Home to Capitalist Times LLC’s headquarters, Old Town Alexandria has experienced a marked uptick in pedestrian traffic over the past week. Bars and restaurants are filled to capacity, and parking spots are hard to come by–all courtesy of the government shutdown. What I’ve gathered from overheard snatches of conversations: Many furloughed government employees have opted to while away their newfound free time by complaining about the shutdown or blaming either the Democrats or Republicans for the disruption.
The financial media has covered the shutdown and its implications ad nauseam and in characteristically sensationalist fashion. Here’s a dose of reality: The partial closure of the US government won’t have a lasting effect on the stock market or economy.
Past Shutdowns and the Stock Market
The federal government has shut down on 18 occasions since 1976, usually because of standoffs between the president and Congress on a range of hot-button issues from abortion to spending on missile and defense programs. And in 1982 a White House barbecue and Democratic fund-raising dinner that kept Congressional leaders from both parties out past the budget deadline.
Most of these closures have been short-lived: The average shutdown in our survey lasted seven days, though our data sample includes several lengthy stoppages. Previous disruptions to government services produced only a negligible ripple in the stock market: On average, the S&P 500 ticked up by 0.9 percent in the 30 days leading up to the shutdown, fell by 0.8 percent during the closure and rallied 1.7 percent in the month after the government resumed operations.
Source: Washington Post, Bloomberg
Even if we only consider government shutdowns of longer duration, these closures still produced only a modest blip in the stock market.
For example, consider the infamous standoff between President Bill Clinton and Speaker of the House Newt Gingrich that shuttered the federal government for 21 days in late 1995 and early 1996.
Amid all the political hoopla, the S&P 500 shrugged. The index gained 4.8 percent in the month prior to the shutdown, treaded water during the closure and rallied another 5 percent the month after the two sides reached a compromise.
The 1995-96 government closure subtracted 0.9 percent from US gross domestic product (GDP) on an annualized basis, while the subsequent reopening contributed 0.25 percent to GDP in the first quarter.
The federal government also shut down on multiple occasions during Jimmy Carter’s presidency, even though the Democrats controlled both houses of Congress. The S&P 500 rallied after two of the three shutdowns that occurred in 1977, but tumbled 5.6 percent in the month after an 18-day closure in 1978. This market selloff likely reflected soaring inflation and elevated levels of unemployment, not Carter-era government shutdowns.
Some policy wonks have argued that government closures that occurred before 1981 are irrelevant to the current situation.
Congress in 1884 passed what’s come to be known as the Anti-Deficiency Act. At its core, the law prohibits the federal government from spending money that hasn’t been authorized by a budget or continuing resolution passed by Congress.
Prior to 1981, the government failed to meet its budget deadlines on many occasions; however, the government’s day-to-day operations continued as usual.
This changed when Attorney General Benjamin Civiletti issued two opinions that argued for a stricter interpretation of the Anti-Deficiency Act. Under Civiletti’s interpretation of the law, the heads of federal agencies needed to suspend operations until a new appropriations bill is enacted. This reading includes some exceptions for expenditures classified as mandatory. (The Congressional Research Service recently issued an excellent overview of past government shutdowns and their implications.)
Although Civiletti’s opinion changed the complexion of the modern government closure, the argument that post-1981 shutdowns have been worse for the stock market doesn’t hold much water. In fact, the S&P 500 has performed better before and after post-1981 government shutdowns.
Estimates peg the cost of the government shutdown to the US economy at $150 to $300 million per day in lost spending, suggesting that a two-week shutdown would reduce fourth-quarter economic growth by 0.3 percent to 0.7 percent.
Although this estimate is admittedly rough, the fallout from the latest game of legislative chicken between Congressional Democrats and Republicans should be manageable for an economy that’s expected to grow by 2 percent to 2.5 percent in the fourth quarter.
Moreover, history shows that government shutdowns are largely a sideshow for stocks: The strength of the economy tends to dictate equity performance, which explains why the S&P 500 has rallied during some government shutdowns.
The worst part of the current government shutdown: The closure delayed the release of some widely-watched economic indicators, including the Bureau of Labor Statistics’ September unemployment figures. This lack of new economic data ensures that the financial media will continue to bombard us with tedious stories and meaningless prognostications about the shutdown and its implications for the stock market.
Of course, a failure to raise the US debt ceiling could result in a technical default by the US government on its bond obligations. That’s a separate and much more serious issue where we have little precedent for gauging the market impact.
Fortunately, the likelihood of the US defaulting on its sovereign debt remains low. Speaker of the House John Boehner (R-Ohio) reportedly pledged to Republicans that he would push a bill to raise the debt ceiling through the House of Representatives, relying on Democratic votes if necessary. Although such a move would violate the informal Hastert Rule to pass only bills supported by the majority of the majority, there would be more than enough votes in the House and Senate to enact the legislation.
Bottom line: Regardless of how many days the current shutdown lasts, the US economic growth should continue to accelerate modestly through year-end and into early 2014. In the most recent issue of Capitalist Times Premium, we added a new specialty chemicals name to the Wealth Builders Portfolio that could rally by 40 percent if our economic outlook pans out.
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