- US government shutdowns are recurring political events, and historical data shows that they had a muted, negligible impact on financial markets.
- The S&P 500 Index has averaged only a modest decline during (some of) these shutdowns, and rebounded once a resolution had been reached.
- They are rarely seen as threats to fundamental corporate earnings or the long-term health of the US economy.
The recurring drama of a US government shutdown is once again commanding news headlines. As an observer, it might fuel a rush of uncertainty, especially for those who hold an outsized position to US assets, all while US valuations have been elevated for some time.
At Endowus, we believe in anchoring your investment decisions in evidence and a long-term perspective. While a shutdown creates genuine, disruptive noise in Washington, the historical data suggests its lasting impact on financial markets is often more noise than catastrophe. Here’s why.
What a US shutdown actually entails
A US government shutdown is triggered when Congress fails to pass funding legislation for federal agencies, forcing non-essential services to halt under what’s called “the Antideficiency Act.”
During this period, there are impacts on passport processing, national parks, and IRS operations. While essential functions, like air traffic control, border security, and military operations, continue, many federal workers, on an individual level, are furloughed or work without pay.
Since the 1970s, there have been 15 funding gaps, with four lasting four or more business days. Notable shutdowns include the 21-day closure in 1995-1996, the 16-day shutdown in 2013, and the longest 35-day shutdown in 2018-2019. Each event stems from political disagreements over spending, but the key takeaway for investors remains consistent: these are short-term political crises, not long-term economic shifts.
The mixed yet rather muted market response
During past shutdowns, the market’s reaction had been muted (as with the latest shutdown), amid increased newsflow and short-term volatility. On the third day of the current shutdown (3 October), the S&P 500 Index edged up to a record closing high.
Historically, the S&P 500 Index had averaged only a modest decline during these periods. Crucially, these effects were almost always short-lived. Markets tended to recover quickly once a resolution had been reached, as these events were rarely seen as threats to fundamental corporate earnings or the long-term health of the US economy.
Most government shutdowns are short, with half lasting three days or less. These brief shutdowns, particularly those that occur over a weekend, typically have a minimal effect on the markets and the economy. For example, the S&P 500 Index saw a 3.1% advance during the 16-day shutdown in October 2013. While short-term volatility can occur, the economic activity that was lost often recovered once the government reopens.
Historically, the S&P 500 had averaged a modest 0.1% decline during these periods. Certain sectors, such as government contractors and businesses reliant on federal spending, felt a sharper, immediate pinch. For the diversified investor, however, the direct impact was limited.
During the 35-day shutdown in 2018-19, the S&P 500 initially declined but ultimately posted a positive return of 10.3%. Moreover, more factors were at play than merely the shutdown and the eventual resolution—a pivot of the Federal Reserve to be more dovish sent stocks higher following rate hikes.
Historical S&P 500 performances amid shutdowns
What is at force driving US equity markets now?
While the S&P 500 is still up year-to-date, that performance is highly concentrated, leading to stretched valuations in parts of the US market.
That said, strong corporate earnings were still a major tailwind for the market. In the second quarter, the average S&P 500 company grew earnings by around 12% year-on-year, easily beating analyst expectations of 5%. This marks the third consecutive quarter of double-digit year-on-year earnings growth. This fundamental strength, the ability of companies to execute and deliver profit, is anchoring US equity valuations.
Some investors are increasingly looking for value elsewhere, though. Driven by relative valuations and earnings prospects, this search for value has been a more relevant theme. The rally in August started to show signs of broadening beyond the mega-sized tech names, as robust performance was seen in sectors like materials and healthcare, suggesting that market leadership is expanding. Small and mid-cap stocks have also seen a rosy picture.
To sum up, government shutdowns are perennial features of US politics. As an investor, especially located far away in Hong Kong, your focus should remain on what truly matters: your long-term plan. By looking beyond the political theatre and maintaining a diversified strategy, you can navigate these periods of uncertainty with confidence.
Remember, your investment goals shouldn’t change with times, and be guided by simple rules:
- Maintain perspective: A shutdown does not alter the fundamental drivers of long-term wealth creation—corporate earnings, global economic growth, and demographic trends.
- Ensure diversification: Your best defense against country-specific risks, whether political or economic, is a well-diversified portfolio across different asset classes and geographies. Depending on your investment objectives and risk tolerance, investing in a global portfolio, like Endowus Flagship Portfolios, would ensure the opportunities outside of the US are also captured.
- Avoid market timing: Attempting to trade the volatility caused by political events is speculative and typically diminishes returns. Stay committed to your financial goals and investment strategy.
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