Look, I don’t want to pretend like I’m the angel of social justice (I do enough masquerading of that nature on my own site) and really, just to keep it real with you people, I don’t even want to pretend like I care all that much about the fact that due to abject congressional ineptitude, the U.S. government partially shut down over the weekend.
Fact is, it doesn’t affect me and chances are, it doesn’t affect you either. And let me tell you something else it doesn’t really affect: equities.
Over the past week, every sellside desk on the Street has been hard at work creating charts that document how various assets have responded during previous funding gaps and shutdowns. Without subjecting you to the details, suffice to say the impact of these episodes is generally muted. If the current Beltway wrangling ends up getting entangled with the debt limit, then the potential exists for problems, but given what the presidential Twitter feed tells us about Trump’s commitment to preserving the rally, it seems like he’d sooner put up a family of Mexican meth dealers in the White House than he would risk a technical U.S. default and all that would come with it for markets.
Also, it isn’t really the stock market’s job to punish politicians for acting reckless until those reckless actions pose a clearly identifiable threat to all of the things the market actually is supposed to care about. As a reminder - because everyone seems to have generally forgotten this over the past several years - the market is supposed to be a price discovery mechanism; an efficient way for capital allocators to, well, to allocate capital in accordance with their tolerance for risk. Under normal circumstances, that risk tolerance determines what they can expect as far as returns. Of course the extent to which that’s still true is debatable. Here’s how Salient’s Rusty Guinn put it late last month:
Markets have been made into a utility. More to the point, they have been made into a political utility, a tool for ensuring wealth and stability of our political structures. The easing tools we dabbled in to stabilize prior business cycles were brought to bear instead as tools for propping up and expanding financial asset prices. Beyond the direct marginal price impact of the easing itself, central bankers tailored communications policies to create Pavlovian responses to every narrative. Our President tweets about the policy implications when the S&P 500 hits new highs, for God’s sake. This isn’t a secret, y’all.
It would be difficult to put any more succinctly than that. Of course one problem here is that to the extent the market has become a political utility and a tool for ensuring wealth and stability of political structures, the power that comes with that for market participants is concentrated in the hands of a relative few.
Implicit in the arrangement described there is the notion that market participants can themselves dictate policy even as the policies their actions have a role in shaping dictate those same actions. The policy narrative is not self-contained. It is constantly evolving and can be influenced by the very people who are affected by its evolution. If you and everybody who looks like you sells, well then there are implications for policy, both monetary and fiscal due to the market’s newfound role as a political utility.
To be sure, this has always been the case in extreme circumstances, but in the post-crisis world, governed as it is by forward guidance, it has become a real-time information exchange between those who set policies and market participants. As I’ve previously described it, policy has become a kind of rolling plebiscite with no preset course.
But if you take a look at the composition of stock ownership in America, it’s clear that whatever power markets have in terms of influencing policy is concentrated in the hands of a small minority:
Given that, it should come as no surprise that on the rare occasions when markets looked shaky in 2017, the proximate cause was in many cases uncertainty about the future of the tax cuts.
There were three instances last year when banks (the KBW index), energy shares (XLE) and big-cap tech (QQQ) all declined by 1% in the same day. One of those three days was August 17, the day a rumor began to circulate among traders that Gary Cohn was set to resign in disgust following the Charlottesville debacle. Any guesses why that was a particularly distressing rumor for market participants? Hint: it’s wasn’t because everyone loves Gary Cohn. Rather, it was because everyone assumed that if Cohn left, the tax cut push would die on the vine. And who do the tax cuts benefit disproportionately? Well, the very same people in whose hands financial assets like stocks are concentrated.
Subsequently, the administration used that episode to push for the tax cuts. Mnuchin, for instance, said this in a podcast with Politico back in October:
There is no question that the rally in the stock market has baked into it reasonably high expectations of us getting tax cuts and tax reform done. To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done you’re going to see a reversal of a significant amount of these gains.
Meanwhile, Trump continually touted record highs in stocks and variously suggested they would go even higher if the tax cuts became law.
The irony there is that the audience wasn’t really investors. The turmoil that hit markets on August 17 demonstrated beyond a shadow of a doubt that Mnuchin and Trump were preaching the proverbial choir as far as real market participants were concerned. The people who hold the most stocks and who have the most skin in the game are by definition the people who would benefit the most from the tax cuts which is why they got so damn nervous when it looked like Cohn might have had enough white supremacy for one lifetime.
So why bother talking up the connection between stocks and the tax cuts? Well, because Trump had to convince all the everyday Americans who own relatively few stocks to effectively vote against their own self-interest by not rebelling against a tax plan that disproportionately benefits people who definitely aren’t them. As Bloomberg reminds you, “only about 45 percent of private-sector workers participate in any employer-sponsored retirement plan, and the lower-income workers in Trump’s political base are the least likely to hold money in such an account.”
In short, for markets to serve as a tool for ensuring the stability of political structures, even those whose stake in those markets is pitifully small have to believe they have a vested interest in those markets. If you can convince them of that and you can plausibly tie the fate of those markets to something you want to get done (like say, a corporate tax cut), well then you can effectively fool people into acquiescing to something that actually doesn’t benefit them.
But note the problem with this arrangement. The composition of stock ownership in America clearly suggests that to the extent policy is affected by what happens in markets, the power to affect policy rests increasingly in the hands of those who aren’t likely to focus on issues that matter to the vast majority of Americans. Note also that because the benefits of an ongoing rally in stocks accrue exponentially (i.e. in a nonlinear way), ownership of financial assets will by definition become more concentrated over time. If a selloff in stocks is a threat to the stability of political structures (as would be the case if markets have become a political utility) and the ability to create that selloff rests increasingly in the hands of people whose interests aren’t aligned with society’s interests more broadly, well then what you end up with is a system where the market only punishes legislative ineptitude when that ineptitude imperils legislation that somehow advances the interests of those in whose hands financial assets are concentrated.
How do central banks factor into this equation? Well, if what the above-mentioned Rusty Guinn says is true (and I think it is), their unspoken mandate basically amounts to perpetuating the system, but perhaps more importantly, to ensuring that in the event all of this goes horribly wrong, the ATMs won’t go dark. Perversely (and this is the great irony of the post-crisis policy regime), staving off a painful purge of misallocated capital like that which would have occurred in the aftermath of Lehman had policymakers not intervened, entails adopting policies that exacerbate inequality. I’ve variously suggested that when it comes to central bankers, that’s an unfortunate side effect rather than a nefarious attempt to harm society.
So given all of that, it’s no fucking surprise that the only thing Congress has managed to do over the past year is pass a corporate tax cut. To the extent the market can influence policy whether fiscal or monetary (lighting a fire under lawmaker asses in the former case and prompting dovish forward guidance in the latter) that influence is collectively wielded by people who, on balance, don’t give a good goddamn about what’s going on in D.C. unless there’s a readily apparent connection to their money.
Maybe - just maybe - if everyone suddenly sold everything and the VIX spiked to 25, all of those lawmakers who are quite literally getting paid to not do their job on Monday would huddle up and figure something out. But no one gives a shit right now because what’s on the line are immigrants and you know, rich people can always find another groundskeeper on the off chance José gets picked up by ICE in the middle of manicuring a hedge animal by the pool.
Remember how I said “I don’t want to pretend like I’m the angel of social justice”?
Yeah, I was lying.