Lowdown on the shutdown: How could the government shutdown affect investors?

A perspective from E*TRADE Securities1

01/18/19

If you find yourself with an unusual urge to don baggy carpenter jeans, do the macarena, or ponder how long Apple can fend off bankruptcy, we wouldn’t blame you. After all, it’s 1996 all over again. Or so it seems. That was the last time a federal government shutdown lasted this long. At 21 days, the memorable 1995–1996 battle of wills between the Clinton administration and Newt Gingrich’s newly emboldened House Republicans ranked as the longest US federal government shutdown on record.

Until now.

The latest government shutdown is now the longest ever, which raises the question: What effect might the current political standoff have on investors and the markets?

The ABCs of a government shutdown

While today’s partisan divide seems wider than ever, government shutdowns are actually nothing new. According to the Congressional Research Service, there have been 21 government shutdowns in US history, and every one of them came after 1975.1

Technically speaking, shutdowns occur because of what’s known as the Antideficiency Act. This scintillating piece of legislation, passed in 1884, “prohibits federal agencies from obligations or expending federal funds in advance or in excess of an appropriation, and from accepting voluntary services.”2  Bottom line: Congress must appropriate funds to keep the government running.

But since December 23, 2018, Congress has failed to do so. The reason, of course, is a funding dispute over a proposed border wall with Mexico. And the effects are already being felt.

Consider, for example, that garbage is no longer being collected at national parks, federal courts are running short on cash, and Americans applying for disability benefits are facing a growing backlog of claims with no one to process them. They say you don’t know a good thing until it’s gone, and right now many folks are in need of a few good government workers.

Potential ramifications for the economy

For most investors, the ramifications of the shutdown may not be readily apparent. The markets are still operating efficiently, and stocks have actually gained ground since Congress turned off the spigots.

But there may still be cause for concern. Nearly 400,000 federal workers have been furloughed and another 420,000 are working without pay, with an increasing number calling in sick. This situation can directly affect the broader economy.

When air travelers expect to see longer lines at the airports, they may be less likely to take trips. Visa and passport processing slows to a crawl. Farmers applying for subsidies must wait to receive them. Government-backed mortgage applications are put on hold, reducing demand for housing. Manufacturers applying for tariff exemptions don’t know if they’ll receive them, so how do they price their products? The list goes on and on. Keep in mind, too, that government spending comprises more than one-third of US gross domestic product.

And because markets reflect expectations about corporate profitability, the real question is how much these interruptions will affect the earnings of publicly traded companies. In theory at least, such changes would eventually be reflected in stock prices.

What’s the historical record?

Since there’s no way of knowing how long the shutdown will last or how much it could undermine economic growth, it may be instructive to look at the historical record. Interestingly enough, the effects of past government shutdowns on the markets have been negligible, although nearly half of the shutdowns occurred on weekends.

The chart below demonstrates that S&P 500® median performance was unaffected during the 20 previous federal government shutdowns. And, during the longest shutdown of 1995–1996, stocks actually eked out a miniscule gain.

S&P 500 Index performance during previous government shutdowns

Source: LPL Financial Research, MarketWatch, Inc.


What can investors do?

Since there’s nothing any of us can do about the shutdown, the best strategy may be to simply focus on individual financial goals.

“In the context of long-term investing, government shutdowns tend to be fleeting affairs,” says Mike Loewengart, Vice President of Investment Strategy for E*TRADE Financial. “Even if the shutdown lasts a while longer, it’s not enough to warrant making major portfolio adjustments. Decisions like that should be based on an investor’s long-term goals, rather than political bickering.”

There are also larger trends to consider, including tariffs and trade wars, troubles in the oil patch, a flattening Treasury yield curve, and a potential shift away from growth stocks toward value-oriented shares. These could all influence the markets as much or more than a government shutdown.

Ultimately, it may take measurable economic pain for the White House and Congress to come together on a budget deal—even if it’s a short-term funding resolution. When that will happen is anyone’s guess.

With the current shutdown making past versions look like the blink of an eye, we can at least say this: It only took two weeks, but 2019 has already been a record-breaking year.

Click here to log on to your account or learn more about E*TRADE's investing choices, or follow the Company on Facebook or Twitter for useful investing and trading insights.

1.    Congressional Research Service, “Shutdown of the Federal Government: Causes, Processes, and Effects,” December 10, 2018, https://fas.org/sgp/crs/misc/RL34680.pdf

2.    U.S. Government Accountability Office, “Antideficiency Act Resources,” https://www.gao.gov/legal/appropriations-law-decisions/resources#overview