Why Don’t Investors Care About a Shutdown?

The Dow closed above 26000 and the NASDAQ finally topped its inflation adjusted high
last week, begging the question: Why don’t investors care about a government
shutdown? The answer may be that they don’t care about lots of risks that exist, but
more specifically, previous periods when Congressional impasses have lead to Uncle
Sam shuttering some of its operations, have not spelled Armageddon for stocks.

There have been 18 shutdowns since 1976 and on average, the S&P 500 has fallen 0.6
percent over the period of the closure, according to data from LPL Financial. That said,
the last three shutdowns (two at the end of 1995 and the most recent in 2013), the
index has GONE UP during the closure. Over the 16-days in 2013, the S&P 500 gained
3.1 percent!

Meanwhile, the latest stock market surge is probably due to upbeat expectations for
Q4 corporate earnings, which are expected to rise about 10 percent from a year ago,
due to strong global growth, a soft US Dollar (great for US exporters) and still-low
interest rates. That’s pretty amazing, considering that we are talking about the period
before the GOP tax cut went into effect!

What could go wrong? In its recently published historical analysis of the financial crisis,
the FDIC noted, “Prosperous times can mask the building up of risks.” So what could go
wrong that would upend the rosy outlook?

Although a shutdown may not freak out investors, an impasse over the debt ceiling is
another matter. In 2011, when the debt ceiling debate caused Standard & Poor’s to
downgrade the credit worthiness of the United States, stocks tumbled by 19 percent
from the highs. Without a Congressional deal to increase the nation’s borrowing limit,
early March could be a dangerous time for markets.

The biggest risk to the bull market is that growth will be stronger than expected, which
would prompt the Fed to raise interest rates faster than anticipated. Last week,
renowned economist Martin Feldstein wrote an op-ed in the Wall Street Journal
claiming that “Stocks are Headed for a Fall”. Feldstein argues that the Fed, which in his
opinion, kept interest rates too low for too long, will be the cause of the eventual
market sell-off.

In the bigger picture, the World Economic Forum released its annual global risks report,
which highlighted environmental risks, like extreme weather events and natural
disasters, Cyberattacks and geopolitical volatility as potential problems that could upend
the world’s forward economic progress.

Finally, the rally has started to spark some familiar “Fear of Missing Out” (FOMO)
investor behavior, which often is associated with market tops, not to mention a bit of recency bias, which is the propensity to be influenced by what you have seen in the
recent past (i.e. stocks have gone up recently, therefore they will likely continue to rise.)

What to do: Your best defense is to acknowledge that risks always exist and to build a
plan that can see you through the good and bad times.