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Last Updated on: 20th February 2015, 03:15 pm
The American government just can’t seem to function anymore. The two parties can’t agree on anything and it’s taking a toll on normal government operations. In 2013, the federal government shut down for a full 16 days as the two parties argued over budget issues. A little over a year later, another potential shutdown is just around the corner. Investors need to understand what’s going on in this standoff so they can prepare for any possible fallout.
The current problem
For government agencies to keep running, Congress needs to regularly pass bills to fund department spending for a set period of time. Normally, these votes go through without any problems. However, the government divide has made these votes much less certain. If a vote doesn’t pass by the time the agencies reach the end of their budget, they run out of money. That means they need to temporarily lay off their staff and end most of their operations. Right now, the Department of Homeland Security is in trouble.
A few months ago, Obama caused an uproar when he launched a controversial executive order for illegal immigrants. He temporarily blocked the possible deportation of over 4 million illegal immigrants and set the groundwork for many illegal immigrants to settle in the United States long-term. This infuriated the Republican Party who felt that Obama overstepped his authority and should have left this kind of decision to Congress. The timing was particularly frustrating because it came right after the 2014 elections when the GOP won large majorities in both Houses of Congress. The Republicans believe that Obama’s action flies in the face of what voters decided in November.
The Department of Homeland Security is caught right in the middle of mess. The Department’s current budget expires on February 27th and it needs Congress to approve more funding for it to keep running. The Republicans tried to pass a bill that would’ve funded the DHS but the bill included a provision that would have stopped Obama’s executive order. The Democrats in Congress blocked the bill saying that Congress should pass a clean funding bill and debate immigration separately. Unless the two sides can come to an agreement soon, the DHS will shut down at the end of the month.
Financial impact of a shutdown
If the DHS ends up shutting down, it’ll be frustrating but it shouldn’t be too bad for the overall economy. This time only one federal agency would shut down compared to the entire federal government in 2013.
Looking back, even the full 2013 shutdown wasn’t too costly for the economy and the stock market. The nonpartisan Office of Management and Budget estimates that the 2013 shutdown cost the economy about $2 to $6 billion in lost output which cut 0.2-0.6% of the quarter’s GDP growth. In comparison, 4th quarter GDP growth was 2.6% at the end of 2014. The DHS shutdown would have even less of an overall impact. Also, the stock market shrugged off the event and stayed strong. As you can see below, the S&P 500 took a slight dip in October right before the shutdown started but then immediately recovered to continue its strong run.
The biggest concern from the past government shutdown though is that badly damaged consumer and investment confidence. Consumer confidence fell from 80 to 71 after this crisis. The American economy is going through a fragile recovery driven by growing consumer spending. This could unravel if American consumers get spooked by more government dysfunction, especially if the economy takes another hit at the same time like a collapse in the European Union.
Advice for investors
Investors shouldn’t take any dramatic action even if the DHS shuts down. The market shouldn’t take too much damage though defense stocks might go through a tough stretch, especially companies that mainly depend on the DHS.
Instead, investors should keep this event in mind and watch to see if any other more serious problems develop: Greece splits off from the EU, consumer confidence falls, the American economy gets hit with an unexpected shock etc. The DHS shutdown is important because it’s just more evidence the government couldn’t respond to a crisis.
A shutdown could prompt investors to take a slightly more defensive strategy. Maybe by rebalancing their portfolios a bit more out of the stock market or taking a bigger position in hedges like gold which would gain in the event of a market collapse. Still, unless something else happens the DHS shutdown shouldn’t be enough to cause investors to take a major shift.
It’s frustrating the American government can’t function but that’s the World we live in right now. Fortunately, it looks like we’ll be able to shake off this upcoming problem but investors should remember we might not be so lucky next time.