Jason Glisczynski, CAS

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 U.S. Government Fails to Avoid Shutdown

On October 1, the U.S. federal government shut down for the first time in 17 years after Congress failed to agree on a new budget and refused to extend the current one. While essential services will continue, including Social Security and Medicare payments as well as many others, non-essential services were immediately shut down and employees of these departments (such as national parks) were furloughed. The self-funded post office will remain open.  The markets historically have not responded dramatically to government shutdowns, and the past few days show they seem to again be shrugging it off. Global stocks rose after the biggest decline in a month and Treasuries fell on speculation that any economic effect from the shutdown will be limited.  Minor Impact of Past Shutdowns This marks the 18th time the federal government has shut down since 1976*. The longest came in 1995-1996, and lasted 21 days, as Bill Clinton wrangled with congressional Republicans over budget matters.  On average, these historical shutdowns have been followed by positive equity market returns 30 days later. While you might think shutting down the U.S. government—especially with all the associated uncertainty—would trigger a market decline**, that hasn’t always been the case:

• Of the 17 previous shutdowns, stocks dropped during eight of them and rose during the other eight (one was unchanged).

• After the shutdowns ended, the average stock market gain was 2.5% over the following three months and 13.3% over the following 12 months.

Although we have no history of a U.S. government default, we do have an historical reference point for the ill effects of a protracted negotiation process. In the summer of 2011, U.S. politicians negotiated back and forth on raising the debt limit until finding a compromise in the final hours. The irresponsible brinksmanship led to a downgrade of the United States’ perfect credit rating and a subsequent nosedive in U.S.markets. In 2011, Standard and Poor’s made the reasoning for the downgrade exceptionally clear. The downgrade was linked to the U.S. government’s inability to compromise or act when it comes to routine matters of governing.

My View:

While there are concerns among lawmakers that the shutdown could bleed into the more consequential fight over how to raise the U.S. debt limit to avoid a first-ever default after Oct. 17, no one can know for sure how long this partial shutdown will last or the full impact. The shutdown was expected and we have history to help us understand its larger repercussions for investors. We expect a compromise in the coming days/weeks and expect the overall effect on GDP to be negligible.

With regards to the U.S. debt default issue, we believe that a last-minute compromise will be met avoiding a U.S. debt default. Unfortunately, we also believe that the heightened uncertainty driven from the ensuing political debates over the next two weeks will temporarily spook global markets.

It’s concerning that our leaders in Washington are unable to reach agreement on a budget to keep the federal government operating. But we believe that investors are best served by remaining true to their long-term investment plans and avoid being swayed by short-term changes in politics. In the meantime, you’ll need patience, discipline and common sense to keep government policy dramas in perspective and continue with your long-term financial strategy as usual.

The significantly more serious threat to our economic recovery and to global investors, however, is the looming October 17^th deadline to raise the debt ceiling.

If a compromise is not made, the U.S. Treasury won’t be able to borrow money to pay for spending that

Congress has already approved. In that case, either Congress will have to lift the debt ceiling or the federal government will have to default on some of its bills, possibly including payments to bondholders or Social Security payouts. That could trigger big disruptions in the financial markets, or

a long-term rise in borrowing costs. This could also potentially trigger another downgrade.

Sources:

* CNBC, October 1, 2013, The government shutdown: What you need to know, http://www.cnbc.com/id/101068904

** USA Today, October 1, 2013, Wall Street is so far refusing to be rattled by a partial shutdown of the government,

http://www.usatoday.com/story/money/markets/2013/10/01/stocks-tuesdayshutdown/2900125/

This article was written by Jason Glisczynski and is not to be treated as investment advice.  Investment Advisory Services offered through Brookstone Capital Management, an SEC Registered Investment Advisor.