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Government budget fight keeps pressure on stocks

(MoneyWatch) Stocks fell Friday as nervousness over a possible government shutdown continued to cast a pall over the markets.

The Dow Jones industrial average fell 70 points, or 0.4 percent, to 15,257. The Standard & Poor's 500 index declined 6 points to 1,691, while the Nasdaq composite lost 5 points to 3,781. The yield on the 10-year Treasury fell to 2.62 percent, from 2.64 percent on Thursday.

Congress must pass a bill to fund the government by Monday, and the threat of a shutdown and the roiling debt ceiling fight are taking a toll on consumers as well as investors. The Reuters/University of Michigan consumer sentiment index fell in September to its lowest reading in four months. Rising public anxiety about the impact of the clashes in Washington could put a damper on spending during the key holiday shopping season.

"Consumer sentiment is currently at the lowest level since April," said Ozlem Yaylaci, senior U.S. economist with IHS Global Insight, in a note to clients. "Consumer sentiment has turned sour due to a more pessimistic outlook on economic growth and political bickering and finger-pointing."

Even without factoring in the government's dysfunction, some stock analysts think the market is at a crucial juncture, a point at which gains, or perhaps losses, could be extreme.

"There is something wrong with the uptrend, and we have to be worried about a significant pullback," said Brian LaRose, a technical analyst at investor advisory firm United-ICAP. While he said there is a good chance the market could head higher from here, LaRose noted that bullish sentiment has been strong and that investors with short positions have been washed out after the recent rally prompted by the Federal Reserve's decision to delay tapering its monetary stimulus efforts. Both indicators offer seemingly paradoxical indications of a market pullback.

LaRose doubts that Congress would really shut down the government, but that's a political calculation not shared by everyone.

Doug Handler and Paul Edelstein, economists at IHS, said that the mere fact that there is a debate about raising the government's borrowing limit has already introduced tremendous uncertainty and begun to play havoc with bond and equity markets. "A period of high market volatility has already begun, well before any specific spending restrictions have been implemented," they wrote in a note Friday.

"A delayed debt payment will have a notable impact on bond yields and would trigger a credit downgrade, harming economic growth. But the situation will not look like the eurozone in recent years. The solvency of the United States is not in question -- just the political will to solve complex fiscal issues. The degree to which financial markets understand this point will determine the extent of the economic fallout that results."

Analysts at Bank of America Merrill Lynch put the risk of a shutdown at roughly 30 percent.

As investors tried to read developments in Washington, President Barack Obama addressed the country just before the trading session closed, urging the GOP to pass a budget.

"Past shutdowns have hurt the economy, and this one would as well," Mr. Obama said.

As for the risk of failing to raise the federal debt ceiling, the stakes are even higher, he warned. "We don't totally understand would would happen -- the danger involved -- because no Congress has actually threatened default."

"Nobody gets to threaten the full faith and credit of the United States just to extract political concessions," Mr. Obama added.