10/04/2013 03:04 pm ET Updated Jan 23, 2014

Why The Stock Market Should Not React to Government Shutdown

One of my students, Matt Ady, asked, "What happens if government shuts down?" Despairing to come up with an intelligent answer quickly, I replied with a line from David Letterman's monologue: "Don't worry about it. During Bush's era, the government was shut down for eight years." I was further bailed out by the fact that the U.S. stock market, U.S. dollar, and global stock markets have been generally muted since Oct. 1.

As for the stock market it looks at the numbers, so let's do some number crunching. According to IHS, Inc., it costs $300 million a day for the lost production of the displaced 800,000 federal employees, which is equivalent to 0.69 percent of U.S. daily economy. Therefore, it is estimated that a two-week shutdown will cost 0.027 percent of the $15.7 trillion economy.

Considering that there is already an 18 percent stock market return this year, a two-week delay of selected federal services will erase -- at the worst estimate -- 1/26 of the return, or around 0.80 percent. Just one day of trading (prior to Oct. 1) already took care of that decrease, especially after the 3 percent increase markets saw when the Fed indicated there was no tapering yet.

The stock market has learned from its past that prices should not react to nonsense of any kind, especially the kind from Washington. According to Bloomberg, stock markets actually performed better than average the year after the last 17 government shutdowns since 1976.
The potential impact on the stock market, if any, is through the increase of risk premium. Studies show, while there were no permanent differences in stock returns days around political events -- such as government shutdowns, debt limit changes, and elections -- the volatility increased significantly. In other words, risk only turns into real damage if you trade to realize the risk. As a result, some experts even believe government shutdown is a buying opportunity.
In short, government shutdown may be a media event, but it is definitely not a stock market event. After all, the stock market shrugged off the Republicans' first 41 attempts to repeal Obamacare, why should it be different the 42nd time?

Another student, Justin Hunter, posted on Facebook: "Government shutdown. Moving to Canada," because he worries that nobody will fly drones to protect us from imminent danger. Edward Snowden may come home for a couple of weeks to visit his folks because there are no federal agents listening to his phone conversations or reading his emails. "The only person left in the White House is Forest Whittaker," Letterman quipped.

These may sound like bad jokes. But the real bad joke is that 800,000 federal employees are out of a job. The bad joke is that my assistant's son, injured during the Iraq War, waiting for veteran's disability pay for the last seven years, was told that he may have to wait for "a few more days" until the government reopens. The bad joke is that a few dozen Republican radicals in the House are able to keep John Boehner hostage and blackmail the majority of the country. The bad joke is that with a 10 percent approval rating, Congress is expected to get away with this, and walk away with "pork" in their pockets. Finally, the real joke is on Americans who will have no memory of all this when election time comes around.

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