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Rob Schultz, CFP®, PFP

OCT
14
Government Chaos- What you need to know

Key Takeaways 

  • Expect near-term volatility and concern over the debt ceiling and government shutdown
  • Volatility should provide some valuation opportunities
  • We expect the market to continue to make progress over the longer term, given the stronger health of the economy in the US and globally
  • We believe Fed tapering likely will be on hold until the government theatrics subside
  • Eventual tapering by the Fed should signal that the economy is improving and inflation is under control, which we believe should lead to continued strength in the equity markets
  • Government is being held hostage by the two parties, which is expected to have a negative impact on growth and the economy. 
  • When compared to the last government gridlock in 2011, the economy is generally on a stronger footing globally and the current event is not likely to trigger as strong a response as in 2011.
  • We believe treasuries are less likely to rally as strongly as they did in 2011.
  • There will likely be some short-term market volatility from investor uncertainty and distrust in government to get anything done.
  • The Fed is less likely to taper with government policies in flux due to concerns about the potential impact on the economic recovery.

Looking Back at Government Gridlocks

With the US government in the midst of a shutdown, it may be instructive to look back over history for clues as to how markets have responded to such events in the past. There have been 17 previous government shutdowns since the beginning of the current budget process in the 1970s. US stocks as represented by the S&P 500 Index have suffered a median decline of -0.3% during these shutdowns, according to Ned Davis Research. However, in most cases the market has rebounded in the ten days after the government has gone back to work, with a median gain of 0.9%. An important point to keep in mind is that the duration of the shutdown will likely play a key role, as longer shutdowns have typically had more negative impacts on stocks.

Shutdown During 1995 and 1996

Many economists have pointed to the 1995-96 shutdown as most representative of the current environment. The government shut down for 28 days between November 1995 and January 1996 over 1996 federal budget conflicts. This shutdown disrupted the US economy as growth slowed from 3.5% in Q3 1995 to 2.9% in Q4 1995 and 2.6% in Q1 1996, before rebounding to 7.2% in Q2 1996. One bright note is that US stocks performed well during the 1995-1996 government shutdown, with the S&P 500 posting positive returns in Q4 1995 and Q1 1996. The Barclays US Aggregate Bond Index also gained during Q4 1995, but declined in Q1 1996 (see Table 1). 

Table 1: Market Performance Around Government Shutdown

October 1995 – March 1996 

Month

S&P 500
US Equity Index

Barclays US Agg. Bond Index

Oct. 1995

-0.36%

+1.30%

Nov. 1995

+4.39%

+1.50%

Dec. 1995

+1.93%

+1.40%

Jan. 1996

+3.40%

+0.66%

Feb. 1996

+0.93%

-1.74%

Mar. 1996

+0.96%

-0.70%

Q4 1995

+6.02%

+4.26%

Q1 1996

+5.37%

-1.78%

Source: Zephyr

Debt Ceiling Deadlock in 2011

Even with the government shutdown, the larger concern remains the debt ceiling issue, which the US government is anticipated to reach on October 17. The 2011 debt ceiling debate and S&P's downgrade of US long-term debt from AAA to AA+ contributed to heightened market volatility two years ago. Amid an uncertain political environment and global economic weakness, the S&P 500 declined 13.87% during the third quarter 2011. At the same time, Treasuries gained as the issue intensified during July/August and S&P downgraded US debt on August 5 (see Table 2). This historical example highlights the important role that broader fixed income allocations, including exposure to absolute return strategies with potential to moderate volatility, can serve in broad-based portfolios.

Table 2: Market Performance Around US Debt Ceiling Crisis

July 2011 – Sept 2011

 

Month

S&P 500
US Equity Index

Barclays US Agg. Bond Index

July 2011

-2.03%

+1.59%

Aug. 2011

-5.43%

+1.46%

Sept. 2011

-7.03%

+0.73%

Q3 2011

-13.87%

+3.82%

 

Indexes are unmanaged and investors are not able to invest directly into any index

Past performance does not guarantee future results.



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Securities and investment advisory services offered through Royal Alliance Associates, Inc., member FINRA/SIPC and a registered investment advisor. Additional investment advisory services offered through NWF Advisory Services Inc., a registered investment advisor not affiliated with Royal Alliance Associates, Inc. Certain insurance products offered through New World Financial & Insurance Services, Inc., an entity not affiliated with Royal Alliance Associates, Inc. or registered as a broker/dealer or investment advisor.



This communication is strictly intended for individuals residing in the state(s) of AL, AZ, CA, CO, IL, ME, MA, NV, NM, NY, OR, PA, PR, TX, WA and WY. No offers may be made or accepted from any resident outside the specific states referenced.
 


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