Last week, Congress failed to agree on a new budget and the government was subsequently forced to shut down, with many federal agencies operating in a limited capacity. There’s a lot of buzz around this complex topic known as the ‘government shutdown’. And the question on everyone’s mind is pretty much the same: “How does this affect me?”
Well, this isn’t The Walking Dead just yet. Before you take up arms and stockpile infant formula, you should know that vital government functions are still funded and operational. In fact, most of us have probably noticed that outside of a few minor inconveniences, our day-to-day routines have been relatively intact since the shutdown went into effect. With the exception of those who work for (or closely with) government agencies, the true impact of the shutdown isn’t very visible, but it is quite profound.
In a nutshell, the shutdown creates lots of uncertainty. How long will the impasse last? Does this suggest Congress will always be at each other’s throats for future fiscal disputes? Will you have to cancel your plans to spend winter living among the grizzlies in Yellowstone?
Stocks hate uncertainty because it leads to indecision, and an extended stretch of indecision leads to paralysis. If you’re uncertain about tomorrow’s weather, you’re more likely to hold off on buying those baseball tickets. Likewise, companies are more hesitant to invest and expand if the political-economic climate is unclear. This wait and see response=less economic activity=lower profits=lower stock prices. While the shutdown is a negative for all stocks across the board, some will feel the pain more than others…
Which stocks will be hurt the most?
Let’s take a look at two sectors that are most directly affected by the shutdown.
Aerospace and Defense:
The government buys lots of bombs and bullets and hires an army of private contractors to keep infrastructure afloat. As these programs get cutback or put on hold, defense contractors will take a hit on earnings, with their equity performance likely to reflect that. Here’s a view of how the stocks of some large names in that sector have performed over the last 2 weeks. We use 9/23 as our reference point even though the shutdown went into effect on 10/1 on the presumption that the market anticipated the shutdown and began pricing in its impact beforehand. As you can see, defense stocks underperformed the S&P 500 considerably over that time span.
Travel and Leisure:
Another sector that is directly impacted by the shutdown is travel and leisure. The shutdown has led to the closing of national parks/attractions and forced a halt in Visa processing by US consulates abroad. Additionally, federal employees and contractors will have less money to spend on vacations. This means more people will choose to stay at home binge watching Netflix in place of going on trips, which is negative for companies that make a business out of travel, such as hotels, airlines, and car rental agencies. Again, here’s a view of how some major stocks in the space have underperformed since 9/23.
If you’re looking to buy stocks in these sectors, be extra wary of these issues. If you already own stock in these sectors, be mindful that much of these effects have probably been priced in already, so setting fire to your portfolio may not be the best course of action either. The bottom line is that the shutdown is bad for stocks, with the effect worsening as the shutdown persists.
So what stocks are safer?
While the shutdown will hurt all stocks in general, some will feel less pain than others. These defensive stocks tend to be ones that deal in staples that are in constant demand. What do we consume every day, regardless of the financial outlook?
Food, water, medicine, toothpaste, shampoo (hopefully). Here are some retailers of such products and their corresponding stock performance over our comparison period. The -2.4% performance isn’t spectacular, but getting bitten by a dog sure beats getting mauled by a bear!
The big picture…
During periods of elevated volatility, your posture should shift into a defensive one where you minimize losses so that you can live to fight another day. Rebalancing your portfolio among different sectors is one way to achieve this. The difficulty lies in not overreacting and throwing everything overboard at the market bottom (traders call this getting “whipsawed”). Consistently successful investors manage their portfolio like they are steering a large ship. Turns are made gradually and in a measured manner. Extreme maneuvers might make for some short term excitement but you’ll inevitably turn into shark food.