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Stocks Could Fall 20-30% if Shutdown Isn’t Resolved Soon: Barry Ritholtz

Daily Ticker

The government shutdown and the looming debt-ceiling deadline are dominating headlines but haven’t really made much of a dent in the stock market. Heading into Friday’s session, where major averages are up modestly in recent trading, the S&P was still within 3% of its all-time high, reached on Sept. 18.

“It turns out the market really doesn’t care much if [the shutdown] is a day or a couple of weeks,” says Barry Ritholtz, chief investment officer of Ritholtz Wealth Management. “Where it becomes a concern…is if weeks turn into months. If it goes past three or four weeks, that could take a big chunk off GDP, effect consumer confidence and really have an impact on earnings.”

Related: Shutdown Could Literally Make America Sick

How big a chunk off GDP is subject to debate. Every week of the shutdown will cut 0.3 percentage points from GDP, according to Standard & Poor’s. Macroeconomic Advisers estimates half as much of a hit in the first two weeks of a shutdown and that a three-week furlough would drag 0.5 percentage points from growth; if the shutdown lasts all of October, they estimate quarterly GDP growth would be receded by roughly 0.7 percentage points.

Whatever the true impact, economists agree the absence of federal spending and, as importantly, the direct and indirect effects of 800,000 federal workers being furloughed will crimp an economy that’s producing subpar growth absent a shutdown. Should that hit corporate profits, the market will surely notice.

“It’s not that the market is so horrifically expensive but earnings are at a high cyclical level,” Ritholtz says. “If we do anything to damage that you risk a 20-30% correction in the market if this [shutdown] goes on a month or longer."

Related: Government Shutdown: Good News or Bad News for the Economy?

Hopefully cooler heads will prevail and there is some expectation an agreement to address both the continuing resolution and the debt ceiling could be in the offing. But if the shutdown were to last “a month or longer” and the Oct. 17 deadline passes without action on the debt ceiling, economic chaos could result.

“The impact of such a failure of political leadership on business, consumer and investor confidence is difficult to say and could lead to further downgrades of the U.S. sovereign debt,” according to the Institute of International Finance. Among others, the Institute notes spreads on credit default swaps on 5-year Treasuries – effectively insurance against a U.S. default – have risen 45% in the past three weeks and now exceeds the highest levels reached during the 2011 debt-ceiling drama.

Related: Twitchy Traders Overstate Market Alarm Over DC Noise

Again, Ritholtz is sanguine despite rising nervousness about America’s political dysfunction, although it's certain to be a topic of conversation at his Big Picture Conference on Tuesday in NYC.

“At the risk of sounding glib, we really don’t care about any of the stuff that’s going on in Washington,” he says, reiterating a longstanding view the stock market deserves the benefit of the doubt and it doesn't pay to bet against it. “Eventually the adults will reassert themselves. Nobody is so stupid as to cause the extraordinary privilege we have as the world’s reserve currency to go away.”

Regardless of your political affiliation, let’s hope he’s right but there seems to be a great absence of common sense in Washington right now. As I'm writing this, House Speaker John Boehner (R-OH) and Majority Leader Eric Cantor (R-VA) are on TV and appear to be hardening their positions rather than giving signals a compromise to end the shutdown, much less address the debt ceiling, is at hand.

Stupid is as stupid does.

Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo! Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com

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