Shutdown and Equity Values

Reminder: I am not giving trading advice, just my interpretation.

Some of my students wondered why equity markets are not down more and at times look to potentially increase. Equity markets are an imperfect reflection of future economic prospects because there are company specific issues that could dominate national negatives.

One obvious point is that there is increased volatility in markets and strikes there will be opportunities to pick up companies with good prospects for potentially cheap prices. This is the normal risk-reward play of markets.

One factor students were not considering is the impact of the shutdown on monetary policy. Several issues arise for the Federal Reserve such as a housing market slowdown due to the FHA ceasing the processing of loan applications. Also, the Fed saw fiscal inaction as a threat to economic recovery. This is not likely to calm those fears.

All this is likely to keep rates lower and delay the taper by the Fed out to December or longer. This makes low equity returns and yields more competitive against low bond rates. As such, continued buying in equity markets for short term gains can be justified.

As I said there are other scenarios possible, I am just providing one explanation for short run behavior.

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