Shutdown masks debt ceiling, earnings, Doll says

Equities were mixed last week as the markets were focused on the budget impasse in Washington, D.C. that forced the federal government into a partial shutdown. As with the 17 prior shutdowns, we do not anticipate a lasting impact on the economy or markets. While the shutdown makes headlines, the issues that will likely have the most impact are the debt ceiling debate and third quarter corporate earnings announcements, which could mean a bumpy ride for investors. Taper Talk and Fiscal Dispute Overwhelm Markets Three main issues are hanging over the market: Fed taper talk continues to stalk the investment community, but the focus is on timing instead of the actual need to begin slowing accommodative policy. The rancorous debate in Washington has compromised investor confidence The earnings outlook may be far from encouraging in the upcoming earnings release period The government shutdown could reduce fourth quarter real GDP by approximately 0.25%. A minor impact is that federal pay will probably only be temporarily postponed. Leadership does not want to risk political fallout from a protracted shutdown, but compromise is not on the horizon quite yet. It may take an outcry from voters and/or the markets to force resolution. We think the most likely outcome is an agreement that combines an increase in the debt limit and a continuing resolution that reopens the government. We anticipate a deal may pass sometime between the end of this week and the October 17 U.S. Treasury deadline. The House Republicans appear ready to unveil an initial request to reopen the government and raise the debt ceiling, with potential proposals for entitlement reform, spending cuts and tax reform. There will be discussion of grand bargains, but we doubt the end result will match the upfront hopes. Weekly Top Themes We view profits and economic growth as a bigger challenge to the outlook than the fiscal impasse or Fed tapering. Equities are currently 3% from all-time highs, and we believe that in order to advance, equities will need stronger growth, better earnings or a major policy surprise. ADP nonfarm private-sector employment rose by 166,000 jobs in September.1 This number was slightly less than the consensus expectation of 183,000. Initial unemployment claims edged up to 308,000 for the week ending September 28.2 Lower claims data trends are positive for labor markets. The Manufacturing Purchasing Managers Index (PMI™) beat expectations in September.3 This marks the fourth consecutive month of expansion. U.S. natural gas production has surged and surpassed Russia as the largest energy producer.4 Crude oil production has reached its highest level in 24 years. U.S. energy production growth has positive economic implications. The Big Picture Despite the political noise in Washington, a fiscal agreement is probable soon, which should allow the U.S. economy to gradually improve as consumer and business spending advances at a moderate pace. The economic outlook outside the U.S. is becoming stronger as Chinese growth is solidifying, Japan is in recovery mode and Europe is climbing back. Even a moderately better growth outlook should bolster investor confidence and spur a shift out of bonds into equities once the political dust settles. The Fed's decision not to taper underscores its commitment to promoting economic recovery. The Fed intends to lag the economic recovery by keeping real interest rates artificially low, which can be inherently favorable for equities. Investor positioning and relative valuations reinforce our overweight stance on equities. Fiscal shenanigans in D.C. highlight numerous risks to the outlook; however, the global economy has not achieved escape velocity and is vulnerable to adverse shocks such as policy issues or geopolitical turbulence. The U.S. economy has shown impressive resilience over the past three years, suggesting the recovery may only be blown off course in the event of something sizable and protracted. Bob Doll is chief equity strategist and senior portfolio manager at Nuveen Asset Management LLC. This commentary originally appeared on the firm's website.