stifel Nicolaus & Co., which oversees about $150 billion. The S&P 500's valuation slid to 16.1 times reported operating earnings yesterday, from a three-year high of 16.5 on Sept. 18. The benchmark's multiple has increased 14 percent this year.
Fair Value

"We haven't seen a significant correction yet," Caron said in a phone interview. "We're right around what we would consider to be fair value for the market."

A shutdown of the U.S. government may reduce fourth-quarter economic growth as federal workers from park rangers to telephone receptionists are furloughed, according to Moody's Analytics Inc. Mark Zandi, chief economist at the firm, has estimated that a three-to-four week shutdown would cut growth by 1.4 percentage points. He projects a 2.5 percent annualized pace of fourth-quarter growth without a shutdown.

E. William Stone, chief investment strategist at PNC Wealth in Philadelphia, said the gridlock in Congress isn't likely to weaken the overall economy. Earnings for S&P 500 companies will increase 9.1 percent in the fourth quarter, the biggest expansion since the three months ending September 2011, according to more than 11,000 analyst estimates compiled by Bloomberg.

Profits have been climbing for the past four years and analysts forecast growth will continue in 2014 and 2015, when they rise more than 10 percent. For the full S&P 500, earnings expanded 1.8 percent last quarter, projections compiled by Bloomberg show. Alcoa Inc. (AA), Yum! Brands Inc. (YUM) and Safeway Inc. (SWY) are among the 316 companies in the S&P 500 scheduled to report in October.

"It certainly makes sense in our mind to take advantage of these kinds of selloffs," Stone said by phone yesterday. The firm manages about $119 billion. "At the end of the day you go back and say, does this whole fight really harm the long-term market or the underlying economic picture? And I don't think it will really have any true impact there."
Source: Bloomberg