The market and Congress are locked in a high-stakes game of chicken — and who blinks first will ultimately determine where stocks go next
Reuters
- Congress is set to resume debate over another round of stimulus this week, and how negotiations proceed has the potential to either accelerate the US economic recovery or halt it in its tracks.
- Aid from the last stimulus bill has dried up even as millions of Americans remain jobless. Yet record-setting stock prices "have not really done their job of pressuring Congress into action," Morgan Stanley said in a recent note.
- The scenario is a "chicken or the egg situation," Seema Shah, chief strategist at Principal Global Investors, said. Either Congress expedites its negotiations to avoid additional economic damage, or investors lose hope for a bill, drive a sharp sell-off, and prompt lawmakers to act.
- In Shah's best-case scenario, a package of at least $1.5 trillion in new aid will be passed in early September. Such a deal would help stocks stabilize and continue their rally, she said.
- On the other side of the spectrum, failure to pass a deal would fuel outsized selling and could even send stocks tumbling anew.
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Stimulus negotiations are expected to restart this month, and both lawmakers and investors face dire deadlines in order to keep the US economic recovery on track.
Nearly 29 million people are collecting some form of unemployment benefits, Labor Department data shows. Permanent job losses are also mounting at the same time experts increasingly warn that a wave of small business failures is looming with the flow of federal aid drying up.
Yet the economic devastation stemming from the pandemic hasn't kept stocks from soaring to repeated record highs amid an unwavering commitment from the Federal Reserve to stimulate the economy. The central bank slashed interest rates and announced unprecedented asset purchases, which equity investors took as a green light to buy at will.
This growing disconnect between markets and the underlying economy has left experts pondering which side will blink first: optimistic investors expecting more stimulus, or lawmakers who don't feel urgency to enact more stimulus because the stock market is prospering.
It's created a staredown of sorts — a catch-22 between the two parties, each of which is waiting for the other to act first.
Markets "have not really done their job of pressuring Congress into action," Morgan Stanley economists led by Mike Wilson said in a recent note.
Outside of a market-supported lack of urgency, Congress has also been plagued by infighting. While Democrats call for significant federal spending to keep the economy afloat, Republicans argue its already recovering after lawmakers pumped $3 trillion over the spring.
"It's not that the two sides don't want to provide more support to an economy that still needs it," said Morgan Stanley. "Rather, the disagreement is around how much spending to approve, where it goes and perhaps, most importantly, who gets credit."
Chicken-or-egg situation
Republicans and Democrats are deadlocked on another round of economic relief with fierce disagreements over federal unemployment benefits and aid to states. Democrats are seeking to revive the $600 federal supplement to state unemployment benefits and grant nearly $1 trillion in aid to states.
Negotiations between top congressional Democrats and the White House collapsed after two weeks of fruitless talks in August.
The White House and Senate Republicans aim to pass a smaller relief package. The latter initially introduced a $1 trillion plan in late July, but they failed to coalesce around it. They unveiled a $500 billion stimulus plan on Tuesday that includes a $300 federal supplement to state unemployment benefits and another round of small business aid.
Meanwhile, stocks are within shouting distance of record levels, despite a three-day meltdown that pushed the Nasdaq composite into correction territory. Jason Furman, a former top economic advisor to President Barack Obama, said the trend may have cooled the urgency among lawmakers to enact another stimulus package.
"It's possible the stock market's rise has dented the interest of policymakers," Furman recently told Business Insider. "But I think the stock market may very well be right in rising, but it just isn't telling us about the economy as a whole."
The scenario heading into the fall is a "chicken or the egg situation," Seema Shah, chief strategist at Principal Global Investors, said in an interview.
She noted that if Congress doesn't show progress in passing stimulus come mid-September, markets will turn bearish on hopes for new aid. On the flip side, a stock slide could be just the spark to spook legislators into expediting a deal, the strategist said.
Even if a stimulus deal is passed this month, the "delay effect" on when aid reaches Americans could see economic indicators turn worse before improving, according to Rich Steinberg, chief market strategist at The Colony Group. Recent executive orders from the Trump administration have yielded little immediate relief, and its unemployment program is still several weeks away from being implemented in most states.
"If we don't get a stimulus deal that gets more money back to consumers ... it's going to trickle back into retail sales and other components," Steinberg said in an interview.
Picking a path
Congress remains on track to meet investors' expectations, but its window to approve timely aid is shrinking. The market expects a package of at least $1 trillion to be passed over the next month or so, Shah said.
Waiting any longer jeopardizes a new deal in its entirety. Shah noted that governments are "increasingly reluctant" to increase their fiscal spending as their deficits surge, making debates for passing new stimulus "tougher and tougher." Should policymakers take too long and fail to pass a deal, she sees the resulting investor reconciliation likely driving a steep sell-off.
"If the market was assuming [a deal] wasn't happening, there would be no way for record highs," Shah said.
In Shah's best-case scenario, Congress would pass a package of at least $1.5 trillion in new aid in early September. Funds allocated to widespread programs like unemployment insurance would be sent to localities that need it most.
The market wants to see "some genuine thinking behind where the money is being allocated," she said. The CARES Act already pushed the US deficit to new records, and inefficient spending would only inflame fears of a future budget crisis.
Still, such a bill would solidify stocks' valuations rather than push them higher, according to Shah.
"Are we going to see markets driving another leg higher? I don't think so ... It will push the upper trend a little bit more, but we've seen those easy gains in the equity market," she said. "The upside to the market is still quite contained, it's quite limited. There's a lot more downside potential."
That downside could fuel a market reckoning akin to that seen at the start of the coronavirus pandemic, said Shah, citing the dislocation between stocks and the economy. In her mind, that makes stocks especially vulnerable to a sudden shift in sentiment.
"The further the market moves [upward], the further it has to fall if it's not being driven by strong fundamentals," she said. "The sudden move in the market could be really really quick considering this dislocation has been ongoing."
Shah ultimately sees Congress acting before stocks dive. It remains to be seen whether weakening economic indicators, a party shift, or White House messaging prompts a compromise.
But with the recent three-day skid reminding investors of March's market chaos, traders will be waiting with bated breath for any signs of a policy breakthrough.
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