If the Government Shuts Down, Here’s What Investors Need to Know

Once again, the U.S. House of Representatives is careening toward a government shutdown thanks to a failure to find consensus on legislation to fund the federal government.

Those who have watched Washington for a long time know this is a frequent and unfortunate occurrence. There have been four shutdowns in the last 10 years alone, varying in length from just a few days at the beginning of 2018 to a 34-day shutdown that spanned from December 2018 into January 2019.

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The lack of federal funding can cause a host of headaches including furloughed government employees and curtailed services. But if the government shuts down, what does it mean for investors and the stock market?

— The stock market generally shrugs off shutdowns.

— The bond market is a different story.

— Stay calm, but stay alert.

Shutdown Date* Number of Days S&P 500 performance**
Sept. 30, 1976 to Oct. 11, 1976 10 -3.4%
Sept. 30, 1977 to Oct. 13, 1977 12 -3.2%
Oct. 31, 1977 to Nov. 9, 1977 8 +0.7%
Nov. 30, 1977 to Dec. 9, 1977 8 -1.2%
Sept. 30, 1978 to Oct. 18, 1978 17 -2%
Sept. 30, 1979 to Oct. 12, 1979 11 -4.4%
Nov. 20, 1981 to Nov. 23, 1981 2 -.01%
Sept. 30, 1982 to Oct. 2, 1982 1 +1.3%
Dec. 17, 1982 to Dec. 21, 1982 3 +0.8%
Nov. 10, 1983 to Nov. 14, 1983 3 +1.3%
Sept. 30, 1984 to Oct. 3, 1984 2 -2.2%
Oct. 3, 1984 to Oct. 5, 1984 1 +0.1%
Oct. 16, 1986 to Oct. 18, 1986 1 -0.3%
Dec. 18, 1987 to Dec. 20, 1987 1 +2.5%
Oct. 5, 1990 to Oct. 9, 1990 3 -2.1%
Nov. 13, 1995 to Nov. 19, 1995 5 +1.3%
Dec. 15, 1995 to Jan. 6, 1996 21 +0.1%
Sept. 30, 2013 to Oct. 17, 2013 16 +3.1%
Jan. 19, 2018 to Jan. 22, 2018 2 +0.8%
Dec. 21, 2018 to Jan. 25, 2019 34 +9.3%

*Shutdown dates sourced from the U.S. House of Representatives. **S&P 500 data sourced from Vanguard.

The Stock Market Generally Shrugs Off Shutdowns

The strange truth about these congressional antics is that thanks to their regular occurrence, the investing community tends to take them in stride.

The first government shutdown was way back under President Gerald Ford in 1976, after all, and a 2024 government shutdown would be the 22nd such funding crisis. That means investors tend to operate as usual and not act as if the gap in legislation is going to last forever.

Past shutdowns have impacted only “nonessential” workers and services, so it’s not like the entire U.S. military closes up shop. Also, employees are made whole later thanks to the Government Employee Fair Treatment Act, signed into law in 2019, that guarantees furloughed federal workers are entitled to back pay once a shutdown ends.

As the most tangible sign of resilience amid the political shenanigans: Consider that the prior 2018-2019 shutdown saw stocks rise more than 9% while D.C. was shuttered, according to Vanguard. And despite starting the year with the longest shutdown in history, the S&P 500 finished with a more than 30% gain on the year.

So much for a shutdown in Washington causing a slowdown on the Street.

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The Bond Market Is a Different Story

Generally, the government keeps paying many of its bills during a “shutdown” and eventually pays the balance of outstanding bills later, after the dust settles. But as anyone with a mortgage or a car loan knows, being late with your payment is still bad news even if your check eventually arrives.

Recently, the bond market has been losing patience with all the fuss around whether the U.S. is actually going to pay on time or not. In 2011, ratings agency S&P downgraded the creditworthiness of the U.S. federal government for the first time in history. Granted, it was from the tip-top AAA rating to just one tier down, but any change at all is noteworthy.

Credit ratings giant Moody’s then followed suit later that year. Rival firm Fitch wasn’t as hasty, but last year followed suit with a downgrade of its own amid persistent budget spats in D.C.

As with consumer credit, poor standing means you’re forced to pay higher rates on any loans. That means the U.S. government has been paying slightly elevated interest on its long-term obligations. What’s more, given the overarching interest rate environment that has led to higher rates across the board, the bond market has seen significant changes in the last few years.

There’s no telling how credit ratings agencies would react to news of a shutdown. But considering Fitch downgraded the U.S. in 2023 even as Congress escaped a formal shutdown at the last minute, it may not take a prolonged or significant budget fight to have an impact.

Stay Calm, But Stay Alert

It’s critical to note that the U.S. government is still one of the most dominant and solvent entities in the world. These self-inflicted wounds by Congress are embarrassing, but not enough to cause the economy or the stock market to crater.

But that’s just a shutdown. A dreaded debt default is a different story.

After all, a shutdown is meant to avoid a default because the U.S. isn’t allocating more funds for the next fiscal year — and stopping payment to areas like the National Park Service frees up cash to meet debt service obligations.

Eventually the math doesn’t add up, even with a shutdown.

Most institutional investors think that there is a big gap between political grandstanding around a shutdown and the catastrophic realities of a debt default. But it may be naïve to presume that the old norms of Capitol Hill are still at play in 2024. Recent years have shown that a small group of Republican holdouts can cause a fair amount of chaos. Just look at the 2023 ouster of then-Speaker of the House Kevin McCarthy — and the current rumblings about whether current Speaker Mike Johnson is also at risk of being deposed.

When disorder and inaction is the default setting in D.C., it’s hard to just take at face value that Congress will come to its senses before it’s too late. So while it may be premature to sell everything, it is definitely wise to take this year’s shutdown seriously and pay close attention to the latest developments.

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If the Government Shuts Down, Here’s What Investors Need to Know originally appeared on usnews.com

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