Washington dysfunction looms over markets as September approaches

Squabbles over the budget, debt ceiling could roil your clients' investment portfolios

Aug 24, 2017 @ 2:11 pm

By John Waggoner

Most investors and advisers try to steer clear of politics. But two big events — a possible government shutdown and a potential default — could make the markets choppy in the next few months, and it's probably best if advisers brief their clients about them now.

The two events may not be the first thing on clients' minds.

"It really hasn't been brought up by clients," said Peggy Ruhlin, chief executive and financial planner at Budros Ruhlin & Roe Inc. "They're more concerned with the bigger picture."

And that, she says, generally revolves around their opinion of President Donald J. Trump.

At the moment, at least, neither clients nor the markets seem to be terribly worried about an impending disaster.

"People seem to be ignoring what goes on D.C., and that might not be a bad thing," said Jonathan Pond, president of Jonathan Pond LLC.

But Washington's woes could affect them.

"People who say they aren't concerned are ignoring certain facts on the ground," said Gary Schatsky, president of ObjectiveAdvice.com.

The first problem: Unless the government passes a budget, or more likely, a continuing resolution, by Sept. 30, the government will be forced to have a partial shutdown. The U.S. mail would continue, and essential employees, such as soldiers and FBI agents, would continue to work.

Other federal employees, however, would be furloughed. They will be paid for their missed days when Congress reaches a budget agreement, essentially paying them for not working. National parks and museums are likely to be shut down, and those seeking passports and other government services would likely have to wait. Contractors may also face delayed payments.

The second problem: The federal debt ceiling currently stands at $19.8 trillion. Above that level the government has to resort to extraordinary maneuvers to finance the difference between what it gets in revenue and what it spends. Unfortunately, the government has some large bills due in early October, and Treasury Secretary Steven Mnuchin told Congress on July 28 that the government will run out of money sometime around September 29.

Of the two, failing to pass a budget is viewed as the least problematic, since Congress is likely to pass a continuing resolution to fund the government for some interim period until a budget agreement is reached — despite Mr. Trump's threat Tuesday to shut down the government if the bill does not include funds for a wall on the Mexico border. Senate majority leader Mitch McConnell, R-Ky., said August 4 there would be no government shutdown.

Failing to raise the debt limit — which Congress has done 78 times previously — could mean the government would be unable to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds and other payments.

"Failing to increase the debt limit would have catastrophic economic consequences," the Treasury said on its website. "It would cause the government to default on its legal obligations — an unprecedented event in American history. That would precipitate another financial crisis and threaten the jobs and savings of everyday Americans — putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession."

Most of Wall Street agrees. Although the government could withhold payments for all but Treasury debt, stiffing employees, contractors and other obligations is not the behavior generally associated with an AAA credit rating, which the U.S. enjoys from Fitch and Moody's. Standard and Poor's downgraded the U.S. from AAA (outstanding) to AA+ (excellent) on August 5, 2011, in the middle of the last major fight over the debt ceiling.

"We have previously said that prioritizing debt service payments over other obligations if the limit is not raised — if legally and technically feasible — may not be compatible with 'AAA' status," Fitch said in a statement.

Making matters more problematic: The next congressional session begins on Sept. 5, with only 12 congressional working days before month-end.

Dan Wiener, co-founder of Adviser Investments, said he's not worried about the shutdown or the possibility of a default.

"We've had a zillion shutdowns — it's all sturm und drang and doesn't mean anything," he said.

And, he pointed out, the bond market doesn't seem particularly concerned about the possibility of a default, since yields on the 10-year Treasury note have been falling the past few days. Bond yields would be rising, not falling, if traders were worried about default.

"Nobody thinks it's going to happen," he said.

For advisers, one problem is what can be done to protect a client's assets if the nation lurches into default.

"It simply gives people more factors of concern," Mr. Schatsky said. "It's more likely to make people reallocate and trim back equities a bit."

For Mr. Pond, the best advice would be to rebalance portfolios that have gotten too equity-heavy.

"I've already rebalanced twice this year," he said.

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