Although the S&P 500 is down almost 3% from its mid-September high, it is actually holding up remarkably well given the machinations going on in Washington, DC. However, economists of all political stripes are warning that the government shutdown is damaging GDP growth to the tune of about 0.1 to 0.2 percentage points per week on an annualized basis, enough to push the economy back into recession if a resolution is not reached soon. The fact that the stock market has not sold off even more severely is a clear indication that investors, at least so far, are betting that politicians will come to their senses sooner rather than later and reach some sort of compromise before the debt ceiling is breached around October 17. However, the longer the process takes and the closer we get to October 17, the more severe a sell-off in stocks will become.
This self-inflicted wound to the economy is unfortunate and untimely. There already were signs that the economy was slowing. As discussed in my September 27 post, Wal-Mart (NYSE:WMT), the world's largest retailer, has been cutting back on orders placed with its suppliers. Subscribers to my Money Masters Stock Report know that Wal-Mart's troubles were among the reasons I cited for closing out my recommendation on Children's Place (NASDAQ:PLCE), an apparel retailer. And the job market is still weak. Of course, we can't know for sure how weak since the shutdown kept the Bureau of Labor Statistics (BLS) from publishing the closely watched unemployment rate and nonfarm payroll numbers. I suspect, however, that the three employees still at work at the BLS managed to tip off the White House and the Federal Reserve Bank.
In several recent speeches, President Obama stressed that the Republicans are unnecessarily alarmed about the budget deficit since it has been decreasing. The decrease in the deficit is in part due to this year's increase in taxes, as well as the automatic spending cuts known as the sequester. While both of these measures reduce the deficit in the short run, they have the potential to hamper growth over the long run. In fact, if you look at the budget deficit projections published by the Congressional Budget Office (CBO) in May, the problem becomes clear. The CBO is forecasting deficit reductions each year through fiscal 2015; however, it is also forecasting deficit increases every year from fiscal 2016 on. The CBO also projects increases in debt beginning right away. In fact, according to the CBO, interest on the debt, which is expected to triple in seven years, is the fastest growing expenditure in the budget. So while the deficit projections are trending in a favorable direction right now, it is the longer term that we really need to worry about. Due to the increasing projected debt burden, future budget deficits will not be sustainable.