As politicians on both sides of the aisle wrangle over spending cuts and Obamacare, the US government shutdown continues into its second week. The implications of this shutdown — none of which are positive — vary depending on the length of time that the shutdown remains in place. We thought we would share with you a couple of likely scenarios and their affect on global markets.

The first scenario, which we hope to be most likely, is a resolution to this crisis in short order — weeks not months. This would require compromise on both sides which, at the moment, seems as if only a miracle could bring to fruition. Each day that the shutdown drags on, global market participants are becoming less confident that a resolution will be reached in short order — putting downward pressure on equity prices. At this point stock, prices are a mere 6% off their highest leve, reached just a few weeks ago, and well within the 9-10% margins of a normal correction. Our view, and that of our research partners, is that any sign of a near term compromise will likely send equity prices back up and quickly — keeping the bull market on track. We will be monitoring the negotiations for such a possibility.

The second, uglier scenario is that any agreement is months away and the government shutdown remains in place during the crisis. The second scenario goes beyond the short term negative implications that are obvious — unemployed government workers and falling stock prices — and brings about a reduction of the US economic growth rate and possibly that of the global economy. Given the already tepid pace of economic growth, we are concerned that a significant period of government shutdown may bring economic growth to a stand still, or worse, a recession. In this scenario, if the economy returns to recession-like status, unemployment will soar, corporate profits will decline and stock prices will suffer something much worse than a normal correction. Historically, recessions reduce stock prices by 25-50% and last between 9-18 months. Obviously, we would want to reduce our stock exposure prior to such a scenario.

Government officials are keenly aware of the effect of a prolonged shutdown and all that we have expressed above. It is in their interests — and ours — that they resolve this conflict sooner rather than later. Though in recent days a short term solution looks unlikely, we would suggest that there is just too much to lose, for too many people, for this to be dragged on beyond the short term. Therefore, we remain invested during this, so far normal, correction in stocks prices and look forward to its resolution and stock price recovery.

In the event that the current situation gets worse and goes longer than we anticipate, we will continue to manage the risk of your stock exposure through your portfolio’s asset allocation, sector management and the use of stop loss orders.

Together, let’s hope (and/or pray) that our elected government officials can come to agreeable terms and avoid making the world more difficult for the rest of us. If you have any questions about this matter or anything has significantly changed in your financial circumstances please let us know.

Sincerely,

Your Team at Main Street Research