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Why the Government Shutdown Is Good for Investors

Story updated Oct. 1.

The government shutdown everyone dreaded became reality as of midnight Monday, but that simply means the game is afoot for investors.

Anticipating the failure to compromise, the markets fell in Monday’s trading – the Dow Jones Industrial Average shed 128.57 points, or 0.84%, and the Standard & Poor’s 500 Index lost 10.20 points, or 0.6%.

Contrary to expectations, markets were up slightly on Tuesday as many investors clung to the hope that the two sides would soon find a way to break the impasse and end the government shutdown.

"People expect this will be relatively short-term, with the impact hopefully minimal, but the longer it goes on, the more pressure Washington will face," Robert Pavlik, chief market strategist at Banyan Partners LLC in New York, told Reuters.

"If this lasts longer than a few days, you'll really start to see volatility pick up."

House Republicans refused to back down in their attempt to attach a provision to either delay or defund Obamacare to a “continuing resolution” that would have funded government operations until Dec. 15.

Democrats were just as determined that Obamacare must stand untouched.

The next few days will determine just how big the market fireworks will be, although as we’ll see, an ugly week or two on Wall Street could have its benefits.

But even if the two parties in the House and the Senate somehow reach an agreement and engineer an escape from this self-made trap, the government shutdown threat will not be over.

That's because continuing resolutions only cover a few months, whether it's mid-December (as in the House version) or mid-November (as in the Senate version). Then it's right back to where we are now.

Then there's the looming fight over the debt ceiling, which has even deeper implications for the markets because it also holds the threat of a default.

Congress is close to its limit on borrowing and needs to raise the debt ceiling by Oct. 17. Otherwise the federal government won't be able to borrow any more money – a big problem when you borrow 40 cents of every dollar you spend.

The last debt ceiling fight in the spring and summer of 2011 also featured threats of a government shutdown, as well as a near-default that dinged the nation's credit rating, which lopped about 15% off both the S&P 500 index and the Dow Jones Industrial Average.

Given the potential for more — and even more serious — budget battles between now and the end of the year, investors need to make sure their portfolio is ready for whatever happens.

And strange as it may sound, it's not all bad…

How the Markets Will React to a Government Shutdown

Before we get to what investors should do in the event of a government shutdown, we need to talk about what to expect.

Most markets will react negatively to an actual government shutdown, of course, though not all:

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