Why investors shouldn’t fear a government shutdown

This isn’t August 2011, when the government hit the debt ceiling and the Dow Jones industrial average endured three weeks of triple-digit swings. Europe’s economies are no longer is crisis and the U.S. recovery is farther along.

In fact, stocks rose 6.5 percent in the first three months of 2013 heading into the most recent government “crisis,” the start of the automatic federal budget cuts, also referred to as the sequester.

Still, investors this week have been warily eyeing Washington’s budget negotiations. If a budget fails to pass, a government shutdown could start as soon as Tuesday. The stock market has fallen six of the past seven trading days. Although the two percent decline over that stretch is modest, it shows that investors have been leery of buying stocks ahead of two big financial deadlines for the U.S. government.

Congress needs to pass a funding bill to keep the government operating after Tuesday, when the new fiscal year starts. There is also the nation’s debt ceiling, which needs to be raised before Oct. 17.

Investors worry that a shutdown or default would damage consumer confidence and the economy.

During Ronald Reagan’s presidency from 1981 to 1989, shutdowns were a fairly regular occurrence and the government faced a funding shortfall on eight occasions. However, none of those lasted more than three days and many of them occurred over a weekend. Because stocks don’t trade over the weekend and the shutdowns were brief, investors had little reaction back then.

When shutdowns are prolonged and federal employees are out of work for weeks, the effect on the market is usually more negative. Under the Gerald Ford and Jimmy Carter administrations, when the government was shut down for 10 days or more, the average decline for the stock market was more than 3 percent during closures.

But in the last major pair of shutdowns, from November 1995 to January 1996, the stock market actually rose.

President Bill Clinton and Republican House leader Newt Gingrich failed to agree on a plan to reduce the nation’s budget deficit as well as cuts to Medicare premiums. As a result, the government shut twice in three months. First, it closed from Nov. 14, 1995, to Nov. 19, 1995. Then a second shutdown lasted from Dec. 15, 1995 to Jan. 6, 1996.

The S&P 500 rose 4 percent between Nov. 13 and Jan. 6, suggesting that investors were focused elsewhere. The stock market had just started its five-year, technology-fueled bull run, during which the S&P 500 more than doubled.

Even if the government shuts, investors should take a long view because Europe and the U.S. are more stable than two years ago, says Dan Veru, chief investment officer of Palisade Capital Management.

“If things get really tricky, maybe there will be a three to five percent pullback,” in stocks, Veru said.

It’s not worth rearranging your stock investments, Veru added.

“By the end of the year, when all of this blows by, stocks will be higher than they currently are,” he said.