Markets Trust Washington, But For How Long?

Markets Slide Downward As Government Shutdown Enters Second Week
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By Dhara Ranasinghe

Global financial markets are holding out for a deal in Washington to avert a debt default in the world's biggest economy. But that patience could fade quickly if a deal isn't reached soon, analysts say.

Talks to end a partial shutdown of the U.S. government and raise the debt ceiling before a looming Oct. 17 deadline stalled once again Tuesday.

A growing number of voices including the International Monetary Fund and World Bank have warned about the consequences a U.S. default would have on the global economy and on Tuesday Fitch Ratings warned that it could cut the U.S.'s top-notch AAA sovereign credit rating.

"It's interesting that even as we've seen this deadline [Oct. 17] approach, we've not seen quite the degree of strain we would have expected in currency markets," Citi Currency Strategist Todd Elmer told CNBC Asia's "Squawk Box."

"But when we look at other asset markets, in particular the rise in short-term interest rates, those strains are starting to build. And I would expect ... over the next 24 hours and the next few days that we could start to see more fall out in the FX markets," he added.

Lawmakers in the U.S. Senate could announce a deal soon to extend the government's debt limit until February and re-open the government following a shutdown that began on Oct. 1, Reuters quoted a Senate aide as saying.

Hopes for an agreement lifted U.S. stock futures and Asian stocks in early Asian trade Wednesday. The dollar was also slightly firmer against major currencies, trading 0.4 percent higher on the day at 98.53 yen.


"I think people really have been too complacent about what's been going on here," said Adrian Mowat, chief Asian and emerging market equity strategist at JPMorgan (JPM).

"The Senate and the House are completely split on what their objectives are. It is possible that we get to the end of this week and there is no deal, judging by what is going on in Washington today [Tuesday]," he added.

%VIRTUAL-article-sponsoredlinks%The U.S. Treasury expects to hit its $16.7 trillion borrowing limit Thursday, risking the government's ability to pay its bill to its creditors.

Analysts say that although the government is expected to have enough funds to keep it going for a while longer, the failure to reach an agreement on the debt ceiling raises the prospect of a debt default and would be a damaging blow to confidence in holding U.S. assets.

Ward McCarthy, chief financial economist at Jefferies, told CNBC that he visited Asia last week and investors there are becoming impatient. "I can attest to a frustration level that has gone from simmering to close to boiling over," he said.

Investor patience could also be tested if any deal pushes back deadlines for agreement on federal spending and the debt ceiling, indicating that the political wrangling of the past few weeks could be repeated in a few months' time.

"When we get a deal it will be pushed through to Jan. 15, where we will debate and try and avoid a new government shutdown, which coincides with spending cuts that kick in on that same day," said Chris Weston, chief market strategist, at the trading-firm IG.

"Then Feb. 7 could be [the deadline] for a new debt limit extension and boom we're back to square one," he added.

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If You Only Know 5 Things About Investing, Make It These
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Markets Trust Washington, But For How Long?

Warren Buffett is a great investor, but what makes him rich is that he's been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time.

Most people don't start saving in meaningful amounts until a decade or two before retirement, which severely limits the power of compounding. That's unfortunate, and there's no way to fix it retroactively. It's a good reminder of how important it is to teach young people to start saving as soon as possible.

Future market returns will equal the dividend yield + earnings growth +/- change in the earnings multiple (valuations). That's really all there is to it.

The dividend yield we know: It's currently 2%. A reasonable guess of future earnings growth is 5% a year. What about the change in earnings multiples? That's totally unknowable.

Earnings multiples reflect people's feelings about the future. And there's just no way to know what people are going to think about the future in the future. How could you?

If someone said, "I think most people will be in a 10% better mood in the year 2023," we'd call them delusional. When someone does the same thing by projecting 10-year market returns, we call them analysts.

Someone who bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012. That's great! And they didn't need to know a thing about portfolio management, technical analysis, or suffer through a single segment of "The Lighting Round."

Meanwhile, the average equity market neutral fancy-pants hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average long-short equity hedge fund produced a 96% total return -- still short of an index fund.

Investing is not like a computer: Simple and basic can be more powerful than complex and cutting-edge. And it's not like golf: The spectators have a pretty good chance of humbling the pros.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time -- every single time -- there's even a hint of volatility, the same cry is heard from the investing public: "What is going on?!"

Nine times out of ten, the correct answer is the same: Nothing is going on. This is just what stocks do.

Since 1900 the S&P 500 (^GSPC) has returned about 6% per year, but the average difference between any year's highest close and lowest close is 23%. Remember this the next time someone tries to explain why the market is up or down by a few percentage points. They are basically trying to explain why summer came after spring.

Someone once asked J.P. Morgan what the market will do. "It will fluctuate," he allegedly said. Truer words have never been spoken.

The vast majority of financial products are sold by people whose only interest in your wealth is the amount of fees they can sucker you out of.

You need no experience, credentials, or even common sense to be a financial pundit. Sadly, the louder and more bombastic a pundit is, the more attention he'll receive, even though it makes him more likely to be wrong.

This is perhaps the most important theory in finance. Until it is understood you stand a high chance of being bamboozled and misled at every corner.

"Everything else is cream cheese."
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