Stock markets have been resilient through the current partial government shutdown, with the S&P 500 index SPX, -1.11% gaining nearly 10% since the standoff began Dec. 22.

But according to Goldman Sachs analysts led by David Kostin, this rally from oversold conditions is masking the effect that the shutdown and uncertainty over trade policy is having on stock prices— absent these headwinds, Kostin argued, valuations would be higher today.

Kostin points out that the Global Economic Policy Uncertainty Index, which measures policy uncertainty by analyzing the text of newspaper articles, just reached an all-time high of 304, “more than 3 times the historical median reading of 101,” he wrote.

Goldman Sachs Global Investment Research

And despite the stock market’s recent buoyancy, Kostin argued that stock valuations would be higher if levels of policy uncertainty were at more normal levels. He points out that the “equity risk premium,” or the spread between the S&P 500 earnings yield and the yield investors can get on risk-free 10-year Treasurys sits at 3.6%, well above the average of 2.3%.

This means that investors are demanding higher returns than usual to risk owning equities, a demand that is at least partially a result of heightened policy uncertainty, Kostin argued, pointing to the fact that the equity-risk premium tends to rise when policy uncertainty is high. All else equal, a higher equity premium is associated with lower stock prices.

Some of that uncertainty appeared to be catching up with stocks on Tuesday, with the S&P 500 off 1.7% and the Dow Jones Industrial Average DJIA, -0.87% falling more than 400 points at its session low.

A sector and stock-specific view of the markets makes an even stronger case for trade policy and shutdown-related uncertainty weighing on stocks. “Despite positive signals around recent negotiations, stocks exposed to U.S.-China trade show persistent uncertainty,” Kostin writes.

“Baskets of U.S. stocks with high China sales exposure and China stocks with high US sales exposure…remain depressed relative to levels early in 2018 before the escalation of tensions,” he continued.

“The performance of stocks exposed to government policy also reflects heightened uncertainty,” Kostin continued. Volatility for stocks in Goldman’s basket of firms with the highest government revenue exposure was relatively subdued in 2018. But since the government shutdown, volatility in this basket has “rebounded sharply.”

Ed Keon, chief investment strategist at QMA told MarketWatch that this heightened policy uncertainty is coming at a particularly bad time for global stock markets, as slowing global growth has investors concerned that policy makers in Washington won’t be able to collaborate or effectively respond to a serious economic downturn.

“In the U.S. there’s been a lot of churn at the top level. If you do have a slowdown in the economy, how do you deal with it, and who’s going to craft the response?”

Meanwhile, Keon said, uncertainty over trade policy is hurting corporate confidence and investment, and there’s evidence that volatile stock markets and the government shutdown are impacting consumer confidence too, after the University of Michigan’s consumer sentiment indicator fell to its lowest level since October of 2016. “There’s a negative feedback loop due to policy uncertainty,” he said.