How a U.S. Government Shutdown Impacts the Stock Market?

You have probably heard of the U.S. government shutdown but may not have known what it was. It is a recurring event that happens every few years or so.

It happens when Congress does not pass legislation to fund the government on time. The result is the partial closure of the federal government. During these times, government employees who do not perform critical services will be asked to stay at home without pay. The economy becomes uncertain as a result.

The big question is: What does a government shutdown mean for the stock market? Should investors be concerned? Or is it just politics, and traders should ignore it?

In this post, we will talk about the government shutdown and what it means for the economy and the stock market.

Shutdown in Simple Terms

If a government shutdown occurs, it means that the President and Congress are unable to agree on a budget to pay the salaries of federal employees for the next year or on a temporary funding bill called a continuing resolution to keep the government operating for a few months.

Non-essential government agencies will close their doors. However, there will still be government services like air-traffic control, border protection, and social security.

Federal government employees who do not provide essential services will be furloughed without pay. For example, the Social Security Administration has about 60,000 employees, and other agencies will have fewer.

Delayed government functions will include passport services, National Park Services, IRS tax services, and several others. Essential parts of the Federal government, such as the military, the FBI, and the CIA, will continue operating.

Shutdown Effects on the Stock Market

The government shutdown has many effects on the economy, and it will definitely affect stock prices.

Essentially, it is like the largest employer in the country is pressing the “pause” button.

Among the several effects on the economy, one is that federal contractors will not receive any pay.

Consumer confidence may also be affected by all the alarming headlines.

The other main effect is that government data releases like inflation or gross domestic product numbers will be delayed.

Shutdown Stock Market Effects in History

If we look at history, each time the government is shut down, stock markets often sell-off just before the shutdown. However, they have bounced back once the new agreement was signed, and the government reopens.

The examples below will prove this point:

1995–1996 Shutdown

President Clinton faced a government shutdown for 21 days. The S&P 500 rose about 0.4% during the shutdown period but surged more than 10% in the subsequent months.

2013 Shutdown

The government was shut down for 16 days due to issues surrounding Obamacare.

S&P 500 fell less than 2% during the shutdown but gained more than 20% by the end of that year.

2018–2019 Shutdown

It was the longest shutdown in history at 35 days, during President Donald Trump’s term.

The market had already been experiencing a high level of volatility in reaction to the aggressive interest-rate hikes by the Federal Reserve and the trade tensions between the U.S. and China. However, once the shutdown ended, stocks rebounded sharply.

Generally, when there is a shutdown, it creates a lot of uncertainty in the market. The market never likes uncertainty; hence, it reacts to it. However, once the issues are resolved, they quickly rebound.

Why Does the Stock Market Not Fear a Shutdown?

There are three main reasons why the stock market shrugs off a shutdown.

First, a shutdown will only have a temporary impact on GDP. According to the Congressional Budget Office, a shutdown could shave off 0.1–0.3 percentage points from quarterly GDP, depending on the length of the shutdown. This is because most lost output from furloughed employees is often recovered later when the back pay is issued.

Second, corporate earnings are not affected much because most large companies in the U.S. have their revenues coming from the private markets or other countries. If your business model does not involve working with the government, then the federal government shutdown will not directly affect your earnings.

The third reason is that investors do not put much focus on a government shutdown but focus more on the bigger drivers of the market. For example, if there is a shutdown, the market focuses on the monetary policy stance, inflation, and global growth rate.

The above points show that the stock market does not fear shutdowns.

The Risks in a Shutdown

Shutdowns are not always bad. However, if the shutdown lasts for more than a month, there will be more significant risks. Below are some of the shutdown risks to look out for:

Loss of economic data

The Bureau of Labor Statistics and Commerce Department is usually the first to suspend a lot of reports. The department that releases data such as jobs, inflation, retail sales, and housing starts.

If they are unable to release the data, the Federal Reserve and investors will find it challenging to know what to do, which can make the market volatile.

Consumers are less confident in their economy

The shutdown can make consumers lose confidence in their economy. People become scared of losing their jobs and may start to reduce their expenses.

Credit markets are jittery

The government shutdown risk could be serious if the shutdown is accompanied by a debt ceiling standoff. The U.S. has faced the standoff before in 2011 and 2023.

The standoff could be a case where the political leaders will not agree on a country’s borrowing limit. This is dangerous as the U.S. is considered to be a borrower of last resort.

The yield on Treasury will rise sharply, making the market more volatile.

Sector That Are Most Affected by a Shutdown

The different sectors in the economy will be affected to different degrees. The affected sectors in the order of severity are as follows:

The aerospace and defense sector

This sector is one that is highly affected by a government shutdown. This is because this sector depends on government contracts to make its money. Companies such as Lockheed Martin, Raytheon Technologies, and Northrop Grumman count on the government contracts to provide goods and services. When they do not get paid on time, this has a short-term impact on the companies’ cash flow.

Financial Services

The slowdown in IPO approvals, SEC review, and M&A clearances. The shutdown usually delays approvals, which means that investment banks, advisory companies, and companies that want to go public will be affected by this.

Travel & Tourism

This sector is not highly affected by a government shutdown, but it is also not left unscathed.

The government parks, museums, and monuments are closed down, which means that some tourists will not visit the locations. As a result, the tourism income will be reduced.

Retail & Consumer

Consumers lose confidence in the economy or their job, or furloughed workers do not get paid for the long month of the shutdown, short-term retail spending will be affected.

Healthcare

The Medicare and Medicaid operations are left running because they are essential. However, there will be a slow down of some operations of the healthcare sector such as the regulatory review for new drugs or devices.

What Investors Should Do About the Shutdown

The best thing that investors should do during a shutdown is to do nothing. Timing the market during political events has been proven to backfire.

History shows that investors should remain calm during this time and invest in shares that are on the lower side because, in the long run, they will be up again.

What History Shows

Investors should not be concerned with a government shutdown. According to Goldman Sachs, since 1980, the S&P 500 index has fallen only 0.6% on average during the shutdown. But in non-shutdown years, the same period has risen by 0.5%.

Investor Psychology and a Government Shutdown

Shutdowns are more of a test of investor psychology. According to the fear of headlines, the economy has come to a stop. In reality, most businesses have not stopped functioning.

The difference between the two creates some emotional buying and selling.

It is a test for new investors and a reminder for experienced investors that market pullbacks, regardless of the cause, are part of the process.

Could a Government Shutdown Ever Crash the Market?

In theory, a government shutdown could crash the market, but in the real world, this will not happen unless the shutdown is combined with another significant event.

If there are events like a debt-ceiling crisis, a credit downgrade, or a recession, the market might crash.

If the U.S. government failed to make debt payments, the trust in Treasury securities will be destroyed, and it will shake the global financial market.

This is the main thing that policymakers try to avoid at all costs.

The Silver Lining

The good thing about a market sell-off caused by government gridlock is that it provides a golden buying opportunity.

When there is high uncertainty in the market, stock prices become very cheap. In addition, if you invest in stocks with solid fundamentals, then volatility will work to your advantage.

Key Takeaways

A government shutdown is a temporary cessation of government agencies operations that results from a failure of Congress to pass a funding bill. During this time, government employees will be asked to stay at home without pay.

Shutdowns have a few effects on the economy, including the non-payment of federal contractors and reduced consumer confidence.

Shutdowns do not have an impact on stock prices as they are temporary.

The only time a government shutdown might affect the stock market is if it is merged with a debt-ceiling crisis, which may result in the inability of the government to make its debt payments.

Final Thoughts

Uncertainty is the biggest killer of the stock market. During a government shutdown, the economy loses its clarity.

Uncertainty in the market is the number one reason why the market becomes volatile.

However, the moment the government passes the funding bill and reopens, uncertainty is removed. The market immediately regains its normality as well as investors who had sold their holdings during the period of uncertainty move to buy them.

The only thing that the investor should do during the period of a government shutdown is to remain calm and hold on to their shares.

The next time you hear about the government shutdown in the news, do not panic. Remember that it has happened before, and the market will remain fine.

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How a U.S. Government Shutdown Impacts the Stock Market?

Shutdown in Simple Terms

Shutdown Effects on the Stock Market