Profiting from a Government Shutdown

Equity markets have enjoyed a smooth ride on the road to recovery thanks to years of Fed stimulus. But just yesterday they encountered a nasty pothole – the first government shutdown in 17 years.

Several analysts have begun warning of the potential damage the shutdown can cause your investment vehicles, advising detours out of equities until the stoppage has run its course.

Others, though, view any market pullback as a great buying opportunity, given the temporary nature of government shutdowns. If history repeats itself for an 18th time, investors could soon enjoy a nice rebound that has followed every shutdown since 1976.

Be Ready to Buy

Data compiled by Bloomberg indicates the S&P 500 index has fallen an average of 0.59% during the 17 government shutdowns since 1976. It is very likely the markets will not react well to the current shutdown either. But to keep things in perspective, the S&P often falls just as much on the release of a bad jobs report or other economic data.

Just as any jolt to your car depends on the size of the pothole, any jolt to the economy will depend on the length of the shutdown. Moody’s Analytics chief economist Mark Zandi calculated that a three to four week closure could reduce Q4’s GDP growth by 1.4%, down to a slim 1.1%.

Yet the fundamentals underlying the market seem paved for a smooth ride going forward. After weighing together over 11,000 analyst estimates, Bloomberg has calculated a 9.1% earnings growth expectation for S&P 500 companies in Q4.

“At the end of the day you go back and say, does this whole fight really harm the long-term market or the underlying economic picture?” E. William Stone, chief investment strategist at PNC Wealth, poses to Bloomberg. “I don’t think it will really have any true impact there,” he contests.

Of the 17 government shutdowns since 1976, the longest one lasted only 21 days. Even a shutdown of a month would not blow the tires out from under this market.

Of course, we must accept that markets do not like uncertainty, which a government shutdown delivers in abundance. We don’t know how long the interruption will last, we don’t know if the debt ceiling will be raised two weeks from now, and we don’t know if the U.S. will default on its debts resulting in a credit rating downgraded – all of which could run the markets off the road.

The last time the U.S. had its credit rating downgraded on August 5^th, 2011, for example, the S&P 500 plummeted over 10% in less than a week.

Yet Jeff Saut, chief investment strategist at Raymond James, views any dip here as an opportunity. “I’m a buyer on weakness,” he revealed to Bloomberg. “Once it’s in the rearview mirror along with the debt ceiling, the market will start to focus again on the improving economic numbers and improving earnings.”

Rebounds Will Follow

When previous government shutdowns passed into the distance behind us, investors who were prepared with extra cash on hand to snap up stocks at bargain prices were rewarded quite handsomely for their savvy. Bloomberg calculates the S&P index has risen an average of 11% over the first 12 months after a government closure.

“If you go back to the 1990s and the last time we had a government shutdown, that was actually good for the stock market,” Martin Leclerc, founder of Barrack Yard Advisors LLC, relates to Bloomberg. “It seems the market has climbed every wall of worry and every risk that’s out there, the market has seemed to surpass.”

Some sectors in particular should stand out as prime beneficiaries. Logic would dictate that the first stocks out of the gate when the government reopens would be those that were hurt the most during the closure – namely any company that has large government contracts or receives funding, such as defense contractors.

If you see such companies as Lockheed Martin (NYSE: LMT), Raytheon (NYSE: RTN) and Boeing (NYSE: BA) drop significantly when their federal funding gets cut during the shutdown, you might consider snapping them up on the expectation of an upward correction in price when payments are restored on a government reopening.

Another sector to watch would be health care. It is practically assured that Obamacare reforms will not be derailed. Yet the threat of a Republican-induced delay to reforms has been priced into health care stocks to a certain extent. When the government reopens and the debt ceiling is raised (which is also practically assured) the threat of delay will then be taken out of health care stocks, which should enjoy a healthy bounce up.

Within the health care space in particular, investors might want to look at medical device makers, including Boston Scientific (NYSE: BSX) and Medtronic (NYSE: MDT), which develop, manufacture, and market interventional coronary devices and restorative therapy products.

Such companies stand to benefit from the revocation of a new federal tax on medical devices, for which the Republican camp is willing to settle should its demand for a delay to Obamacare reforms be denied. Democrats are expected to trade with Republicans, giving up the medical devices tax in exchange for Republican support of a clean budget bill without any compromising add-ons. The repeal of the tax is expected to save the medical device maker sector some $30 billion a year.

Financial advisor Tom West of Signature Estate & Investment Advisors noted that other beneficiaries of a repeal would include “orthopedic companies, like Stryker (NYSE: SYK) and Zimmer Holdings (NYSE: ZMH). These are the largest suppliers of artificial hips, knees, and joints where demand for these products for aging boomers is already sky high,” he predicted to CNNMoney.

Fasten Your Seat Belts

Though the shutdown itself has never damaged markets all that much in the past, this one can, given its close association with the raising of the debt ceiling in the midst of a still bumpy economic recovery.

Martin Sass, CEO of wealth management firm M.D. Sass, expressed his concern to USA Today that failing to raise the debt limit by October 17^th could “trigger a major crisis” as the U.S. defaults on its debt payments. “It could have very serious implications for the economy and markets,” he stresses.

Tracy Burke, an investment consultant at Conrad Siegel Investment Advisors, cautioned to Reuters that even before reaching the debt ceiling, the uncertainty leading up to it “could potentially send the market into a tailspin and go into ‘correction’ territory.”

Equity markets have already driven 20 months without a sizable correction, and the current atmosphere of uncertainty could be what finally triggers one.

Mike Chadwick, head of Chadwick Financial Advisors, who had already taken all of his clients out of bonds in June, has recently also been exiting equities. “Clients are now about 90 percent in cash,” he informed Reuters. “We’ve cashed out winnings, and now are waiting for good bargains.”

Jeff Seymour, registered investment adviser at Triangle Wealth Management LLC, is even more bearish. “I am poised for the second time this year to take the largest short position I’ve ever taken against the S&P 500,” he revealed to Reuters in an email. “I own 0 percent long equities in client accounts.”

For the most part, however, professional money managers are taking the current uncertainties in the marketplace in stride. “There may be some short-term market moves,” Eric Stein, co-director of the Global Income Group at Eaton Vance, admitted to Reuters, “but markets are getting increasingly immune to nonsense out of Washington.”

President of Penn Financial Group, Matthew D. McCall, reiterated the call to embrace any pullback as a gift. “All short-term sell-offs related to the government have been buying opportunities in the past, and I view this as just another opportunity to buy at a discount from an all-time high,” he advised Reuters.

So strap in your portfolios good and tight, perhaps trimming some profits where you can, thereby freeing up some cash to take advantage of any dips on the road ahead. And if we do hit a pothole between now and the debt ceiling deadline on October 17^th, remember that the path underlying the overall economy is still relatively smooth going forward. Reduce your margin, keep some cash on hand, and stick with those stocks you know have a future.

Joseph Cafariello

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