Washington crisis over …what now?

Federal government workers in the eastern US are on their way beck to work as I’m writing this.  The debt ceiling crisis has been postponed for several months.

What happens next on Wall Street?

On the one hand (the bigger one), I think investors will also go back to their “normal” work.  That is, they’ll:

–continue to absorb information from the 3Q13 earnings season and company guidance about 4Q13 prospects, and

–continue to form expectations for the global economy in 2014.

They’ll reshape their portfolios in response to news.

Here’s what I expect–

Prior to the shutdown, the US economy appeared to be gradually picking up steam.  My guess is that steady progress will resume, after a short air pocket caused by the layoff without pay of government workers.

As for 2014, it will probably be a stronger year for the global economy than this one:

–the EU continues to give signs that its economies have bottomed and are trundling, albeit slowly, down the road to recovery

–China is trending up again, possibly more quickly than the consensus expects

–ex more destructive emanations from Washington, the US will likely continue to have the strongest growth in the developed world.

This analysis suggests that the same equity portfolio structure that produced market-beating results in 2013 should be good for 2014, as well.

On the other hand,

there’s the question of possible stock market fallout from Washington’s continuing dysfunction.  This could come in one of two ways:  investors might demand a higher risk premium for investing in the US than they have previously; or Washington might, by accident or design, do something that further damages the country’s economic prospects.

Who knows?  I certainly don’t   …nor, in my opinion, does anyone else.  Nevertheless, this is an issue.

In situations like this, what professionals do is to try to construct a portfolio where the answer to an imponderable question is unimportant.  This is not a hedge.  It’s an attempt to find stocks where the answer to a thorny question makes little difference.

For example, an investor can:

–rotate European holdings away from multinationals with US exposure toward domestic-oriented firms (something one would probably do anyway)

–shift away from domestic names in the US toward companies with EU or Pacific ex Japan exposure

–get China exposure through Hong Kong stocks instead of US ones

–opt for secular growth companies rather than business cycle-sensitive ones.

I think professionals will do all these things.

In addition, foreign pms will probably opt to hold less in the US.  Domestic US managers may do so as well–although this would be an active portfolio response to the question of the future tone of Washington policy, rather than simply a way to make it as irrelevant as possible.

The net result will be to take some of the shine off US equities.  They’ll still go up, in my view, but not as much as if the government shutdown had never happened.



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