US GOVERNMENT SHUT-DOWN & DEBT CEILING
It’s Implications on Stock Markets
US Government Shut-Down on 1st October 2013
Debt Ceiling on 17th October 2013
US Government Shutdowns: It is a political situation in which the government stops providing for all but "essential" services such as police, fire fighting, military, agriculture, etc. So unless Congress raises the federal borrowing cap (the legal limit on how much debt the US government can pile up), some of the government would shut down on October 1 as it will run out of money to pay its bills.
Debt Ceiling: The US government will reach the limit at which it can borrow money to pay its bills, the so-called debt ceiling.
Haggling and grandstanding went on into the night, with hope of a last-minute deal, but no agreement could be reached. With no deal on emergency funding for the Government, it was allowed to run out of money as the fiscal year ended. The sticking point remained Republican opposition to the funding of the Affordable Care Act, President health care reform. The Republicans want the law amended and delayed.
Stocks and other asset classes now have to negotiate a tricky few weeks of new territory. After Monday’s midnight deadline, Congress now has to agree to raise the United States’ $16.7 trillion debt ceiling by October 17 so America can avoid defaulting on its debt.
The government shutdown and threat of a default on the federal debt reminds many investors of 2011 when a similar stand-off in Washington led to the United States losing its AAA credit rating and helped prompt a stock market correction.
The US federal government has shut down on 17 occasions since 1976.
A three-week shutdown would slow the economy's annual growth rate in the October-December quarter by up to 0.9 percentage point, estimates. If so, the growth rate next quarter would be a scant 1.6 per cent compared with the 2.5 per cent that many economists now forecast.
What if Congress can't agree to raise the cap in time? It could be disastrous. The government might be forced to immediately slash spending by 32 per cent, estimates. The government could miss interest payments on Treasuries, triggering a first-ever default by the U.S. government. U.S. Treasuries are held by banks, governments and individuals worldwide. Ultimately, a prolonged default could lead to a global financial crisis.
The last major fight over the borrowing cap, in the summer of 2011, wasn't resolved until hours before the deadline. Even though the deadline was met, Standard & Poor's issued the first-ever downgrade of long-term U.S. credit. That, in turn, led to a 635-point plunge in the Dow Jones industrial average the next day. The International Monetary Fund estimated last month that U.S. budget disputes, like the 2011 showdown, can slow annual growth by up to 0.5 percentage points in other parts of the world.
• 1995-96 government shutdown. The S&P 500 fell 3.8% during the government shutdown period that ran from mid-December 1995 to early January 1996. The good news is stocks quickly rebounded after the government got back to work, rising 10.5% in the subsequent month.
• Debt ceiling fight in summer 2011. Stocks took a big hit despite Congress' last-minute deal announced by President Obama on July 31. The damage from political dysfunction was already done. A credit-rating agency, put the USA's triple-A rating on "negative watch" on July 13, to the actual downgrade from S & P on Aug. 5 and through the Aug. 10 low, the Dow tumbled 1,700 points, or nearly 14%. The Dow didn't make back those losses until five months later.
• 'Fiscal cliff' fears December 2012 - After Obama won a second term, Wall Street shifted its focus to the automatic government cuts and tax hikes, dubbed the "fiscal cliff," that were looming at year's end 2012. From the Dec. 18 high to the Dec. 28 low, the Dow fell more than 400 points, or 3.1%. But after Congress averted the cliff and softened the fiscal blow with a Jan. 1, 2013, deal, the Dow soared more than 300 points on the first trading day of 2013, wiping out all its losses.
According to estimates, if a shutdown occurs, stocks will likely suffer just a "temporary setback," as they did in 1995-96 and the recent fiscal-cliff fight. However, a default and adverse credit event for the U.S. could be "immeasurably more disruptive," more akin to 2011's debt-ceiling fight.
Nothing has changed between 2011 and 2013 that bolsters confidence in the ability of the United States Congress to behave differently.
Stock market crashes of 1929, 1987, and 2008 all occurred in October, which is coincidental, but another harbinger that lurks on the horizon. Traditionally, investors breathe a little easier when the first of November rolls around, although this coming October could feel a bit longer than usual with a full 23 days of trading, the most possible for the month.
What it means for Indian stock Markets?
During the last Debt Ceiling issue in US in August 2011, the Dow Jones plunge more than 15% in 1 month period, which had created corrections in all the markets in the world.
CNX Nifty the benchmark index of Indian stock market also plunge from the levels of around 5500 to 4700 in the month of August 2011 before closing the month around 5000 levels. Nifty also corrected a whopping 10% for the month.
On 1st October trading session following changes where absorb in Open Interest in Index:
5400 PE: + 1015000 5900 CE: + 280000
5500 PE: + 400000 6000 CE: + 340000
5600 PE: + 600000 6100 CE: + 400000
5700 PE: + 700000 6200 CE: + 330000
Total PUT OI Change: 4500000 CALL OI Change: 2300000
Current Month Nifty Futures OI: + 590000
The PCR OI for the current month stands at 1.25 levels
From the above data it is indicative that the Puts are being bought for the Hedge with slight increase in PUT volatility.
Technically also a close below 5720 – 5750 levels on closing basis on Cash Nifty will open the downside risk to 5350 levels in coming weeks.
So theme here is be invested but hedge (protect) yourself from downside.
We believe every dip towards 5350 – 5500 levels should be used to add stocks to your portfolio for long term.
Shaurya Mehta - CEO, Metcon Finance Ltd.
Jagrut Shah - Research Analyst, Metcon Finance Ltd.
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