Shutdown Drama: Will There Be a Market Decline or Relief Rally?

Last week saw more turbulence in global financial markets and the Dow Jones Industrial Average (NYSEARCA:DIA) as Republicans and Democrats squared off over their differences in approach to averting a government shutdown. With no compromise in sight, it appears that at least a short-lived shutdown could get underway by Tuesday morning. The bigger issue, however, still looms ahead as the U.S. government is scheduled to run out of money to pay its debts sometime in mid-October. This event would have global ramifications and, while nobody believes it will happen, the standoff in Washington sets the stage for a rocky month.

For the week, the Dow (NYSEARCA:DIA) fell 1.3 percent, while the S&P 500 (NYSEARCA:SPY) dropped 1.1 percent. The Nasdaq (NYSEARCA:QQQ) edged slightly higher with a gain of 0.2 percent for the week, while the Russell 2000 Index (NYSEARAC:IWM) closed narrowly in the green with a gain of 0.2 percent. Gold (NYSEARCA:GLD) gained 0.3 percent to close at $1336/oz., while oil (NYSEARCA:USO) fell 1.6 percent to $102.81/bbl on Friday.

On My Stock Market Radar

The chart of the Dow below shows how a double top has been formed in the 15,600-15,700 level and has fallen some 400 points over the last six trading days. The Dow has also just broken its 50-day moving average, which is widely watched by shorter term traders and the next serious level of support is at the 14,900-15,000 level, approximately 2 percent from current levels.

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So as the third quarter comes to an end, we find the major markets still up significantly for the year, with the Dow up 16 percent and just 2.7 percent off recent all time highs. With October right around the corner, short term fundamental headwinds now center on the political debate in Washington, which will quickly be followed by the beginning of Q3 earnings season. The technical picture shows substantial short term weakness with “sell” signals on various indicators and the recently formed double top which will provide significant resistance if and when the fundamental problems are resolved.

Stock Market News You Can Really Use

The main action at the end of last week was the impasse reached between Congress and the White House that makes a government shutdown more likely. Economic impacts depend upon how long it lasts, while psychological impacts could be more significant if market participants don’t quickly get their expected outcome within a few days. The most likely scenario is intense brinkmanship up until the last minute with some sort of settlement in the nick of time to avert a U.S. default on its debt.

However, the last time this situation played out, the last minute “deal” was the sequestration, reached at the 11th hour and after a 15% decline in major U.S. stock indexes. And this was without any demands to delay or defund “Obamacare” which could prove to be the ultimate line in the sand for both sides.

The net result of all of this is that we’re witnessing a titanic political struggle, the outcome of which will depend on which side blinks first. There appears to be no compromise in sight and, if that remains the case, over the next couple of weeks we’ll see a “winner” and a “loser” emerge. Hopefully all of this drama won’t be at the expense of the U.S. and global economy.

Looking back at previous shutdowns, a pattern of stock market declines followed by rallies seems to be the norm, but nobody has seen what the world looks like if the U.S. breaches its debt ceiling.

All of this action comes just on the heels of last week’s drama over the Federal Reserve and its surprise announcement of its “untaper.” This is particularly troubling news because it damaged the Fed’s credibility and inserted yet another element of doubt regarding the real strength and sustainability of the ongoing recovery.

Last week’s economic reports were mixed with August new home sales rising, along with durable goods and consumer spending. August pending home sales fell, GDP remained flat at 2.5 percent, while consumer confidence missed expectations. The week ahead has a number of notable economic reports, including the monthly Non Farm Payrolls and Unemployment numbers which may, or may not, be published depending upon the situation regarding the government shutdown.

Economic reports currently scheduled:

Monday: September Chicago PMI
Tuesday: September ISM, August Construction Spending
Wednesday: ADP Private Employment
Thursday: weekly jobless report, September ISM services, August factory orders
Friday: September Non Farm Payrolls, Employment rate

It’s going to be a volatile couple of weeks that hopefully will be contained as recent showdowns have been. October is a notoriously bad month for stocks with spectacular declines making news in 1929, 1978, 1979, 1987, 1997 and 2008.

However, it also marks the beginning of the seasonally best months of the year which tend to extend from October through May.

Bottom line: Expect intense volatility ahead, perhaps a significant market decline, and if history repeats, a last-minute settlement and relief rally over the next few weeks. Beyond that, earnings will take center stage and fundamentals might once again replace the theatrics of politics on the investing stage. 

John Nyaradi is the author of The ETF Investing Premium Newsletter.

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