Why Stocks May Soar After the Government Shutdown

A possible shutdown of the U.S. federal government is looming as the government reaches the end of its fiscal year on Sept. 30, 2021, with funding for its operations expiring at the end of that day. A key point of contention is a bipartisan infrastructure bill, debate over which is holding up the passage of legislation funding other government operations for the upcoming fiscal year.

Additionally, in mid-October, the government is projected to reach its spending limit, and unless Congress votes to raise the debt ceiling, this may cause the U.S. government to default on debt payments for the first time ever, as well suspend various other payments, including Social Security checks and monthly child tax credits, among many others. Below is an examination of the effects of previous shutdowns on investors and the markets.

Effects of Past Shutdowns on the Markets

While shutdowns of the U.S. federal government typically induce anxiety among investors, sharp gains in stock prices often follow. "Past shutdowns have largely been a nonevent for the U.S. economy and stocks," according to research by LPL Financial. "Business and consumer confidence indicators usually decline and government spending drops during a shutdown, but any losses have typically been recouped quickly," their report continues.

The government shutdown on Dec. 22, 2018, was the 20th since 1976. In the 12 months following the end of 18 previous shutdowns, the S&P 500 Index (SPX) enjoyed an average gain of 13.0%, (See table below for the six biggest rallies.) The one-day shutdown that ended on Feb. 9, 2018, was not included in LPL's analysis since less than 12 months had passed as of the date of their report. However, the gain during that period eventually proved to be 3.4%.

5 Biggest 12-Month Gains After Shutdowns

• 36.2% after shutdown ending Oct. 2, 1982
• 24.7% after shutdown ending Oct. 12, 1979
• 23.7% after shutdown ending Jan. 25, 2019
• 23.5% after shutdown ending Oct. 9, 1990
• 22.8% after shutdown ending Nov. 19, 1995
• 21.3% after shutdown ending Jan. 6, 1996

Sources: LPL Financial, Investopedia (for shutdown ending in 2019)

The 2018 Shutdown

The latest shutdown began at midnight on Dec. 22, 2018, and ran for 35 days, until Jan. 25, 2019. This was was the longest in U.S. history. The S&P 500 Index rose by 10.2% during this period. The previous longest shutdown was 21 days, ending Jan. 6, 1996, during which time the S&P 500 posted a slim 0.1% gain, as calculated by LPL.

"The current shutdown has lasted for an unprecedented amount of time with no end in sight. The U.S. economy is also especially sensitive to a shift in confidence right now. Consumer and business confidence gauges have declined from cycle highs recently," LPL warned during the last shutdown. Partly because U.S. federal employees missed their first payday of 2019 on Jan. 11, 2019, "the shutdown eventually could weigh on consumer demand," said John Lynch, chief investment strategist at LPL Financial Research.

'Risks Grow as Time Goes On'

"The market historically has shrugged off government shutdowns, but the risks to the economy/market grow as time goes on," Bank of America Merrill Lynch observed in a Strategy Snippet during the 2018-19 shutdown. Their economists estimated that the U.S. GDP growth rate falls by 0.1 percentage point for every two weeks that the shutdown continues.

In only two of 20 instances since 1976 did the S&P 500 fall in the 12 months after a shutdown concluded. These were drops of 6.6% after the shutdown that ran to Oct. 11, 1976, and 0.4% after the closure that ceased on Nov. 14, 1983.

During the 19 shutdowns studied by LPL, the S&P 500 rose nine times and fell 10 times, with the average result being a decline of 0.4%. Prior to the 10.2% gain posted during the 2018-19 shutdown, the biggest advance was 2.3% during the 17-day shutdown that ended Oct. 17, 2013. The most severe prior pullback was a 4.4% decline during the 13-day closure that ended Oct. 12, 1979.