Closure Creates an Investor Opening

As they sift through the Washington mess, some money managers think it could be a blessing, at least for their investments.

With the government shutdown heading toward a second week, economists say it could hold back economic growth, business confidence and corporate earnings, but probably won't cause a recession. Many money managers doubt the damage will be lasting. Any stock selloff, they say, would be a great buying opportunity.

"We are looking to take advantage of it if it drives turmoil in the markets," said Bruce McCain, who helps oversee more than $20 billion as chief investment strategist at Key Private Bank, an arm of KeyCorp(KEY) in Cleveland.

Richard Steinberg, whose Steinberg Global Asset Management oversees $600 million in Boca Raton, Fla., said he would buy if stocks fall another 2%. David Kotok, whose Cumberland Advisors oversees $2.25 billion in Sarasota, Fla., said he has moved $100 million into stocks in the past two weeks.

"I view this recurring weakness as an entry opportunity in the U.S. stock market," Mr. Kotok said.

With Wall Street taking things so calmly, there hasn't been much turmoil yet for investors to take advantage of, despite the specter of a government that soon could be unable to pay its bills.

On Friday, the Dow Jones Industrial Average rose 76.10 points, or 0.51%, to 15072.58, just 3.9% below its September record. The S&P 500 index still stood at 18 times its component companies' earnings for the past 12 months, more expensive than the historical average of 16. That means most stocks need to fall farther before they look cheap.

The risk in buying during a crisis is that the Washington gunfight could be a bigger calamity than Wall Street thinks. If an actual debt default, financial crisis or recession began to loom, these money managers say, they might have to adjust their strategies.

"If we see evidence that there is major and lasting damage, obviously we would have to rethink that," Mr. McCain said.

The real crisis could come in a few days, with House Republicans refusing to raise the debt ceiling unless the administration suspends Obamacare or agrees to another, as-yet-unidentified quid pro quo. The Treasury Department says it will run short of money around Oct. 17 unless it can resume borrowing.

In 2011, after a previous debt-ceiling fight, Standard & Poor's Ratings Services cut the U.S. debt rating to AA+ from AAA, citing government dysfunction. Fitch Ratings says it could do the same this time unless Congress raises the debt ceiling "in a timely manner" before Oct. 17.

"Investor confidence in the full faith and credit of the U.S. would be undermined in such a scenario," Fitch said Oct. 1.

Ratings firms generally expect the government to use tax revenue to keep servicing the debt even if the debt ceiling isn't raised. Other bills would go unpaid. For Fitch, that would merit a downgrade. Moody's Investors Service says as long as debt payments are made, it wouldn't downgrade.

Many money managers think Congress will raise the debt limit because failing to do so would damage the U.S. position in the world. But even if congressional Republicans refuse to do so by Oct. 17, professional investors widely view that as a short-term tactic that wouldn't lastingly hurt financial markets.

After the S&P downgrade in 2011, stock prices fell sharply. Bond prices rose as investors sought havens. Stocks finally recovered and surged to new records.

"We just believe the odds of lasting economic damage are very, very minimal," Mr. McCain said.

Mr. Steinberg said he would watch closely for signs of economic damage, but he doesn't expect it either. "We are hoping to pick up some bargains on any weakness," he said.

One hidden benefit for investors is that the confusion could delay any Federal Reserve cutback in financial stimulus.

The looming political mess was one reason the Fed decided against trimming its $85 billion monthly bond-buying program at its September meeting. The Fed meets next at the end of October, and it could delay again.

"All of these shenanigans indicate that the Fed is going to continue this stance for a longer period," Mr. Kotok said.

Fed stimulus supports economic growth and funnels cash directly into financial markets, some of which winds up supporting stock prices. The longer the Fed stimulates, the better the stock outlook, investors figure.

The fight in Washington is proving particularly helpful to investors who want to adjust their bond portfolios.

They think long-term bond prices will suffer and yields will rise once the Fed cuts back on bond buying, so many want to reduce holdings now. And with the Fed still buying and some investors fleeing to the perceived safety of bonds, bond prices have risen. That lets investors unload long-term Treasury bonds at higher prices now and shift to shorter-term bonds or stocks.

Some clients are too scared to follow the "take advantage of the turmoil" strategy, Mr. Kotok said. He said half a dozen clients have phoned in the past week, saying, "I can't stand it, take me out, liquidate everything." But that represents a tiny proportion of his total investments.

What makes some people nervous is that Washington already has sunk deeper into dysfunction than most people believed possible. If a refusal to raise the debt ceiling provokes another financial crisis, it could cause a bigger stock slide than markets anticipate.

Many money managers shrug off that risk.

"We don't see an apocalyptic event," Mr. Steinberg said. "The way we view it is we are watching a train wreck in slow motion, but eventually there won't be a crash."