Would A Government Shutdown Boost the Market?

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The Government Shutdown unlikely to stop Wall Street (Shannon Stapleton/Reuters)

 

 

Wall Street and Washington haven’t been getting along for a while. So perhaps it isn’t a surprise that the stock market seems somewhere between indifferent and gleeful at the prospect of a possible government shutdown. Stocks are up today, even as the likelihood of a government shutdown seems to have climbed from no-way to probably.

But maybe that the recent market climb is not that strange. In fact, if the shutdown were happen it could actually be a boost to the market. Here’s why:

First of all, stocks have risen during past government shutdowns. The December 1995-January 1996 shutdown, for instance, did nothing to stop the then gaining momentum 1990s bull market. Stocks rose during the shutdown, and in the six months following the shutdown, the market was up nearly 6%. Stocks did fall during the government shut down of the fall of 1978, which at 19 days was, after 1996, the second largest shutdown in the past three decades, but only by 2%. And in the half year following that shutdown the market was up 1.2%.

Why would a government shutdown cause a rally? It’s not entirely clear. But one reason is that shutdowns do little to impact corporate profits. Paul Ashworth, chief US strategist of Capital Economics, predicts that a government shutdown of a similar length to 1995-1996, which included a 5-day shutdown in November and then a 21-break in December and early January, would only lower GDP growth by about 0.25%. What’s more, all of that drop off comes from government spending. Some industries could be effected like defense contractors. But the government is likely to make all of those purchases when it restarts. The rest of corporate America could see little impact, especially at a time when the stimulus has run its course and the economy is picking up.

What’s more, some people are worried that the Federal Reserve might act sooner than later to raise rates now that the economy is recovering and inflation is rising. But a government shutdown could cause the Fed to put off raising rates for now. The Fed actually lowered rates in the wake of the 1995-1996 shutdown in order to keep the economy on track. This time, the Fed would likely delay raising rates after a shutdown to see if the government closure had slowed the economy is anyway.

Next, the banking sector, which as we were told during the financial crisis, is one of the most important factors in the economy, won’t be affected by a government shutdown. Bert Ely, a banking consultant, says it looks like the government would keep open any functions that are essential to banks. The Federal Reserve has already said that it will remain open. Other regulators like the Federal Deposit Insurance Corp. are funded by premiums paid by the banks, not the federal government. So there would be no need for them to shut down.

What’s more, the threat of a government shutdown has added some uncertainty to the market. Once it happens, and is over, that’s one more shock investors don’t have to worry about. And there has been talk for the past two years about whether the government would boost taxes or cut spending in order to reduce the budget deficit. Or whether Washington would do anything to cut the deficit at all. It is possible that if a deal is brokered between the White House and Republicans, Wall Street could get a little more clarity on where the national debt debate is going.

Lastly, strangely, a government shutdown could boost confidence in the economy. How? Early on in the recovery there was a lot of talk on how the bounce back was entirely because of the government. With the government shut down, that would be a hard argument to make. What’s really amazing recently is that despite what is thrown at the market – Middle East revolutions/civil wars, rising oil prices, earthquakes and nuclear disasters – the market seems to take it all in stride. And keep moving up. In all, the Dow Jones industrial average is up 7% this year. “It shows that investors have a lot of confidence that the economy is healthy,” says Frank Fantozzi, CEO of Planned Financial Services of Cleveland, Ohio.

If the shutdown isn’t able to close off the gains on Wall Street, that will be another sign that investors think the economic recovery is here to stay.

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