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US stocks are vulnerable to a correction, even if the shutdown impact proves short lived

The failure of America’s deeply divided politicians to agree spending plans will put up to one million government workers on unpaid leave, so will clearly have a negative economic impact. The impasse also augurs badly for the 17 October deadline to raise the US government’s $16.7 trillion debt ceiling. A US default would be a huge humiliation for America’s position as the leading global superpower, a reminder of the scale of the game of brinksmanship being played by America’s intransigent politicians.

Jason Hollands Jason Hollands
01 October 2013

The US stock market had however increasingly begun to factor in a potential shutdown in recent days, with the S&P 50O Index sliding by around 2.5% from its recent peak on 18 September and month end. Yet despite this pullback, the US market remains within a whisker of its all-time high.

Over the last three years, earnings at US companies have benefitted from rock bottom financing costs, which have accounted for almost half of earnings growth over this period. But this factor won’t be around in perpetuity as monetary tightening is ultimately coming and borrowing costs will rise. Investors should note that US companies have been warning about Q3 earnings at levels not seen since 2001, and businesses issuing negative outlooks for the quarter are doing so at a ratio of 5:1. The US recovery therefore remains fragile.

Past evidence suggests that the impact of multiple US government shutdowns on markets can be short lived, and even a buying opportunity with the S&P 500 Index rising 11% on average in the 12-months following the 12 instances of government shutdowns since 1976 according to Bloomberg.

However, we caution that investors should not lose sight of fundamentals at this point in time. In this respect US stocks simply look pricey, with earnings having arguably peaked. We are therefore in a period where US stocks are vulnerable to a correction.

In the current environment Bestinvest favours value managers for US equity exposure, with our top rated fund being GAM Star GAMCO US Equity.


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