Barring a last minute fly in the ointment, it appears that there will be some sort of Debt Ceiling deal in the U.S. Equity markets over the last week have already discounted this outcome by bidding up prices.
So, clear sailing ahead?
Not really.
In fact, from an investment perspective, the whole Debt Ceiling / Government Shutdown debate has been a red herring. There has been almost no surprise element or unknown factors with respect to these debates. We have had a dozen networks literally giving us play-by-play coverage over the last three weeks. The markets tend to hate real surprises, not slow-motion train wrecks that we can see from miles away.
What IS more important to equity markets over the next month is the level of corporate earnings; specifically corporate earnings for the 3rd quarter. It is not as racy and dramatic as political warfare, but the earnings have a greater bearing on the long-term direction of stock prices.
And how are 3rd quarter earnings looking? On the surface, they are not bad. However, companies have been warning of earnings that would be less than initial analysts’ expectations for a couple of months now. As a result, the hurdle is not that high. With expectations lowered, it may appear to be a reasonable “earnings season.”
Unfortunately, that does not change the fact that U.S. corporate earnings are almost unchanged over the last year while the U.S. equity markets are up about 15% over the same period!
The Price-Earnings graph for the S&P 500 almost perfectly overlays the actual graph of the S&P 500, clearly indicating that earnings have been stuck in neutral for the entire year.
The longer that equity markets remain elevated without an eventual corresponding increase in earnings, the greater the chance that prices will come down.
And, the best way to avoid going out with the tide in that scenario is to find individual companies with better-than-average earnings results and earnings growth, or defensive stocks that can maintain their profit margins and may attract a safety premium as a result.
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