Tuesday witnessed the second day of a federal government shutdown, with the looming possibility of a U.S. government debt default on the horizon and another chance that the U.S. government could see its credit rating fall. On top of the fears are worries that the 800,000 federal employees who are temporarily furloughed will cause a significant hit to domestic consumption in the United States, causing the nation’s GDP growth to slow or reverse, hitting those companies who rely on the American consumer for their revenue.
In short: the shutdown is horrible for stocks. Yet the S&P 500 rose on Tuesday just as the shutdown began. What gives?
Systemic risk is not systemic opportunity
Systemic risk is not just a matter of large events impacting the value of individual companies. It’s also a matter of how large events relate to expectations. If stocks predictably went up after the Federal Reserve announces it will continue to buy mortgage-backed securities, or if stocks predictably went down after the government announces a calamitous nationwide shutdown, then it’d be easy to bet on these things by longing or shorting equities and taking huge profits in a short period.
Unfortunately, the market’s response to these macroeconomic events is unpredictable, which is why day trading often ends in tears.
The initial response to the Fed Reserve’s surprise announcement that it would not taper was a hockey-stick: the S&P surged over 1% in a matter of minutes on Sept. 17th, and opened higher on the 18th. But then a steady decline has meant the S&P 500 has closed lower on most days since, and we’re down about half a percent since the start of trading on the 17th.
In hindsight, timing these ups and downs looks easy, but traders know that it’s much harder than it looks when these events are unfolding.
The unpredictable market
While some short-term cash could be made in betting on the taper and riding the wave for an hour or so on the 17th, markets’ immediate response will not always make total sense. On Tuesday, the government officially shutdown all but the most essential services, with hundreds of thousands of government employees being told not to come to work and facing uncertainty as to when their next paycheck will come in the mail. On top of that, the Congressional deadlock hints that a debt ceiling showdown could cause the U.S. government to default on its debt. Considering the U.S. dollar’s central position in the global economy, the effects of such an event are so calamitous and far-reaching that no one, in any bank or hedge fund, can say what exactly would happen. But everyone agrees that it would be very bad.
Yet the S&P 500 closed nearly a full percent higher on Tuesday, since the economic impact of a shutdown was perceived to be less extreme than expected. However, news from the ADP that employment growth is below expectations does not help mounting fears that a government shutdown could linger and cause lasting effects to the nation’s GDP. The S&P opened half a percent lower.