Eric Singer, manager of the Congressional Effect Fund (CEFFX), laughs when he recalls the last government shutdowns in November 1995, during which he sat with a congressman on Capitol Hill.
During the very public battle between then-President Bill Clinton and Speaker of the House Newt Gingrich, expectations were that the stock market would be crushed as Americans lost confidence in the ability of the government.
In addition, after threats Gingrich made about refusing to raise the debt ceiling for the Treasury Department, there were fears interest rates would head higher.
Singer says the major networks began scrambling to find video footage of a tangible change in function of the government to show U.S. viewers. The results, Singer says, were unintentionally hilarious.
"Finally, they showed a guy in a station wagon pulling up to Yosemite National Park in the middle of November so he could go camping," Singer says.
"That became the video for why a government shutdown is so horrible. That was the only thing they could come up with."
The effects of government shutdowns more than a decade ago were minimal on the market. During the first five-day work stoppage, from Nov. 14 to 19, 1995, stocks rose slightly. The second, more prolonged shutdown from Dec. 16, 1995, through Jan. 6, 1996, resulted in miniscule gains for the three major market indices, a far cry from the investor calamity many pundits had expected.
Among the best-performing stocks during the first furlough of federal employees in 1995, Gilead Sciences and Chesapeake Energy rose more than 14%.
Other energy companies like Southwestern Energy and Baker Hughes were also big winners.
Next: The Biggest Decliners?
Tech firms like Microsoft , JDS Uniphase and KLA-Tencor were thebiggest decliners.
During the more prolonged government shutdown that lasted into early 1996, both Chesapeake and Gilead outperformed, along with Biogen Idec and Celgene .
Tech stocks were once again weak, with Adobe Systems and Symantec each down more than 30%.
Singer, though, doesn't expect U.S. citizens to fret as much over a government shutdown as they did nearly two decades ago.
"The public expectation in 1995 was that the market was going to go crazy," Singer says. "Now, the idea that Congress is so dysfunctional that they can't cut their budget by more than 1% or 2%, when you contrast that to the re-pricing of the entire housing stock for the U.S., it's a complete disconnect."
As manager of the Congressional Effect Fund, Singer knows plenty about the role government plays in the stock market. Singer's investing mandate is to capture the historically higher returns on out-of-session days and avoid political risks when the House and Senate are in session.
It is the first mutual fund that explicitly attempts to minimize exposure to the potentially negative effect of Congressional legislation. According to his data, annualized daily price gains on the S&P 500 from 1965 through 2009 are 16% on days when Congress is out of session, compared to less than 1% on days when Congress is in session.
The Congressional Effect Fund is small ($14 million in assets) and has a fast turnover rate due to the nature of the investment theme. Singer's fund is either in cash, Treasurys or neutral (for dividends) when Congress is in session. When Congress is out of session, the fund goes long the broader U.S. market through S&P 500 exchange traded funds.
The strategy resulted in a 15.2% return for the fund last year, matching the S&P 500. Since its inception in May 2008, the fund's return of 2.9% through Dec. 31 topped a -1.7% return on the broader index.
With his historical knowledge of the last government shutdown and his experience managing money around Congress sessions, Singer says U.S. investors should welcome a government shutdown with open arms this time, claiming it would actually be bullish for the market as it would be a litmus test on how well the U.S. can function with smaller government.
Next: The Appropriate Size of Government?
"A shutdown is the sign that we're going to have a more serious discussion," Singer says.
"On balance, the government shutdown is probably a plus for the market. If the government does shut down, the market will view it as a first indication that the United States will begin to seriously think about what is the appropriate size of government."
The government is now acting like any other business in the U.S. Singer notes that businesses have shutdowns all the time.
"They shut divisions, they lay off people, they manage the actual resources they have," he says. "The beauty of a government shutdown shows how much we can get by with a smaller government."
While the general media is playing up the effects of a government shutdown — most notably decreased spending, the closing of national parks in the U.S., unprocessed passports and uncertainty of Social Security payments — Singer notes that the vast majority of the government are local functions.
"The kids won't stop going to school. The cops will still be on their beats. The garbage will still be collected," he says. "Life goes on."
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