government shutdown

Government Shutdown Explained

11 min read

Why are there continuous threats of a government shutdown in the US? When the parties don’t agree on the spending bill, everything stops until both sides agree to terms. Since the 1980s, the government has shut down ten times, and there have been multiple threats of shutting down. Some lasted half a day, while others went on for weeks. According to the data, each week negatively impacts the GDP by 0.1%.

Earlier in October 2023, a last-minute deal was reached to avoid a shutdown, but only for the next 45 days. In other countries, non-essential government agencies will continue functioning even without government in the US. Not only does it affect government workers, but it can also affect the stock market. What causes a government shutdown, and how does it affect the economy and the stock market? Let’s find out.

How Does a Government Shutdown Affect the Stock Market

Government shutdowns in the United States occur primarily due to budgetary disputes and failure to pass appropriations bills to fund federal operations. The government can remain shut until both parties agree on spending priorities, which implies one party making some concessions in their spending bill. Certain branches of the government may run out of funding before the year expires.

They won’t resume their activities until the party in power extends their funding. In the past, shutdowns have affected numerous essential and non-essential agencies, such as:

  • Non-essential government employees are sent home without pay until the disagreement is settled in their agencies (Environmental Protection Agency), Department of Education, etc.)
  • National parks and museums will have a fraction of their staff, which affects tourism and local economies.
  • Immigration, visa services, and embassies will have less staff to process applications.
  • Other agencies such as the IRS, federal courts, the FDA, and health services can also be disrupted.
  • Some agencies, such as Social Security, Medicare benefits, military and law enforcement, postal services, air traffic control, and US passport agencies, aren’t disrupted.

Budget disputes over Ukraine’s funding caused the most recent dispute. It was settled over the weekend, but only until November 17th. The risk of a shutdown didn’t affect the stock market because there were other more important issues, such as inflation and rising bond yields. In the past, shutdowns affected the stock market and certain sectors. Let’s take a look. 

Economic Impact of Government Shutdowns

In the last decade, the US government shut down three times. Long-term investors don’t worry too much because the companies they’re invested in usually aren’t immediately concerned. However, the broader stock market often reacts negatively, and a bear market occurs for a short time.

However, if you know how to make money in a bear market, a government shutdown is another opportunity to profit.

Stock Market Reactions

The following reactions will be more extreme depending on how long the government shutdown lasts. 

Increased volatility

Government shutdowns often result in increased stock market volatility. Most stock market indexes tend to decline during shutdowns, with specific sectors experiencing more significant volatility depending on the reasons behind the shutdown.

Investor uncertainty

Investors dislike uncertainty, and some may liquidate positions during a shutdown in anticipation of market declines. However, this doesn’t necessarily imply a long-term exit from the market.

Consumer confidence

Employees are sent home without pay, many agencies can’t complete their duties, and the economy isn’t growing during a shutdown. This leads to a decline in consumer confidence.

Short-term declines

The stock market experiences periodic declines throughout a shutdown but is relatively modest. The S&P 500 fluctuates but doesn’t experience a major crash or a prolonged bear market.

Resolution, rally, and recovery

When a resolution is reached, the stock market experiences a rally. There is less volatility, investor uncertainty, and consumer confidence increases. Declines turn into increases and major indexes rally. You can expect the S&P to reach its previous level quickly.

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Last 3 Government Shutdowns

Now that we know how the market reacts during a government shutdown, we can look at what happened in the previous three shutdowns.

1. Sep 30, 2013 – Oct 17, 2013 (16 days)

In 2013, one of the major reasons for the shutdown was the disagreement concerning the adoption of the Affordable Care Act (ACA or Obamacare). Republicans sought to defund or delay its adoption. After 16 days of negotiations, the resolution passed without any significant changes.

During that period, the S&P declined by 2.8%, the DJIA by 2.2%, and the Nasdaq Composite by 1.6%. There were several days of modest declines but nothing too dramatic. All three indexes recovered shortly after the resolution and finished the year at a high level. 

Some sectors were greatly affected than others. The financial, utilities, and energy sectors suffered no substantial losses. However, the consumer discretionary, defense and aerospace, technology, and healthcare sectors suffered 2 to 5% losses. These sectors rely heavily on the government to approve measures; many have contracts with various agencies. Many government workers were affected, and investors were more uncertain about these sectors.

2018 Shutdowns

2. Jan 19, 2018 – Jan 22, 2018 (2 days)

In 2018, we were in the Trump era, with two shutdowns. The first lasted only two days and revolved around the Deferred Action for Childhood Arrivals (DACA) program, which Obama established. Trump wanted to abolish it. The shutdown lasted only two days because a short-term resolution was passed to allow further negotiations. 

All three major indexes declined by around 0.5% during those two days, and the recovery was swift. The healthcare sector’s decline was more important than others. The materials, industrials, and consumer discretionary sectors didn’t see a decline at all.

3. Dec 21, 2018 – Jan 25, 2019 (35 days)

The second shutdown in 2018 centered on constructing the border wall between Mexico and the US. Trump’s government needed funding to enhance border security and combat illegal immigration with the wall. This led to the longest government shutdown in US history. After 35 days, it ended when an agreement was reached to temporarily reopen the government for three weeks, allowing negotiations to continue without further interruptions. The agreement did not include the full funding for the border wall sought by Trump.

During that period, the S&P declined by 2.7%, the DJIA by 2.5%, and the Nasdaq Composite by 3.4%. Those numbers were slightly higher than during the 2013 shutdown but recovered within a few weeks.

The consumer discretionary (7% decline) and technology (6% decline) sectors were the most affected during this shutdown. Trade relations were in jeopardy, which impacted consumer spending and confidence.

What Happens to the Stock Market?

A government shutdown in November would likely impact the stock market but only minimally. Historically, in analyzing past government shutdowns, studies found that stock market investors need not worry about the impact of a mid-November shutdown. The stock market’s reaction to past government shutdowns has shown that it generally recovered after the shutdowns ended.

However, it’s important to note that the specific impact of a government shutdown on the stock market can vary depending on various factors, such as the duration of the shutdown, the economic consequences, and market sentiment at the time. These factors may influence investor confidence and market volatility.

What Factors Contribute to the Impact of Government Shutdowns?

The specific impact of a government shutdown on stock market volatility can vary depending on various factors. Firstly, the shutdown duration, economic disruption level, and investor sentiment. 

Other factors, such as economic indicators, corporate earnings, and geopolitical events, can also influence market reactions. It is important to note that each government shutdown and its impact on the stock market can be unique and may not follow a consistent pattern.

During a government shutdown, investor sentiment can be affected by concerns over the economic impact, disruption to government services, and political uncertainty.

Congressional Research Service

A report published by the Congressional Research Service found that market indicators, such as stock market indexes, “tend to decline after the start of a shutdown” but then recover once the shutdown ends. The same report also noted that the stock market recovery typically depends on the shutdown’s impact on the broader economy.

It’s worth noting that the stock market’s response to government shutdowns can vary depending on the specific circumstances leading to the shutdown, such as the duration and potential economic consequences.

In summary, government shutdowns can result in short-term negative impacts on the stock market, especially if the shutdown lasts for an extended period. However, the exact impact of a government shutdown on the stock market is challenging to predict and depends on several factors.

Ned Davis Research - Government Shutdown

Data from Ned Davis Research indicates that when a government shutdown lasts longer than nine days, the S&P 500 has, on average, declined by 0.7%. This 0.7% decline is in the month following the shutdown. Interestingly, the 0.7% decline is followed by S&P gains of 2.8% in the following three months. 

These sources provide an understanding that government shutdowns have led to short-term declines in the S&P 500. Still, the exact impact can vary depending on factors such as the duration of the shutdown and its economic consequences.

Final Thoughts: Government Shutdown

As you can see, you can expect most sectors to experience modest declines during a government shutdown. However, it’s nothing to be alarmed by. As soon as the shutdown resumes, markets tend to recover immediately. Some sectors are more affected than others.

They might also have the quickest recovery. The best time to start a new position or to add to an existing one is when an agreement is reached and the government reopens. Of course, other global and economic factors must be considered before investing. Stay informed and make the right decisions!

Frequently Asked Questions

Government shutdowns can have a noticeable but short-term impact on the stock market. Experts suggest that the longer a government shutdown lasts, the more significant the negative impact on the stock market. According to a Forbes article, during the 14 government shutdowns since 1980, the stock market posted minimal returns leading up to and during the shutdowns. Additionally, on days politicians didn't pass the budget, median losses were 0.1%. Another Forbes article states that a government shutdown can negatively impact investors. This negative impact is because investors may interpret it as a sign of systemic political failure, leading to less confidence in the market and lower share prices.

Government shutdowns have had varying effects on the S&P 500. During government shutdowns, the median drop in the S&P 500 was around 2%. However, even though we don't expect a potential government shutdown to impact the stock market heavily, some cases have seen more than a 5% dip in the S&P 500. 

Yes, government shutdowns have resulted in increased stock market volatility. While there is no definitive consensus on the exact magnitude of the impact, historical data suggests that government shutdowns can contribute to market uncertainty and heightened volatility. Research analyzing the impact of government shutdowns on the stock market has found mixed results. Some studies suggest that shutdowns have a negligible effect on stock market performance. However, other research indicates that government shutdowns are associated with increased market volatility. One study examining the impact of government shutdowns from 1980 to 2018 found that stock market volatility tends to rise during shutdown periods.

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