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October 4, 2013

Market Performance During Past U.S. Government Shutdowns

By Lance Roberts at Street Talk Live

There is a lot of angst about the government shutdown that is, at this point, just about assured to happen.  However, despite much media rhetoric, there is really much less to fear than most think.  As I discussed in this past weekend's missive "3 Stages Of A Bull Market": 
"With the sell signals still in place, and the market remaining overbought on an intermediate term basis, I am not changing the allocation model this week. Remaining overweight in cash at the moment gives us some protection against a potential market selloff that may occur if Congress fails to reach an 11th hour agreement to avoid a government shutdown.
The real risk in the markets continues to be the elevation in prices due to artificial interventions without an economic recovery underpinning the fundamentals.   In other words, when prices rise without the underlying fundamentals also increasing – it has historically ALWAYS led to a poor outcome."
Wunderlich Securities recently put together a research report showing the historical performance of the markets during government shutdowns:
"Did you know that this would be the 18th government shutdown (if it is not averted) and that the first one goes back to 1976?! The brief analysis that follows shows each of the government shutdown dates and the respective returns for the S&P 500 Index over those same periods. Below is a synopsis of the analysis:
Number of U.S. Gov't Shutdowns: 17
Average Length of Days: 6.4
Average S&P 500 Return  (during a shutdown): -0.52%
Worst S&P 500 Return (during a shutdown): -3.75% (1979)
Best S&P 500 Return (during a shutdown): +2.45% (1987)
What does this tell us? There have been pullbacks in the S&P 500 Index during government shutdowns. However, there have also been positive market returns during government shutdowns, as evidenced in the following table. In fact, the S&P 500 has been positive (during 8 shutdowns) almost as often as it has been negative (during 9 shutdowns). The looming government shutdown is not a proper strategy to employ as whether to invest or not. There is an equal opportunity to be right as there is to be wrong."
While it is human nature to grab at headlines to provide meaning to short term market movements - history clearly shows that such movements border on complete randomness.  For investors it is more important to focus on the underlying fundamentals of the economy and earnings as it relates to the market.
It is here that we find a detachment of price, which is being driven and supported by the ongoing monetary interventions of the Federal Reserve, from a weakening trend of corporate earnings and revenues and economic strength.  As noted by my friend Tyler Durden at Zerohedge:
"The equity market has discounted a large portion of any improved outlook that the always-optimistic sell-side strategists believe is just around the corner. As Barclays notes, we have just witnessed the largest two-year expansion of P/E multiples since the late 90’s. This 'bubble' of optimism, sparked by a repressive Fed policy, combined with historical valuation metrics that are above their long-term averages, implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014."

While the "Government shutdown" fiasco ensues, quickly to be followed by the upcoming debt ceiling debate, it only serves as a diversion from what is important to long term investors.  I have discussed many times in the past that the economy, and ultimately the markets, will experience of reversion back to fundamental realities.  These reversions do not occur without some catalyst to spark the ensuing flight from risk.  While mainstream analysts will point fingers of blame stating that "...if it hadn't been for 'X' the crash would have never happened" it is a simple fact that market crashes are always created by an event and crashes only occur from levels where prices have become extended beyond their norms. 
I am not suggesting that the next major "crash" is just around the corner although it very well could be.   I am suggesting that as an investor it is far more important not to make emotionally based decisions based on media headlines and commentary but rather through an analytical and logical approach to the management of risks inherent within your portfolio. 

Courtesy Lance Roberts at StreetTalkLive.com (EconMatters author archive here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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