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 began to shut down Tuesday.
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, Tuesday 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 18 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 17 times over the last 40 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 1970s, 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 1970s 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 10 out of 11 times. On average, the market advanced by 2.55 percent two weeks after the big, bad event. And the median return 10 days after all prior government shutdowns is positive 0.9 percent.
While history rarely repeats itself, the last government shutdown, which took place between Dec. 15, 1995 and Jan. 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 percent 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 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 shut down could lop about 0.1 percentage point from GDP in the fourth quarter.
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 Oct. 1 shutdown deadline, it is worth noting that the REAL deadline for negotiations on the debt ceiling is Oct. 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.
Mr. David Moenning is a full-time professional money manager and is the President and Chief Investment Strategist at Heritage Capital Management. He focuses on stock market risk management, stock analysis, stock trading, market news and research. Click here to claim a free copy of Dave's Special Report on changes in the current market.