Understanding a partial U.S. government shutdown
A partial 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 U.S. federal education and transportation programs.
The shutdown does not immediately affect critical government functions, such as Social Security benefits and air traffic controllers.
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, 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 U.S. stock market return during the event was –0.94%. Average returns for the 12-month period after the shutdown, however, were 10.77%. While 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.
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.”
U.S. government shutdowns:
Possible short-term volatility but no long-term effect
*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.
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