Citi’s government shutdown playbook: which stocks to avoid, how volatility may react, and the plan for gold

Unfortunately, October may not get off to a great start either. Because unless an unlikely budget deal is struck in Washington in the next few days, the U.S. government will shut down on Sunday.

The question for investors is what does that mean for markets. A research team at Citigroup, led by David Glass, has looked at what occurred to various assets during and after previous shutdowns.

First thing to note is that Citi thinks a shutdown is likely, but may be short. Still, as millions of government employees aren’t paid, and with discretionary government spending comprising about 1.9% of gross domestic product, the shutdown could trim GDP by 0.1 of a percentage point per week.

However, if the government reopens relatively quickly that impact to growth would likely swiftly reverse, as retroactive wage payments are disbursed, says Citi. But the market as a whole may not get off so lightly as heightened uncertainty, amid a dearth of official data, causes volatility to spike.

As the chart below shows, when a long shutdown occurs the CBOE VIX index
VIX,
a measure of equity angst, sees a consistent rise into the event followed by a slow dissipation, says Glass and his colleagues. Volatility in fixed income also tends to rise, but is usually relatively short-lived. In fact, the bank finds that overall shutdowns have relatively little impact on fixed income assets.

Stock market performance depends on shutdown duration. “Equities are not thrown off their unconditional rise around shutdowns, although longer ones tend to be anticipated with a several percentage point sell off into the event (as now) and a reversal after 10-15 days (note the average of the 3 ‘long’ shutdown is 23 days) a pattern that is not evident when we examine shutdowns of less than 5 days,” says the Citi team.

Recent market performance suggests equities may be anticipating a longer shutdown this time, says Citi, “although this sell-off has not come in a vacuum with rising rates a distinguishing feature.”

Clearly, individual stocks with significant exposure to government are likely to underperform approaching any shutdown, before rallying once Washington re-opens, says Citi. But the weak relative performance has been more pronounced the longer any shutdown drags on.

Citi’s screen of stocks with direct government exposure — on a market cap basis — has a top ten of Pfizer
PFE,
-0.03%,
Accenture
ACN,
-4.33%,
RTX
RTX,
-1.21%,
Honeywell
HON,
-0.41%,
Boeing
BA,
-2.57%,
Lockheed Martin
LMT,
+0.55%,
General Electric
GE,
+1.31%,
CVS Health
CVS,
+0.36%,
Northrop Grumman
NOC,
+0.52%
and General Dynamics
GD,
+0.63%.

Citi notes that perceived safe havens may have a role during periods of Washington budget angst. “Unsurprisingly, longer shutdowns typically pose more of a threat for risk assets. However, perhaps given the US-centric nature of such events, the dollar
DXY
often tends to weaken both before and immediately after funding gaps commence,” says Citi, (though as the chart below shows that is not the case currently) before quickly reversing losses upon a reopening.

As for gold
GC00,
+0.62%,
Citi notes there is a clear difference in price action around long and short shutdown episodes: “The precious metal weakens into and out of shorter shutdowns. Near longer shutdowns, however, gold range-trades into the event and then, as the shutdown persists with no clear resolution in sight, gold catches a bid, rallying around 2% on average and holding onto that strength in the ensuing couple of months.”

In summary, Citi says: “For those wishing to hedge a prolonged shutdown, gold may be a better bet than the dollar and government exposed equities provide an interesting lens to view the political risks.”

Markets

U.S. stock-index futures
ES00,
+0.70%

YM00,
+0.63%

NQ00,
+0.96%
are higher as benchmark Treasury yields
BX:TMUBMUSD10Y
dip. The dollar
DXY
is lower, while oil prices
CL.1,
+1.29%
climb and gold
GC00,
+0.62%
rises.

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The buzz

All eyes are on the August personal consumption expenditure index, released at 8:30 a.m. Eastern. The core PCE is among the Federal Reserve’s favored inflation gauges, and as such equity and bond investors were hoping to see evidence that price pressures continue to ease. They are: the increase in the core annual PCE index fell from 4.3% in July to 3.9% last month.

Other U.S. economic data on Friday, include the September Chicago Business Barometer released at 9:45 a.m., followed at 10 a.m. by the final reading of September consumer sentiment.

Shares in Nike
NKE,
+0.23%
are jumping more than 8% in Friday’s premarket action after the athletic-gear giant posted results that beat expectations.

Tesla shares
TSLA,
+2.44%
are up 1.5% ahead of an update next week on quarterly sales. and after the electric vehicle maker was sued for racial discrimination.

Nvidia’s
NVDA,
+1.46%
offices in France were raided in a cloud-computing antitrust inquiry.

Mainland China’s markets are now on holiday ahead of Golden Week. They reboot on October 9.

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The chart

“Current 50-day stock/bond correlations are +0.26 and have averaged 0.32 over the last 10 days. We are well through the 2 standard deviation level. Stocks and bonds are trading much more in sync than is usual,” says DataTrek.

“Longer spells of high stock/bond correlations are…quite bad for equity prices. The 2002 – present data shows only 2 such periods, but they are 2022 and right now,” DataTrek added.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

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