Drama in Washington May Offer Opportunities for Investors

The stock market’s nervous reaction to the government shutdown reflects Wall Street’s uncertainty about the possible outcome. Although most market pundits say they’re fairly sure that Congress will pass a budget and approve a hike in the debt ceiling in the coming days, the slight chance that it won’t gives investors the willies. “This is a binary outcome — either it’s not going to be that relevant or it’s going to be massively disruptive to the economy, and that affects everything,” says Russ Koesterich, chief investment strategist for BlackRock.

As the drama unfolds in Washington, the best course of action for investors is to avoid panic. In reality, a short-term shutdown of government is a non-event, likely to produce no more than a temporary blip in consumer spending, says Koesterich. Indeed, shutdowns have occurred 17 times since the mid 1970s. Though the S&P 500 fell 3.7% during the last shutdown in 1995-1996, the stock index rebounded 10.5% in the month following the government’s return to work.

But the government has never defaulted on its debts. And if Congress fails to raise the debt ceiling by October 17, the U.S. Treasury will lose its ability to borrow funds to pay existing debts. No one is 100% sure what will happen, but the possibilities could have far-reaching implications for the economy and would almost certainly batter the stock market.

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Every day of impasse brings the debt ceiling drop-dead date nervously nearer, which is likely to make the stock market increasingly volatile. That could create opportunities for intrepid long-term investors who are willing to gamble that the worst-case scenario will be avoided. But playing this market with money you might need in the next year or two would be particularly inadvisable. Even though most experts think the chance that Congress would fail to raise the debt ceiling is minuscule, the impact of that failure could be devastating.

Hitting the debt ceiling would make it impossible for the government to pay a litany of bills, from interest on the $17 trillion federal debt to payroll for a significant portion of the 4.1 million member federal workforce. That would impact airlines, which rely on Federal Aviation Administration employees to inspect planes and man air-traffic-control booths; defense contractors that call Uncle Sam their primary customer; retailers, which would be hit by a decline in consumer spending; and even the housing market, which turns to the Internal Revenue Service to verify borrower incomes to approve home loans.

“Theoretically, the Treasury could prioritize its debts, paying a portion of its bills from incoming revenues,” says David Kass, finance professor at the University of Maryland’s Robert H. Smith School of Business. “But I would expect that if the U.S. defaulted on its debts for the first time in history, it would have a domino effect all over the world.”

‘What buying opportunities are made of’

Still, the notion that Congress would fail to authorize necessary funds to pay federal debts strikes most experts as implausible. Thus, they consider today’s dicey market a good time for investors to sift through their wish lists to find attractive stocks that may be temporarily depressed because of the brouhaha in Washington. “To step in at a time like this requires conviction, but if you have that, the government shutdown is what buying opportunities are made of,” says David Brady, of Brady Investment Counsel in St. Charles, Ill.

Notably, the shutdown has had a disparate impact — not only on the market overall but also on specific industry groups. A rise in many health-care stocks on October 1, possibly anticipating a benefit from the launch of Obamacare, reversed course the following day. A dip in airline shares on October 1, the first day of the shutdown, hit only a handful of carriers, including industry darlings such as Southwest Airlines (symbol LUV) and JetBlue Airways (JBLU), while sparing Spirit Airlines (SAVE) and US Airways Group (LCC).

Most big defense contractors, including Lockheed Martin (LMT), Northrop Grumman (NOC) and Raytheon (RTN), fell. But a number of housing-related stocks, including builders Beazer Homes USA (BZH), KB Home (KBH) and Ryland Group (RYL), as well as hardware chains Home Depot (HD) and Lowe’s (LOW), were up on October 2, as were several lenders, such as Bank of America (BAC), JPMorgan Chase (JPM) and Citigroup (C).

Industrial and telecommunications companies, such as AT&T (T), Verizon Communications (VZ) and 3M (MMM), are less likely to be affected by a government slowdown, says Hugh Johnson, of Hugh Johnson Advisors in Albany, N.Y. But they all slid on October 2, too. However, none tumbled so much that they seemed like screaming bargains. “The shutdown won’t have a major impact if it doesn’t last that long,” he says. “But if Congress makes a bigger mess of it than they have made already — and that’s hard to imagine — it could set up a buying opportunity. Right now, it’s not that compelling.”

As if to emphasize the point that the situation in Washington is becoming increasingly more nerve-racking for investors, the market opened sharply lower on Day 3 of the shutdown.

Still, this is a good time to watch for opportunities, but not necessarily to jump. As Jeremy Zirin, chief stock strategist at UBS, puts it: “For investors, the best thing to do is turn off CNN and just pay attention to what’s happening in the real economy. The broad fundamentals are still positive.”