Pedestrians pass in front of the New York Stock Exchange (NYSE) in New York, U.S. (Photographer: Michael Nagle/Bloomberg)

Analysts Say Brace for a Steeper Plunge as Shutdown Drags On

(Bloomberg) -- The year-end rout in financial markets may get worse as U.S. stocks fell 1 percent at 9:45 a.m. in New York Monday. Analysts and strategists say investor sentiment is weakening further amid the federal government shutdown, with no quick end in sight.

The S&P 500 Index has fallen more than 13 percent just in December, on pace for the steepest monthly decline since October 2008, as fear of a possible slowdown in the new year gripped the market. Recent cautious commentary from economic bellwether FedEx Corp. stoked concerns, with warnings about slowing global trade and weakness in the European economy. Investors are also possibly pricing in the impact of a policy error by the Federal Reserve and a weak Chinese economy.

Given the bearish backdrop, a prolonged shutdown can only mean one thing: more sell-off.

Analysts Say Brace for a Steeper Plunge as Shutdown Drags On

“Risk aversion is now extreme; even though the Street may point to a ‘less dovish’ FOMC and concerns about a U.S. government shutdown as possible reasons for the selloff, the apparent lack of positive drivers and headlines has curbed risk appetite,” Nomura strategist Masanari Takada wrote in a note. “While sentiment looks to be skewed towards fear, most market participants seem to be looking for a plausible excuse to sell.”

The bone of contention in the standoff between the two parties is the funding for President Donald Trump’s border wall with Mexico. The next possibility for votes in the House and Senate is Dec. 27, but Democrats have indicated the two sides are far from a deal.

“Best/unlikely case to end partial U.S. Government shutdown would be post-Christmas deal when Congress returns Thursday,” Cowen analysts Roman Schweizer and Cai von Rumohr wrote in a note to clients. “Worst/likely case is after Jan. 3 when Democrats get the House back. We do not see Democrats funding Trump’s Wall.”

Government contractors such as technology service providers may feel some pressure, although Cowen expects any financial impact to be very minor. Science Applications International Corp. might be among the most exposed as its three large NASA programs account for an estimated 7 percent of sales, but Cowen expected the impact to be modest.

While the current shutdown affects only nine out of the fifteen cabinet level departments, and excludes the Department of Defense, the uncertainty will be an overhang on defense stocks.

Jefferies analyst Sheila Kahyaoglu sees “an overhang around the fiscal 2020 budget negotiations that will require compromise on both sides of the aisle and a Budget Agreement to repeal the Sequester.” Defense stocks suffered a setback last week after Secretary of Defense James Mattis resigned following Trump’s announcement about withdrawing troops from Syria.

Mattis’s resignation could be a “material negative event” for 2020 budget negotiations, Credit Suisse analyst Robert Spingarn said on Dec. 21, noting that Mattis enjoyed broad bipartisan support. The S&P Supercomposite Aerospace and Defense Industry Index (S15AERO) has dropped more than 14 percent this month, paced by Triumph Group Inc., Arconic Inc., Textron Inc., and General Dynamics Corp.

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