Record S&P shows investors unfazed by U.S. gridlock

Investors are no longer letting political uncertainties in Washington keep them from pouring money into U.S. stocks.

Lawmakers show no signs of agreeing on a federal budget for the 2014 fiscal year, which may trigger more automatic spending cuts in a matter of months. They face a Feb. 7 deadline for raising the nation’s borrowing limit. And questions remain about how the Affordable Care Act will affect what Americans pay for health care. Even so, the Standard & Poor’s 500 Index climbed to a record last week and is up 25.6% so far in 2013.

“There’s this sense that every time we get to the brink, we’ll get over the brink without causing any damage,” said Diane Swonk, chief economist for Mesirow Financial Inc. in Chicago, which oversees $81.2 billion in assets. Lawmakers’ repeated last-minute deals have left investors “somewhat numb and not really all that sensitive to issues on Capitol Hill.”

The disconnect can be measured by comparing the ups and downs in the stock market with an index of policy uncertainty developed by economists at Stanford University and the University of Chicago. Stocks no longer track the economists’ index as closely as they did before the recession ended in June 2009.

The Economic Policy Uncertainty Index, the work of Chicago’s Steven J. Davis and Stanford’s Nick Bloom and Scott Baker, tracks newspaper articles, federal tax provisions and the amount of variation in growth forecasts among economists surveyed by the Federal Reserve Bank of Philadelphia.

Uncertainty Index

The correlation between the uncertainty index and year- over-year changes in stock prices shrank to 0.22 in the period from the end of the recession through October, from 0.43 for the period from January 1985 through June 2009, according to data compiled by Bloomberg. A correlation of 1 shows two groups move exactly in tandem, while zero indicates no relationship.

The newspaper gauge is updated monthly and looks for stories containing combinations of words such as “uncertainty,” “economy” and “regulation.” Considering only this gauge, the correlation drops to zero in the post- recession era from 0.49 over the previous 24 years, indicating stocks have completely uncoupled from policy ambiguity.

Since the recession ended in June 2009, equity investors have followed what game theorists call a “trembling-hand equilibrium,” where market participants believe the consequences of not reaching a deal are so dire that lawmakers will act rationally, said Michael Gapen, a senior U.S. economist at Barclays Plc in New York.

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