The Market Does Not Care About Government Shutdowns

A government shutdown appears imminent.

Unless Congress finds a resolution on nearly a dozen spending bills before the Sept. 30 funding deadline, the government will experience at least a partial shutdown.

For a non-election year, D.C. has been making quite a splash.

In May, we dealt with debt ceiling drama—which was ultimately lifted. In August, the fallout from the debt ceiling resulted in U.S. debt being downgraded by a major ratings agency.

Next up? A government shutdown.

For context, government shutdowns usually take two forms:

1) Partial shutdown: where only a portion of the federal government's operations are impacted. This typically occurs when Congress fails to pass a budget or provide funding to certain agencies. Nonessential services and functions of those agencies are temporarily halted, while essential services related to public safety (national defense and law enforcement) continue to operate.

2) Full shutdown: where the entire federal government ceases nonessential operations due to a failure to pass a budget or spending bills to fund the government. When this happens, all nonessential government functions are temporarily halted, and many government employees are furloughed without pay. Essential services—jobs related to public safety—continue to operate.

The political ramifications—and finger pointing—are being covered by dozens of media outlets. We’ll leave those details alone. The investment implications are much more interesting to us.

For investors, there’s one simple detail to understand: This is not the first government shutdown and likely won’t be the last.

According to data from Statista, the government has shut down 21 times since 1976.

In 1977, the government shut down, reopened, and then shut down again in three consecutive months. While it’s easy to believe the gridlock in D.C. is unique to today, history might indicate otherwise.

Fortunately, history also tells us this type of gridlock is often short-lived.

The average shutdown has lasted 7.8 days across the 21 instances, so roughly a week. And during these periods, the market reaction has generally been muted.

The average return of U.S. large caps has been 0.6%, and the market has been positive approximately 70% of the time from shutdown to reopening.  

But if we extend the duration out to a year, the results tell a much clearer story—which is—the market really doesn’t care about government shutdowns. The average one-year return after the government shuts down has been nearly 18%, and the market has been positive 90% of the time.

Put simply, government shutdowns have minimal impact on stocks. But that doesn’t mean there is no impact, however. There are economic implications associated with shutdowns.

If there is a full government shutdown—the last time was 2013—then hundreds of thousands of federal employees will be furloughed and not paid during that period.

According to multiple estimates, gross domestic product (GDP) could decline by 0.1% to 0.2% each week the government remains closed. The flip side is that this GDP usually isn’t lost forever—it tends to reverse itself when government employees get back to work and get paid.

The 2013 shutdown was the last time we experienced a full government shutdown, lasting 16 days in total. This shutdown could potentially last longer than the historical average, but when this concludes can only be speculated upon.

Investors have the luxury—if we allow ourselves—to be guided by historical evidence, rather than speculation.

And it’s important to keep this in mind, as politics can be a distraction from achieving investment goals.

For example, what Apple says about its business outlook next month when it reports earnings is much more indicative of where stock prices will go than anything happening in D.C.

A government shutdown could be a lingering news story, but don’t lose sight of the bigger picture.