While the inability of the U.S. government to agree upon a budget has forced it to shut down, we don’t believe this is terribly important for investors – at least for the moment. Rather, the duration of the shutdown may be meaningful, but not devastating. Bloomberg estimates that a two-week shutdown would reduce Gross Domestic Product (GDP) by 0.3%. This is much smaller than the enactment of the government sequester at the beginning of the year, which is estimated to lower GDP by a full percentage point. Yet, this fiscal drag has not prevented the S&P 500 from rallying nearly 18% YTD. Additionally, during the 1995-1996 shutdown, the stock market initially dipped 3.7%, but then proceeded to rally 30% over the course of the year.
We are not suggesting the current shutdown is bullish for stocks. Rather, stocks rarely have meaningful reactions to political dysfunction. Some may compare the current situation to 2011, but that was a much different time. The U.S. economic recovery was on much shakier ground and some were concerned about a double-dip recession. Additionally, many feared the dissolution of the European Union causing another “Lehman-like” event and that China was going to undergo a “hard landing”. Today, the world economy is on much firmer ground.
However, the one potential commonality between now and 2011 is the need to raise the debt ceiling. Unlike the government shutdown, this is terribly important for stocks. Over the next couple weeks, should politicians choose to play chicken with their credit and reserve currency status, then we expect the potential for considerable volatility.