When the U.S. legislators failed to pass a budget that would fund federal spending the government began shutting down, sending 800,000 government employees home and shuttering national parks. Although the negotiations are compelling and important to government employees and contractors, the impact on investors is minimal. A short-term (less than 10 days) shutdown of the U.S. government should not have any negative impact on financial markets. However, there are some important concepts to keep in mind as the spending negotiations continue.
• Impact of government shutdown on investment results – There is not a correlation between the government shutdown and stock market performance. A prolonged government shutdown could lower the gross domestic production of the economy but it would be temporary. During the last shutdown in 1995 (two separate shutdowns between November 14 to January 6) the Standard and Poor’s 500 Stock Index (S&P 500) gained 4.98% (Bloomberg, LP).
• Why doesn’t the government shutdown have a more severe impact on investments? The debate on federal spending and Obamacare will only cause short-term volatility in the stock market as non-committed investors are frightened into selling. Real valuations of stocks will not be effected. Stock prices are determined by interest rates (low), employment (expanding at an average of 184,000 jobs per month in 2013), corporate earnings (growing at 9.89% – S&P 500), and price-to-earnings ratios (at historical average of 16 times).
• Are there any investments that can be adversely impacted by a government shutdown? Yes, there can be a few investments such as: precious metals, oil, and individual sectors that can be more impacted than the overall market. A government shutdown is more deflationary than inflationary so hard assets (gold and silver) become less valuable. Even a brief shutdown can reduce the demand for fuel as less travel will occur. Defense contractors can also see their stock price slide as payment for government work is delayed.
• Is there anything that D’Arcy Capital is particularly focused on during a government shutdown? The resources of the firm continue to be focused on finding investments with the potential to grow over the long-term. D’Arcy Capital believes the government shutdown has not influenced the ability to invest successfully. D’Arcy Capital will continue to monitor the events in Washington and will be prepared to make changes within the portfolio if opportunities or threats become more permanent.
• Is there any additional issues facing investors in the fourth quarter? If the shutdown continues for more than ten days it will roll into a similar debate on the government debt limit. At the same time the Federal Reserve will revisit tapering. This perfect storm of government activity will produce volatility and opportunity but should not alter the fundamental value of investment securities.
• What is D’Arcy Capital’s investment approach to the government shutdown, debt ceiling debate, and the tapering of Federal Reserve asset purchases?
The overall allocation strategy remains unchanged. The portfolios are designed to overweight financial companies, small cap companies, and international businesses as the economy remains in a growth mode. The portfolios target an underweight in utility and energy sectors. For bonds we still prefer lower duration, inflation protected, and adjustable rate bonds as there remains a higher likelihood that interest rates will move up than down.
