Will a Government Shutdown Trigger a Market Meltdown?

(Rep. John Lewis)

Congress is working on its fourth stopgap spending bill since the 2018 fiscal year started in October 2017. If it can’t pass a bill by the end of Friday, Jan. 18, America could suffer a partial government shutdown – and even if the Legislature does get the job done, it will merely kick the can down the road to next month, where another impasse may loom.

But whether it’s Friday, or in February, or whenever – if the government shuts down, that does not mean the bull market will too.

It’s understandable if investors are getting nervous. They’re celebrating the market’s record sprint to Dow 26,000, and now the folks in Washington, D.C., look like they might just dump something in the punch bowl.

A government shutdown is serious business. It creates chaos and hurts the economy. Even if lawmakers come up with another last-minute, stopgap funding bill, that just creates more uncertainty down the road. And as you may have heard, the market hates uncertainty.

With the clock ticking down, investors are rightly wondering what they should do in the event of a government shutdown. We’re here to help. Here’s how to handle the situation in three easy steps:

Don’t Panic

Stocks are at all-time highs. By some measures, they’re more expensive than they have been in nearly a decade, with the Standard & Poor’s 500-stock index going for more than 26 times trailing 12-month earnings. Moreover, the current bull market is the second-longest in history, just months away from reaching the nine-year mark.

It’s natural, then, to worry about headlines that could put an end to the rally.

However, neither worrying about government shutdowns nor the actual shutdowns themselves are novel experiences for equity investors, experts note. And it always has worked out OK in the past.

“The market has seen this before, and while the short-term reaction is unpredictable, it tends to be short-lived,” says Oliver Pursche, chief market strategist at Bruderman Asset Management.

Indeed, there have been 18 government shutdowns since 1976, according to LPL Financial and FactSet. They have ranged in length from one to 21 days, and have produced an average loss for the S&P 500 of – wait for it – 0.6%. Even the worst loss, from September to October 1979, was a mere 4.4% that the market clawed back by the start of 1980.

Historically speaking, the market doesn’t seem to care about whether Washington shows up for work.

Buy Dips

Investors still should be at least prepared for a potential hiccup in the markets – that’s just prudent planning. After all, a short government shutdown would affect some small level of spending, which could put an unexpected blemish on what’s otherwise expected to be a rosy 2018 for corporate America.

But rather than being ready to head for the hills, investors should put together a shopping list.

A massive corporate tax cut promises to boost profits for many American companies. And a repatriation tax holiday on overseas cash has numerous corporations bringing home billions of dollars, much of which is being pledged toward new jobs, wage hikes and other investments that should fuel domestic growth. That all points to continued gains for stocks – which is why a government shutdown-sparked drop in the market should be viewed as a dip-buying opportunity.

After all, the idea is to buy low, and when estimated earnings-growth rates are taken into account, stock prices don’t look so out of whack. The S&P 500 trades for a bit more than 18 times analysts’ expectations for future earnings, according to data from Thomson Reuters. That’s not much higher than its long-term average of 17.6, according to FactSet.

Any pullback in share prices, then, will afford investors an opportunity to buy stocks at valuations closer to historical norms.

Enjoy the Ride?

If anything, the market seems to have almost developed an appreciation of government shutdowns. The S&P 500 has actually delivered gains the past three times Congress couldn’t agree on a spending bill.

When the government was closed for 16 days in 2013, the S&P 500 rose a whopping 3.1%. (See the accompanying table, courtesy of LPL Financial and FactSet.) A 21-day shutdown from December 1995 to January 1996 resulted in a 0.1% increase in the benchmark index. And a five-day shutdown in November 1995 delivered a gain of 1.3%.

With numbers like that, investors should be praying for as many shutdowns as they can get.

That is said in jest, of course. But this does hammer home the point that Wall Street does not view government shutdowns as top-priority bear triggers. Why? Because they ultimately have little effect on what actually moves share prices.

“Markets rise and fall based on economic conditions and corporate earnings.”

“And right now, it looks like both are going to continue to rise, which should bode well for the market. In short, ignore the news headlines and focus on what matters – data, and the data looks good,” Pursche says.

(Article written by Dan Burrows)