Seeking Alpha
Long/short equity, registered investment advisor, portfolio strategy
Profile| Send Message| ()  

Well, it's official. The boys and girls masquerading as lawmakers in Washington D.C. have once again placed their political agendas over the good of the country. And as a result of the childish behavior displayed by both sides in this debate, the government will begin to shut down today. Perhaps Standard & Poor's summed up the situation best on Monday saying, "This sort of political brinkmanship is the dominant reason the [U.S.] rating is no longer 'AAA.'"

While it is tempting to rant on about the absolutely ridiculous games the professional politicians in D.C. play these days, this space is reserved for commentary on the stock market. As such, this morning's focus will be on the potential impact a government shutdown could have on the economy and, in turn, the stock market.

It's Not The First Time

First off, it is important to recognize that this isn't the first time that politics have shuttered the U.S. government. Although it has been nearly eighteen years since the last time the politicians turned out the lights in D.C., history shows the government has been shut down a total of seventeen times over the last forty years. Granted, more than one-third of the occurrences took place during a three-year span between September 1976 and September 1979. And then there were another six shutdowns between 1981 and 1984. But, the key is that this situation has indeed happened before.

Historically, the stock market has handled the government shutdowns with mixed results. For example, in the 1970's stocks struggled mightily before, during, and after such an event. In fact, the S&P 500 was lower 10 days after the shutdowns in the 1970's by an average of 2.23 percent.

Stocks Tend To Take It In Stride

However, in more recent times, the stock market has learned to take these things more in stride.

Since 1980, there have been eleven government shutdowns. Ten days after the shutdowns were announced, the S&P 500 was actually higher ten out of eleven times. On average, the market advanced by 2.55 percent two weeks after the big, bad event. And the median return ten days after all prior government shutdowns is positive 0.9 percent.

While history rarely repeats itself, the last government shutdown, which took place between December 15, 1995 and January 6, 1996, the stock market was fell 0.2 percent in the five days leading up to the event. Five days after the shutdown, the S&P was off 2.4 percent. However, stocks then rallied to cut the loss to just 0.8 percent over the next week.

The Impact on the Economy

The big fear, of course, is that the overall economy will be impacted by the government offices going dark. The good news is that the U.S. consumer is responsible for more than 70 percent of GDP growth. The bad news is that some portion of the 30% of GDP controlled by the government will be impacted by the shutdown.

Looking at the data from the 1995 shutdown, 36 percent of government employees were furloughed without pay for during the entire length of the shutdown. According to the Bureau of Economic Analysis, the shutdown cut real GDP by 0.25 percentage points in the last quarter of 1995.

However, the economy is much larger now than it was in 1996. So, if one assumes that the government will once again decide to furlough 36 percent of its employees, an estimated $23.1 billion of wages (which are counted in nominal GDP calculations) will be lost on an annualized basis. Thus, each week that the government is shutdown could lop about 0.1 percentage point from GDP in Q4. Accordingly, two weeks would mean a reduction of 0.2 points while a month-long shutdown would cost the economy 0.4 percent in GDP. However, estimates by S&P have put the damage of a month-long shutdown as high as 1.4 percent.

The REAL Deadline

While politicians clearly frittered away the time leading up to the October 1 shutdown deadline, it is worth noting that the REAL deadline for negotiations on the debt ceiling is October 17. This is the date that, according to Treasury Secretary Lew, the government will hit the debt ceiling. And while this date also likely has a fair amount of wiggle room built in, the debt ceiling is the real issue at hand.

Should the government run out of room to borrow money, it could conceivably not be able to pay some bills. This would be considered a "selective default" by the ratings agencies. And for the record, countries in "selective default" mode carry ratings between BB+ and CCC. Thus, going down this road is really not an option.

But then again, the politicians in Washington do enjoy their time in the spotlight. Therefore, there is a decent chance this drama will continue for a while.

Turning to This Morning ...

All eyes remain on Washington D.C. as the political sparring continues over the budget and the debt ceiling. However, there are other things happening this morning as the European PMI's continued to show expansion and we will get a fistful of economic data later this morning including the ISM Manufacturing Index and Construction spending.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell ...

Major Foreign Markets:

- Japan: +0.20%

- Hong Kong: closed

- Shanghai: closed

- London: -0.42%

- Germany: +0.54%

- France: +0.64%

- Italy: +0.76%

- Spain: +0.76%

Crude Oil Futures: -$0.04 to $102.29

Gold: +$0.40 to $1316.60

Dollar: higher against the yen, lower vs. euro, and pound.

10-Year Bond Yield: Currently trading at 2.652%

Stock Futures Ahead of Open in U.S. (relative to fair value):

- S&P 500: +4.25

- Dow Jones Industrial Average: +31

- NASDAQ Composite: +9.25

Thought For The Day ... Awareness and choice are yours to exercise ...

Positions in stocks mentioned: none

Source: Daily State Of The Markets: By The Numbers: Turning Out The Lights In D.C.