The government shutdown is now in its second week and the negative economic effects are starting to pile up. Here’s a sample, just from Tuesday:
- Global trade is being impacted by the closure of more than 40 U.S. government agencies involved in approving the import and export of various goods, including the Commerce Department, Environmental Protection Agency and Agriculture Department.
- Small businesses are hurting because they can’t get loans from the Small Business Administration.
- An outbreak of salmonella is responsible for 278 illnesses in 18 states but the Centers for Disease Control is working with a skeleton crew and is not currently doing multi-state investigations.
Given that’s just the tip of the shutdown-hurting-the-economy stories, it’s no wonder consumer confidence is falling – fast. In the past week, Gallup’s Economic Confidence Index suffered its steepest fall since the week Lehman Brothers collapsed in 2008.
The drag on the economy is potentially even worse than it appears because “going into the shutdown we had started to see a little of acceleration” in the global economy, says Liz Ann Sonders, chief investment strategist at Charles Schwab. The U.S. economy was poised to “move into the next phase” of the recovery, featuring an acceleration of capital expenditures.
“We’ve been missing a real true investment cycle outside of residential real estate,” she says. “Businesses need to make some commitments beyond stock buybacks and dividend increases and…we started to see signs of that” before the shutdown.
Specifically, Sonders believes there’s a “renaissance” afoot for U.S. manufacturing and a “stacking of up of indicators suggesting it’s about to accelerate,” including the aging of manufacturing plants at a time when the manufacturing workweek is at an all-time high.
“Manufacturers have enough business and are squeezing as much as they can out of their current workforce,” she continues, suggesting that an expansion of spending on plant and equipment, as well as more hiring, is set to follow. “We know there’s a replacement cycle that is kicking in already and at some point will trigger spending.”
And while the manufacturing sector remains a small part of the overall U.S. economy, Sonders notes there’s a big multiplier effect for jobs in most manufacturing sectors; for every 100 manufacturing jobs, there are 300 additional jobs created on average. “The power of that ripple effect is huge” and “it’s nice to think of our economy producing stuff again and becoming an exporter.”
As for the market, Sonders has been predicting a near-term correction but remains optimistic about the intermediate-term outlook for stocks.
Based on the “Rule of 20” for the market's P/E ratio (20 minus the inflation rate) the market could reasonably trade with a multiple of 18, “which gets you back somewhere in the 1900 range for S&P 500,” she says. “That’s not a prediction and I don’t think we’re out of the woods yet, but I don’t think valuation is an impediment” to further market gains.
Furthermore, Sonders believes “just about every precondition for valuation expansion” remains in place, despite the government shutdown.
So the optimistic spin here is that there’s momentum in the economy and the stock market isn’t expensive -- a bullish combination assuming cooler heads prevail and the politicians act before the debt limit is breached.
The pessimistic spin, of course, is that there seems to be dearth of “cool heads” in Washington and this political stalemate could yet lead to a market maelstrom that seriously hurts the “real” economy -- or vice versa.