A looming government shutdown has investors on edge. I break down past shutdowns and how markets really reacted–you may be surprised
KEY TAKEAWAYS
Government shutdown looms at midnight if no budget deal is reached
History of shutdowns shows limited short-term market damage
Average S&P return during shutdowns: small positive gain
Six months after reopening, markets usually rally strongly
Main risk today is delayed economic data releases, not the shutdown itself
MY HOT TAKES
Shutdowns are political theater, not market catastrophe
Investors remember the Fed’s 2018 pivot more than the shutdown itself
Markets fear missing data more than missing government workers
Volatility is more hype than reality in most shutdowns
Steady discipline beats headline panic every time
You can quote me: “Markets fear the Fed more than Congress playing deadlock.”
Sacked. When the clock strikes 12 tonight, something peculiar, but not altogether unfamiliar will occur. That’s right, there will be a government shutdown in the US if Congress cannot agree to a budget resolution. Do you remember the last time this happened?
It was late 2018 and the market was going through a bit of a rough patch. Everyone in Washington was bickering… except for the Fed, whose FOMC members were all in agreement about rate hikes. The Fed was hiking rates relentlessly despite decaying corporate performance. Markets were on edge and ominous news headlines were aplenty. “Worst December market decline since The Great Depression!” Now you remember, don’t you?
Congress was arguing over funding a border wall with Mexico which found its way into budget talks. The standoff ended up in the largest government shutdown on record–35 days! What a mess. Here we are, years later and a new political standoff has brought us back to the brink of a shutdown. This time, the battle is over healthcare–another political flashpoint.
On Wall Street, we like to look back in the history books and see how things played out in the past in order to figure out what might happen if an event were to re-occur. Unfortunately, the conditions during the last shutdown, which occurred in Trump’s first presidency, are vastly different. Despite mass furloughs and countless lost dollars, markets got a lifeline from the Fed, when Chairman Powell famously pivoted sending markets off of lows rallying. Perhaps investors only remember the market result, or perhaps investors know that these standoffs are always ultimately resolved in one way or another, but markets seem to be shrugging off this pending shutdown heretofore.
Yesterday afternoon, House and Senate leaders met with the President in hopes of reaching a resolution. The result? 👎 Are you surprised? Of course, not. I spoke with a number of my colleagues and several journalists yesterday and we all struggled to determine just what might happen to the market if this current impasse resulted in another prolonged shutdown. I decided WHILE I SLEPT that this morning, I would lay out all the facts for you. SO, I got to work starting at 3:00 AM. I looked at the last 10 government shutdowns. Here is a table. Check it out and keep reading.
And there you have it, the past 10 government shutdowns. Some were resolved through budget agreement and others through a continued resolution–kicking the can down the road (CR, in my table). The shutdowns lasted on average for 8.7 days for a total of 87 days with the lights out. Since 1995, you will note that the butt of disagreement was around immigration and healthcare. Also notable is the increase in shutdown length more recently.
Now, let’s talk: markets. Check out this chart and keep reading.
This is a chart of the S&P 500 throughout the last 10 government shutdowns. I labeled the shutdowns so you can get a sense of what might have occurred during and around the shutdowns. Because the S&P has performed so well since 2010, it is difficult to see market reactions in the earlier shutdowns. A keen eye, however, will give you an idea that markets were indeed in transition during most of the events. But of course, we won’t just leave it there, we want to know exactly how the markets reacted. Check out the following table and keep reading.
This table details the return (in %) of the S&P 500 during the shutdown as well as the returns 1 month after reopening and 6 months after. Additionally, I calculated the max drawdown during the shutdown. You can see by this table that the S&P only lost 30% of the time. The biggest loss was -2.43% in 1990 and the biggest gain was 10.27% in 2018. Average performance is a gain of 1.43%, but we know that number is skewed due to the market conditions and Fed pivot in 2018. Excluding 2018, the average gain was 0.45%--not great, but not terrible considering the implications. Beyond the shutdown, markets performed solidly with an average gain of 1.5% but performed really well 6 months after reopening with an average gain of 9.2%!
Looking at the table, you will note that the intra-shutdown maximum drawdowns were not very large, averaging -0.9%. Remember, Max drawdown is the largest peak-to-trough decline in a portfolio (or index) over a specified period, measured as the percentage drop from the highest cumulative close (peak) to the lowest cumulative close (trough) before a new peak is reached. It is kind-of a measure of maximum pain. What about volatility, which is another source of pain for some. Check out the following chart, then follow me to the close.
In this table I show you how the VIX Volatility Index performed through the last 5 shutdowns and beyond. It’s only 5 because the VIX wasn’t around in the 1980s yet. We had big hair, great music, and The Goonies, but alas, no VIX yet. Anyway, you can see that in all cases, except for 1990, the VIX declined through the shutdown period. The biggest spike (peak) came in 2018 but was not likely a direct result of the shutdown. Looking beyond the shutdown, we note no real significance in performance, except for the January 2018 shutdown. That big gain was not the result of the shutdown. No. That was Volmageddon, which refers to the February 5, 2018, volatility shock, when the VIX more than doubled in a single day as US stocks tumbled on inflation and rate fears. The surge obliterated popular short-volatility products like the XIV ETN, triggering forced unwinds.
So where does this all lead us? Well, from a market perspective, stocks perform well during shutdowns, considering the economic tolls. Even excluding the top performer, average returns were positive with small drawdowns. While returns are muted in the immediate aftermath, mid-term returns are really strong. Volatility increases that may come at the start of shutdowns generally end lower by the end of the crisis.
The implications for the current shutdown? Well, considering that we have an already doveish-leaning Fed, and the history I just presented to you. I would say that “steady as she goes” is a solid strategy. However, keep a weather eye on the horizon, because there are plenty of other market movers in the near distance, like this week’s employment numbers and earnings season. We cannot ignore the potential for one important wildcard event; it is possible that a government shutdown may preempt the release of this Friday’s monthly employment series from BLS. That would not be good. With an already decaying reputation of accuracy, a skipped release will only add to angst for those trying to understand what is going on with the struggling labor market. A skipped release may not cause declines in the market; it certainly can eat at investor sentiment and cause additional volatility. So, there you have it, your playbook for navigating the treacherous waters of political theater using the US economy as a prop.
All of these analyses were done using R coding language–happy to share code if you like. 😉
YESTERDAY’S MARKETS
Stocks gained yesterday climbing a wall of worry as threats of government shutdown loomed. 10-year yields slipped, the yield curve flattened, gold gained, and the dollar weakened–bond traders, commodities traders, and currency traders appear more concerned about a shutdown than their equity trader cousins.
NEXT UP
FHFA House Price Index (July) is expected to have slipped by -0.2% for a second straight month.
JOLTS Job Openings (August) will probably show a slight increase to 7.2 million from 7.181 million vacancies.
Conference Board Consumer Confidence (September) may have slipped to 96.0 from 97.4.
Fed speakers today: Jefferson, Collins, Goolsbee, and Logan.