Government Shutdown: Here's What Happens to Stocks Tomorrow

Government Shutdown: Here's What Happens to Stocks Tomorrow

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

I'm typing this from the John Adams building of the Library of Congress. It now looks likely that I'll have to find another location from which to dispatch tomorrow's column -- the library will be closed unless there is an 11th hour agreement to avert a government shutdown.

Were you really expecting U.S. stocks to advance today? There were no signs over the weekend that any compromise to pass a "continuing resolution" to keep funding the federal government was imminent or even that lawmakers were toiling to cobble one together. Predictably, the S&P 500 and the narrower, price-weightedDow Jones Industrial Average finished in the red, losing 0.6% and 0.8%, respectively. It's difficult to imagine any other reaction when presented with such overwhelming evidence of our overlords' incompetence, even with regard to the most basic functions of governance.

Naturally, investor concern manifested itself in the options market, too, with the CBOE Volatility Index rising more than 7% today, to close at 16.60. Oddly, though faced with a probable government shutdown and less than three weeks before the United States faces the (narrow) possibility of default, the index remains significantly below its historical average, which is above 20. The VIX, Wall Street's "fear index," is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.

What will happen to stocks tomorrow? I think we're in for another day of losses, based on two assumptions (the first of which is, admittedly, impossible to test):

  • Today's closing prices reflect overoptimistic investor expectations that a "down-to-wire" agreement announced before tomorrow's market open is still a genuine possibility.

  • No agreement materializes.

Of course, Congress could yet make a deal during tomorrow's trading day, but once the deadline is breached, the economic stakes do not increase dramatically over the next few days... except inasmuch as financial markets deteriorate. In fact, some type of market correction is probably the best short-term incentive for a deal. When the S&P 500 lost nearly 9% on Sept. 29, 2008 -- the day Congress initially rejected the $700 bailout program for financial institutions -- it certainly lit a fire under lawmakers' posteriors.

Furthermore, stocks look pretty well primed for a correction, given the chance, as they are fully valued -- billionaire value investors Carl Icahn and Warren Buffett will attest to that. For the long-term investor, the whole issue of a government shutdown is essentially a distraction, but it's important to be prepared mentally for the possibility of a correction and not let oneself become distracted from the business of saving and consistently investing in superior businesses trading at reasonable valuations.

Beyond the shutdown, a genuine concern for investors
The U.S. government has piled on more than $10 trillion of new debt since 2000. Annual deficits topped $1 trillion after the financial crisis. Millions of Americans have asked: What the heck is going on?

The Motley Fool's new free report, "Everything You Need to Know About the National Debt," walks you through with step-by-step explanations about how the government spends your money, where it gets tax revenue from, the future of spending, and what a $16 trillion debt means for our future. Click here to read the full report!

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Fool contributor Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him on Twitter @longrunreturns. The Motley Fool has no position in any of the stocks mentioned, either. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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