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Weekly Market Digest: Government Shutdown and Brexit Loom Large

Major US indices strung together a fourth straight week of gains and finished the week strong on optimism over US and China trade negotiations. Financials were the strongest performing sector for the week with several of the major US banks reporting earnings to kick off the start of earnings season. However, the most notable event of the week was the duel for the most dysfunctional government display which continues to take place on both sides of the pond. The US government shutdown started the week by breaking a record for longest on record, now entering day 28. The US was the clear front runner, until UK Prime Minister Theresa May’s Brexit deal made history as the largest ever government defeat on the floor of the House of Commons, which lost by a staggering 230 votes. If there were any doubts on who deserved the crown, Britain followed that up with a vote of no confidence on whether the existing government should continue, in which May barely survived.

Weekly Returns

S&P 500: 2671 (2.87%)
FTSE All-World ex-US (VEU): (1.81%)
US 10 Year Treasury Yield: 2.79% (.08%)
Gold: $1,281 (-0.49%)
EUR/USD: 1.1368 (-0.88%)

Major Events

  • Monday – PG&E announced plans to file for bankruptcy citing massive potential liability from the recent California wildfires.
  • Tuesday – UK Prime Minister Teresa May’s proposed Brexit deal lost by 230 votes, which made it the largest defeat for a sitting gov’t by British Parliament in history.
  • Tuesday – Large Banks kicked off the start to earnings season reporting mixed results.
  • Wednesday – May survived a “vote of no confidence” put forth by Labour leader Jeremy Corbyn by a slim margin.
  • Wednesday – President Trump signed the Government Employee Fair Treatment Act of 2019, a bill that requires the compensation of government employees affected by the ongoing US government shutdown.
  • Thursday – Netflix reported fourth-quarter earnings of a slight revenue miss and earnings beat with strong subscriber growth numbers, which caused the stock to trade down about 3% in after-hours trading.
  • Friday – Trade optimism lifted markets after a report surfaced late Thursday that U.S. Treasury Secretary Steven Mnuchin was considering lifting some or all tariffs imposed on Chinese imports.

Our Take

Negotiations for funding the US government have been at a standstill over border wall funding and disagreements about when to reopen the government. This has disrupted nine Federal Departments, specifically (over 800,000 federal workers) the Departments of: Agriculture, Commerce, Justice, Homeland Security, Housing and Urban Development, Interior, State, Transportation, and Treasury. Despite what looked like some signs of concession this week, there have not been any significant developments to suggest much progress.

President Trump has already stated he won’t sign a bill unless the border wall funding is included. Eventually, someone will cave to political pressures and will budge as this has a real effect on people’s lives. Either there will need to be compromising from one or both sides, or Democrats and Republicans could band together to pass a spending bill with a veto-proof majority to fund the government without Trump’s approval, which seems the least likely.

So far, the shutdown has had minimal impact on the overall US economy, but there is clear disruption in certain pockets of the economy and significant impacts on the individual government workers affected. The White House recently doubled its own estimate of the economic growth impact from the shutdown estimating it would now trim first quarter GDP by .5% if it lasts through the end of January, which appears to be on the higher end of estimates. However, many people are not receiving paychecks, some key economic data figures are not being reported, and pain is being felt by many. If these things continue for too long, eventually there would be a larger impact on the economy and the market would not be able to ignore it. History has shown past shutdowns have had very little impact on stock markets, but the longer this shutdown lingers, the more the risks increase. While we are cautiously optimistic there will be a resolution in the coming weeks and we do not foresee a significant impact on the broader economy, there is still a real risk there could be if a resolution is not reached soon.

Meanwhile, across the pond, the UK is scheduled to leave the European Union on March 29, 2019. A European court ruled that the UK can stop the process, or it can be extended if all 28 EU members agree. However, Theresa May already put it into British law, so stopping Brexit would require a change in law. The biggest risk for Brexit would be a “hard Brexit”, meaning no deal and the UK leaving the EU without access to the EU’s single market and customs union. Fear of this is May’s best leverage in negotiating a deal, so she is unlikely to remove this potential outcome in negotiations. If a hard Brexit did happen it would be a significant blow to the UK economy and ultimately spill over into Europe.

Equity and currency markets appear to be pricing in a soft Brexit as the likely outcome with the British pound rallying throughout the week and global markets posting a solid week of returns. It is worth mentioning that this week’s developments reaffirm that a hard Brexit is still a real risk for the UK. There is also still a small but notable chance that it goes back to vote and there is no Brexit, which would likely be Bullish for markets. Ultimately, we think the most likely scenario will be a negotiated exit, and the UK will be able to avoid a hard Brexit. If they don’t, they would likely face a self-induced, potentially devastating impact on the British economy. Not only would it impact trade, but a hard Brexit might also result in companies relocating from the UK to be a part of the European Union and cause major disruption in Britain’s currency and capital markets. The UK is the 5th largest economy in the world, so the global impact would be noticeable, but not enough to cause a global recession on its own. However, this sort of instability would be particularly concerning in what appears to be a larger theme of slowing global growth. We will continue to monitor these events for new developments.

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