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If a Government Shutdown Comes, What Should Investors Do?

Close up of the dome of Capitol Hill, Congress, in Washington DC
Credit: doganmesut / stock.adobe.com

Stop me if you have heard this one before, but the media is full of reports right now saying that we are a week away from a government shutdown. It is not yet guaranteed but is beginning to look just about inevitable. Congress has only two working days left until the deadline for funding arrives at the month’s end, and neither side of the argument is showing any sign of moving from their positions. That makes it hard to see how any compromise can be reached, at least within the Republican caucus. There could in theory be a compromise bill that gets passed with the help of Democrats, but that is the kind of thing that kills Speaker’s jobs (and careers), so while a deal is possible, it is extremely unlikely.

We are, therefore, once again condemned to witness the spectacle of politicians failing to do their most basic job: to keep the government running. It is something that is peculiar to America and amazes anyone who comes here from another country, as I did twenty years ago. What is most worrying, though, is that after a while, you simply become inured to it. We use phrases like “political theater” to describe it, but theater is supposed to entertain, and watching this is not exactly fun. As to whose “fault” it is, it seems to almost always be Republicans who threaten or actually bring about a shutdown, but they couldn’t do it without a cynical refusal to vote for a reasonable spending bill by Democrats if it might avoid what they see as an embarrassment for Republicans.

The real fault, if there is one, lies with voters and the fact that there are no negative consequences for politicians who grandstand this way. Not voting out representatives who don’t do their job just encourages them, and there are no penalties for not reaching a funding agreement. A law that fined House members a grand or so a day whenever funding bills were not renewed or replaced could help to take care of that, but obviously a bill like that would never get through the House.

So, we are stuck with this periodic ridiculousness. The questions for investors are 1) Does a shutdown do economic damage? And 2) Should you make any changes to your portfolio to protect against one?

If the answer to the first were a straightforward yes or no, then that would obviously answer the second, but it isn’t. It really depends how long a shutdown lasts. If it is a few days, then the economic impact is effectively zero. If it gets to the point where the time can be measured in weeks, though, missed payments and wages start to impact economic activity. At a time of such fragility as the economy tries to stem inflation without dropping into a recession, that could be extremely damaging.

However, even if there were to be quite serious damage done by another needless and pointless shutdown, the best thing for investors to do is probably still nothing. One could make a case that moving to a more defensive profile, with less exposure to tech and other “risky” sectors would be sensible, or that avoiding any company that relies on government contracts would be a good idea, but history suggests not. If nothing else, even with shutdowns having been so common recently, the S&P 500 is at an all-time high this morning.

Long term, though, this could prove to be the most stupid in a series of stupid acts of political intransigence. The last one, over the 2018-19 holiday period, cost the government around $5 billion. That is not a massive amount in terms of the federal government but as Illinois Republican Senator Everett Dirksen famously said, “A billion here and a billion there and, sooner or later, you are talking about real money.”

Of course, that $5 billion cost also shows the stupidity of those who say that they are staking out their positions to protest high federal debt levels. More importantly, however, as I mentioned above, it comes at a time when even a small disruption could have a big impact.

Still, that will only happen if the dispute is extended beyond a few days, and most D.C. insiders seem to think that that is unlikely. It is an election year, and with the Biden campaign having a lot more money than Trump's, any mistake by Republicans could prompt an ad blitz later in the year that might prove damaging to Republicans up and down the ticket. The politics therefore indicate a quick resolution and history also suggests that any reaction risks being an overreaction.

If this shutdown happens, it will be the fourth in the last five years and if there is a good side to that, it is that we have some history to inform us of how the market will react. That history tells us that there will be some relative weakness in the couple of days either side of a shutdown, but those often turn out to be buying opportunities for those with cash on the sidelines. Whatever payments and activity are prevented by a shutdown will simply be delayed, and catching up will give the economy, and usually stocks, a boost.

That history and the low probability of an extended shutdown are the reasons why investors should sit on their hands as the story unfolds. It will no doubt be accompanied by extensive media coverage, and it may well seem to you like an unnecessary but very real risk but, for now at least, ignoring the politicians is the best way of minimizing the impact on your portfolio.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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