The debt ceiling is widely seen as more important than the government shutdown, but as the two events get closer together, MoneyShow's Tom Aspray examines the technical evidence for signs of potentially deeper corrections ahead.
As we ended last week with no end in sight for the government shutdown, the economists were weighing in on its potential impact. In a recent WSJ article, the conclusion was that "The furloughs are likely to knock 0.1 to 0.2 percentage point off the annualized rate of fourth-quarter economic growth for each week that it lasts."
There are a wide range of views as some feel that the chances of a big economic shock and severe market decline have increased significantly while others worry about the complacency. Others are not expecting such a significant impact as they feel that the markets have already priced it in and a "shutdown for a couple of weeks would be unlikely to be detrimental."
There is more agreement regarding the impact of a failure to raise the debt ceiling but most feel that the adults won't let that happen. Global monetary authorities are also voicing their opinions as the IMF's Christine Lagarde expressed her concerns over the debt ceiling while the ECB's Mario Draghi is concerned over the impact of a prolonged government shutdown.
In the past two years, there have been three example of politically induced panic selling. The first started in late July and early August of 2011 as the debt ceiling debate ended in a stalemate. This was a decline that was difficult to withstand as the S&P fell from an early July high of 1356 to an October low of 1074. This was a drop of 20.8% from high to low. Soon after the October low, there were clear signs from the market internals that a low was in place.
The markets also reacted poorly to the re-election of President Obama as the Dow Industrials lost 800 points in eight days. The next month, stocks dropped 3.5% at the end of December in reaction to the fiscal cliff stalemate. Before this decline, the A/D line broke out to the upside indicating a pullback would be a buying opportunity.
I would not be surprised to see a 3-5% decline if the government shutdown persists for another week or so. A failure to raise the debt ceiling before the deadline is likely to have a much more severe impact on the global equity markets.
There are no signs of panic in the bond market as yields have declined in an orderly fashion. The weekly chart of the 10-year T-note yield shows the recent top in yields as first support in the 2.545% to 2.636% has been reached. The 38.2% Fibonacci retracement support is at 2.372% with the 50% at 2.197%. This is the likely downside target zone for the fourth quarter.
The daily chart of the Vanguard Total Bond Market ETF (BND) does show a completed bottom formation on the daily chart. From the late April highs to the early September low, BND lost over 6%.
The daily on-balance volume (OBV) formed a bullish divergence, line c, at the lows. The bottom was confirmed by the move through the downtrend, line b, and the July high. The next level to watch is the 38.2% Fibonacci retracement resistance at $81.54 and then the 50% at $82.54. This decline in yields should be an opportunity to shorten the maturity of your bond holdings and reduce your exposure to the long end of the bond market.
The Eurozone markets, like the Dax Index have not yet been hit with heavy selling. It is still up well over 44% since the June 2012 lows and is just 2% below its recent highs. The % change chart of the S&P 500 shows that it is now up 31%, which is down from last month's high of 34.5%.
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