January 22, 2018

Stocks continued to gain on Friday despite a threat of a government shutdown. While the idea of government shutting down may seem like it should derail the bull market, at least temporarily, any shutdown is only partial and is more an annoyance than a matter of high economic significance.

Since the Congressional Budget Act of 1970, there have been 18 prior shutdowns. Obviously, to those directly affected, like veteran payments, the annoyance is more serious than I just alluded to. Both political sides blame the other while the public just throws up their hands and blames the President and Congress collectively. While Friday wasn’t the final day to enact DACA legislation, it was the point in time DACA supporters chose to take a stand. Immigration opponents want to end DACA completely as well as other related visa programs. As has been the case so often in recent years, even though there is broad consensus among the political middle to extend DACA and protect the dreamers, the extremes of both parties are holding everyone hostage, and at least to date, show little sign of backing away from the “my way or the highway” approach that has punctuated Washington politics for years.

Last year, there was a bit of a breakthrough as Republicans could use reconciliation to pass tax reform. While President Trump wants Leader McConnell to use the so-called nuclear option to allow a simple majority vote for everything Congress passes, McConnell refuses, and the Senate will stay true to its ways and require 60 votes to pass virtually all legislation. Due to technical reasons, the Republicans no longer have the use of reconciliation for anything of substance prior to the midterm elections.

This government shutdown will end, probably in a matter of days, as most previous shutdowns have ended because those members of the public displaced or disadvantaged by the shutdown will make enough noise to get the attention of lawmakers. The net change to 2018 GDP will most likely be no more than a tenth of a percentage point, and after the fact, Congress will almost certainly end up restoring lost wages for employees furloughed as a result of any shutdown. In other words, this will be a lot of noise over nothing in basic terms.

But what is happening in Washington isn’t irrelevant in another sense. It points out the diminished chance of anything further of substance getting done in Washington this year. DACA is a bit of an exception because Trump, in canceling the program last year, gave Congress until March 5 to come up with a legislative fix before he would enforce ending the program and start a deportation process. It is beyond my scope to guess whether Congress can get that done or not. While it does have modest economic implications, the ending or extension of DACA won’t change the stock market directionally.

But gridlock has other implications. It will limit any government expansion. It probably also kills any notion of an infrastructure bill. The need for infrastructure improvements is obvious, but the funding sources are not, particularly in the wake of the deficit expanding tax bill passed in the fall. Trump will continue to peel away at regulation. We are already starting to see that in many ways. Other issues, like rising student loans outstanding, remain problems seeking a solution that isn’t likely.

Meanwhile, while government once again grabs the headlines, earnings are what count to equity investors. The parade of reports will accelerate this week and likely be the dominant factor moving stock and bond prices. As we have already seen, the new tax law has varied effects company by company. As results are reported, clarity improves. It is hard to see how most estimates won’t begin to be written in ink, as opposed to pencil, once earnings season is over. From that point on, it will be changes in financial performance and economic direction that will be the primary driver for stock prices, not the impact of the tax law.

While Trump and his supporters believe the good economic news is just beginning, for growth to be sustained, much less increased, corporations are going to have to ramp up investment spending further. So far, early indications are that they are more than willing to take some of their tax savings and plow them into productivity improvements. But it is still early. Stock repurchases, higher dividends, price cuts, increased wages, and other initiatives compete for the tax savings. Time will tell. For now, there are reasons to be optimistic. However, the big gain in stock prices mutes some of that optimism.

Today, chef Guy Fieri is 50. Diane Lane is 53. Journey’s lead singer Steve Perry turns 69.

James M. Meyer, CFA 610-260-2220

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