Shutdown Showdown: How Stocks Could Defy Expectations

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Image: Nasdaq

The U.S. federal government is once again on the verge of a shutdown as Democrats and Republicans feud over budget allocations and the debt ceiling. With the September 30th fiscal year deadline looming, Congress has just days left to pass funding legislation or risk furloughing hundreds of thousands of federal workers until a deal is reached.

However, if history is any indicator, the stock market seems poised to shrug off yet another D.C. budget impasse. Data shows stocks have climbed over 80% of the time amid previous government shutdowns, delivering positive average returns.

Blame Game Begins as Shutdown Deadline Nears

The political blame game has already started, even though the government hasn’t officially run out of money yet. Democrats are accusing Republicans of taking the economy hostage by threatening to block action on the debt limit. Republicans counter that Democrats are responsible for proposing irresponsible levels of spending.

According to market analysts, the bickering is par for the course in Washington. Government shutdowns have become increasingly common occurrences as polarization widens the aisle between parties. There have been nearly 20 funding gaps and shutdowns over the past four decades.

“While shutdowns fuel scary headlines, history shows markets typically take them in stride,” said Mark Hamrick, senior economic analyst at Bankrate. “Investors have seen this movie before, many times in fact. The theatrics and drama feel routine at this point.”

Stocks Have Rallied Through Past Shutdowns

Research by major finance groups reveals stocks have proven resilient through past shutdowns, often posting gains.

According to data from Carson Group chief market strategist Ryan Detrick, the S&P 500 has risen a cumulative 9.1% across the 22 federal shutdowns since 1976. Looking at just the lengthier, double-digit day shutdowns, stocks were up more than 15% on average.

The S&P 500 has managed to eke out gains during 13 of the last 22 shutdowns, about 60% of the time. This includes a more than 10% surge over the 35-day partial shutdown that extended from late December 2018 to January 2019. Defense stocks also climbed nearly 13% throughout that impasse, despite defense contractors being directly affected.

“History shows shutdowns aren’t inherently bearish events,” said Detrick. “Markets tend to look past the unsettling headlines at the dysfunction in D.C. and focus on the actual economic impact.”

Why Do Stocks Rise When Government Shuts Down?

While shutdowns cause very real hardships for federal workers and programs, the overall economic fallout tends to be limited in scope and temporary in nature. Markets seem to understand that shutdowns are political grandstanding, not a fundamental threat.

Essential services like Social Security, Medicare, mail delivery, TSA airport security, and maintenance of the power grid continue operating through shutdowns. And about 75% of the federal budget is mandated spending that is unaffected.

According to PIMCO’s Libby Cantrill, the resulting hit to GDP growth quickly reverses once the government reopens and back pay is disbursed. Other analysts concur the economic effects are marginal and fleeting.

“Stocks look past the sensationalism and recognize that shutdowns rarely cause material economic harm,” said Sam Stovall, chief strategist of CFRA. “Traders view shutdowns as another example of the drama in D.C., not something that will upend the markets long-term.”

With monetary and fiscal stimulus still coursing through the economy and corporate profits strong, there are larger forces buoying stocks beyond the political quibbles in Congress. As long as the economic recovery remains largely on track, investors seem primed to tune out yet another shutdown.

Look For Buying Opportunities in Quality Names

Savvy investors may want to take advantage if a shutdown sparks a bout of market volatility. Historically, shutdown-driven dips have proven to be buying opportunities in economically-sensitive sectors like financials, industrials and technology.

“Rather than worry about a shutdown, investors should look for chances to buy high-quality stocks at reasonable valuations,” said Stovall.

While growth may stutter slightly for a quarter, analysts see the economic rebound continuing once federal spending resumes. With trillions in household savings and strong corporate health, the U.S. economy seems well-equipped to power through another potential shutdown unscathed.

So tune out the hysterical political rhetoric and keep your focus on the long-term fundamentals. Odds are stocks will sail higher, just as they have numerous times before amid government shutdowns.

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