I’ve spent quite a bit of time over the past couple of days talking with advisors about the potential consequences if the government doesn’t make a deal in time. Yesterday, I did an interview with Chuck Jaffe of MoneyLife Radio that focused on exactly that. As we move closer to the supposed drop-dead date—that would be tomorrow—I thought it would be useful to look at how I’m thinking about investing.

First of all, let’s hit a couple of points I’ve made before. In the longer term, the events of the next week or so will not be significant. The U.S. economy is diverse, solid, and set to outperform for at least the next 20 years and probably more. Markets will reflect that growth, and, longer term, you absolutely want to be invested here. At the same time, current valuations are at the very least not cheap, and it’s been some time since we’ve had a correction in the U.S. stock market. Quite apart from the current situation, we are overdue. Again, this isn’t to minimize what might happen, simply to put it in context.

First of all, thank you to everyone who wrote nice things about my appearance on CNBC yesterday—much appreciated. It’s fun to do that kind of appearance because you never know exactly what will be discussed, and you have to prepare. Keeps me on my toes!

This will be a short post because I’m in New York attending a conference on ETFs put on by iShares. ETFs, for those who haven’t run into them, are exchange-traded funds—that is, a portfolio of assets (stocks, bonds, what have you) that is traded like a single share of stock. They are similar to a mutual fund that tracks a specific stock or bond index, such as the Barclays Capital 1-3 Year Treasury Index. ETFs trade on one of the major stock markets and can be bought and sold throughout the trading day, like a stock, at the current market price. And, like stock investing, ETF investing involves principal risk—the chance that you won’t get all the money back that you originally invested—market risk, underlying securities risk, and secondary market price. ETFs have become a major part of the investing landscape over the past several years, changing the way many people and institutions invest.

Over the weekend, I traded e-mails with one of our advisors, who pointed out that I hadn’t yet done a complete explanation of the situation in Washington, DC. Sure, I’d touched on various aspects of it, but I hadn’t really looked at the thing as a whole. So here’s my take. Thanks, Alex, for the great idea!

The Big Picture

One of the great things about working at Commonwealth is the depth of knowledge of our team. Today, we have another post from Peter Essele, one of our portfolio managers and analysts.

The consequences of the debt ceiling standoff and government shutdown continue to reverberate. Markets are increasingly showing signs of nervousness, with excess volatility tracking news reports as they come out of DC.

I’ve been reviewing my posts and articles from the last time we went down the debt ceiling crisis road, and marveling a bit. Trillion-dollar coin indeed! That post proved to be prescient in a lot of ways, although 10 months early. The options I outlined there remain the most probable this time around, but no one has been trotting them out so far. Instead, the discussion has revolved around how to make payments once we run out of money.

I don’t like the spirit of despair that this kind of planning reflects, and I think I have a better idea about how to solve the problem. It requires no issuance of coins, no scrip rather than cash—although the difference is small—and no constitutional confrontation.

As we move into the second week of the shutdown—and another day closer to running out of room to maneuver around the debt ceiling—cracks are starting to appear.

On the political level, there’s an apparent disconnect between a White House potentially willing to accept a short-term rise in the debt ceiling and a Senate holding out for a longer-term deal on the Democrat side. In the Virginia governor’s race, the Democrat appears to be gaining an edge from the shutdown. The Senate Democrats are talking about passing a clean continuing resolution themselves, rather than waiting for one from the House Republicans—who have been taunting them about their unwillingness to force Democrat senators to make a potentially tough vote. In short, we’re seeing the usual political circus.

The government shutdown has gotten most of the press coverage so far, but there is a related and bigger issue pending in the next couple of weeks: the debt ceiling. Although the federal government has partially shut down, it continues to spend money on many items. Normal government financing requires regular additional borrowing, as we typically spend more than we take in.

I hate writing about politics, I really do. But, as we’ve seen repeatedly over the past couple of years, politics is now economics, and, therefore, it behooves us to get to grips with what that means for our country—and our investments.

One of the driving memes about Obamacare has been that it socializes a large section of the economy. The Republicans use this as an argument against, while the Democrats by and large see it as a feature, not a bug. The destination on the horizon, for both, is a more European polity. That means slower growth and stagnation for the Republicans and more social justice for the Democrats—in any event, a more European-style economy.

The market has bounced around without a lot of direction over the past couple of days, popping up this morning after a rough showing yesterday. What’s going on?

Ultimately, stock prices reflect corporate earnings per share, and the bouncing prices can credibly be tied to expectations about what the government shutdown and potential debt ceiling confrontation will mean for those earnings. The changes in prices reflect the market’s attempt to come to grips with what we can expect to see over the next couple of quarters.