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Don't overreact to the US government shutdown

22 December 2018 | Markets and Economy

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Government shutdown graphic

The US government partially shut down Saturday 22 December after Congress and the White House failed to agree on a short-term spending bill to keep it funded through 8 February 2019. While Congress works to resolve the impasse over whether to provide funds for additional border security measures, investors may have questions about how a shutdown could affect markets.

Understanding a partial government shutdown

A shutdown occurs when either Congress does not meet a deadline to pass a funding bill for discretionary spending programs or the president refuses to sign such a bill. Examples of discretionary spending include funding for the National Park Service and many federal education and transportation programs.

When Congress can’t agree on a funding bill, it may pass a continuing resolution that instructs the government to extend the previous funding levels. The most recent continuing resolution has expired, prompting the current shutdown. Since 1976, the government has shut down 21 times. There were two other shutdowns in 2018; the most recent, in February, lasted only a few hours. Before this year, the previous shutdown was in 2013; it lasted 16 days.

A history of mixed results for the markets

The length of the partial shutdown is the main concern for the markets. Markets might experience heightened volatility in response to the uncertainty in Washington. "Government shutdowns will capture the media’s attention and, as a result, can be unnerving to some investors," said Jonathan Lemco, a Vanguard senior investment strategist.

However, Mr. Lemco noted that shutdowns haven’t always been bad for markets, with equities finishing in positive territory more than half the time during these periods (see accompanying chart). He noted that a prolonged government shutdown might provoke some short-term disruption to the markets but probably should be less consequential in the long run.

In the past, when a shutdown lasted more than five days, the average US stock market return during the event was –0.94%. Average returns for the 12-month period after the shutdown, however, were 10.77%. While Mr. Lemco cautioned that Vanguard’s return expectations for stocks over the next decade are relatively modest, this forecast is the result of high valuations and other risks, not the effects of the partial government shutdown.

Mr. Lemco added that a government shutdown is only one of many factors, both positive and negative, affecting the markets. Because there are so many variables, the effects cannot be accurately predicted.

"Political divisions in Washington have made the threat of government shutdowns more common in recent years," he said. "While this is not an ideal practice and a prolonged shutdown could have broader short-term market and economic effects, what’s most important is that investors who remain disciplined, diversified, and patient during an event like that should be rewarded with fair inflation-adjusted returns over the long term."

US government shutdowns: Possible short-term volatility but no long-term effect

Standard &Poor's 500 Index prices, January 1 1967 to December 20 2018

*The government shut down overnight. An agreement was reached before the markets opened.

Sources: Vanguard calculations, based on data from Congressional Research Service and FactSet Research Systems.

Important risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

This material is for professional investors as defined under the MiFID II Directive only. In Switzerland for institutional investors only. Not for public distribution.

Other important information:

This article is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The opinions expressed in this article are those of the author and individuals quoted and may not be representative of Vanguard Asset Management, Ltd or Vanguard Investments Switzerland GmbH.

Issued by Vanguard Asset Management, Ltd, which is authorised and regulated in the UK by the Financial Conduct Authority. In Switzerland, issued by Vanguard Investments Switzerland GmbH.

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