Episode 31 – What Investors Should Think of the Federal Government Shutdown

[MUSIC PLAYING]

Welcome to Market Perspectives, a Mercer Advisors podcast. In today’s episode, we’re talking about the federal government shutdown, which at the time we’re recording is into its second week. What, if anything, should we as investors make of this? I’m Josh Zumbrun. I’m the director of external communications here at Mercer Advisors, and I’m joined by Don Calcagni, our chief investment officer. Don, thanks so much for being here with us today.

Thank you. Josh, it’s great to be here again. And this is certainly a fun topic, so it’ll be interesting.

Certainly, Don. So far the market has taken this shutdown in stride, right?

Yeah, for sure. I mean, if you just look at where the S&P is at year-to-date, I mean, it’s up 15%. It’s up about 30%, 35% off of the April lows. Just to rewind the tape 5 or 6 months to April, Josh, I mean, certainly the market has recovered quite dramatically and has gone on to continually post new highs. And so yeah, by any objective measure, the stock market has taken all of this in stride.

So what are the actual mechanics of a shutdown like this? What’s shut down exactly here?

Well, I think it’s important to remember that the government’s fiscal year runs from October 1st until September 30th of the following year. And so what really happened here, Josh, is government funding ran out at midnight on October 1st, and effectively at that particular point, the government was unfunded. So all non-essential government functions, all non-essential employees are furloughed. Furloughed means that they are laid off. They’re not fired. Although, we’ll get to that.

I think there’s some interest in perhaps in terminating some of these employees, but what it means is the government is unfunded at this particular point. So non-essential functions shut down.

There’s about a half a million civilian department and defense employees have been furloughed. The Bureau of Labor Statistics, which is a government agency that we rely on quite a bit here at Mercer Advisors, and lots of other government support functions ultimately shut down and workers get laid off. Essential workers, folks like air traffic controllers, TSA officers, most federal law enforcement, those folks continue to work.

But importantly, Josh, they continue to work without pay. So I don’t think any of us likes to work without pay. And certainly our mortgage companies, our landlords, things like that still need to get paid. So that, I think, is part of the rub.

There are mandatory programs–

things like Medicare, Medicaid, Social Security, the Federal Reserve. Those particular agencies or programs, they typically have their own funding source, and those are separate. So, Social Security checks. There should be no concern that Social Security checks won’t go out.

Certainly, they should.

What I think will suffer is there are typically government employees that support these programs, either through education or local offices, and things like that. That’s where I think we could see some impact on these programs, but a bit more indirectly.

We’re obviously not a politics podcast, but how did we get here? What is the impasse in Congress that led to this situation occurring?

I mean, I think at the heart of the impasse–

I mean, there’s so many things here, naturally, that the two parties disagree on, but at least looking at this particular shutdown, the issue really has to do with the extension of tax credits under the Affordable Care Act. And the Democrats were pushing to include those, add those back to the appropriations bills for the next fiscal year. Republicans objected to that. Those tax subsidies were removed as part of prior legislation.

The One Big Beautiful Bill, things like that, have had stripped out those tax subsidies.

That’s going to impact about 22 million people across the country, so certainly a pretty significant impact. Democrats have been fighting to include those. Republicans have objected to that. At the moment, that’s really the crux of the issue. And I would say, Josh, I think that’s theoretically, the crux of the issue. I think the much bigger issue here is these two parties just vehemently disagree on a whole host of policy areas. And I think right now, at the moment, it’s just manifesting itself with respect to these particular healthcare subsidies.

Well, right. I mean, if this feels a little like deja vu to some people, it’s because these shutdowns have happened quite a few times. We looked up and it’s been 22 times in the last 50 years that we’ve had shutdowns. So almost every other year on average we’ve had one happen. What are the lessons from past shutdowns? What’s been the experience with past shutdowns?

You’re right that shutdowns are not new. We’ve had shutdowns for–

many shutdowns over the past 50 years. The longest shutdown was in 2018. It lasted 35 days. So under the first Trump administration is when we had really the longest federal shutdown.

And I think from an economic perspective, and we can touch on this here in a moment, like ultimately the long-term impact is pretty muted, but I think this is more an indicator, Josh, of a broken political system.

I mean, we have two political parties that have just really been challenged to put US government funding on a sustainable trajectory over the past 20 or 30 years. And I think what we see is that reality just continuing to worsen, unfortunately.

What has been the economic impact of our track record with these shutdowns?

Yeah. I mean, if we look at the history, the economic history of these shutdowns, what we see is that the short-term impact to economic growth is somewhere between 0.1 and 0.2

points in economic growth per week. So that’s 0.1% decline or 0.2% decline in GDP growth per week that the shutdown lasts. Now, that’s in theory. And certainly that’s not an insignificant amount of money on a $31 trillion economy. But what we see is that, at least historically, once the government reopens, once they finally agree to a set of appropriations bills and the government is funded, all of those workers get back pay.

There are laws in place that protect workers, and ultimately, they get their back pay. And so what we typically see, Josh, is in the months or quarters following the shutdown after the government has reopened, that we actually recapture that lost economic growth. So, I mean, perhaps ironically, even though this is dominating the headlines, longer term the impact of shutdowns has really been a big fat zero in the grand scheme of things.

And that probably explains why the market has reacted the way it has thus far. But like, is there reason to worry that this time could end up being quite a bit different?

I mean, I would say that each time it has been a little bit different. And I think history is a guide. In that it gives us some idea of what this particular shutdown might look like, but to be fair, we are arguably in uncharted waters just based on where we’re at politically in this country. And so, Josh, this time, the administration has threatened to fire rather than simply furlough some or perhaps many federal workers. And that could have a significant impact on things like consumer sentiment, consumer spending, and certainly could impact the economy in certain areas of the country.

Think, for example, the greater Washington, DC area, New York, or LA, areas where we have lots of federal workers. If we certainly fire a number of those workers, certainly could impact those markets, and perhaps quite significantly.

And you mentioned consumer sentiment there. To what extent have we seen the longer these go on, the more they start to weigh on sentiment?

They certainly do. I think when we look at the last shutdown, we saw about a 7% decline in consumer confidence. And what I would say is at the moment, when we look at the University of Michigan’s consumer confidence survey, we’re pretty much near all-time lows. Consumers just do not feel good about the US economy. Now, there’s a lot of psychology that goes into this, Josh. And to be fair, US consumers have been negative on the economy for a very long time.

There’s some research that suggests that that’s perhaps a bit more connected to the political dysfunction in this country at the moment, rather than an actual feeling about how the economy is doing. Now, that said, I do think as the shutdown grinds on, especially as we approach the holidays, especially as we see this tariff induced inflation continuing to build into the system, that those things taken as a whole really could begin to hurt consumer spending. Let’s not forget, consumer spending is really the workhorse of the US economy.

About 70% of all economic activity is driven by consumers–

consumers going to Walmart, or going on Amazon, and clicking away and buying goods and services and things like that. So certainly it could ultimately weigh on longer-term economic growth. However, like we said a few moments ago, when we look at the historical record, we don’t really see any major lasting impact.

One of the things you mentioned that’s pretty interesting is that one of the government functions that shut down right now is the production of economic reports and economic data. October 3rd, we were supposed to get the most recent jobs report, and that didn’t get published. We were supposed to get an inflation report in mid-October that were unlikely to get on time. What do you see as the impacts of blackout of economic data?

And this really taps into a broader theme that I think has market participants–

at least speaking for myself–

has market participants concerned. And that is we do rely on government statistics agencies like the Bureau of Labor Statistics. All 2,000 employees, by the way, of the Bureau of Labor Statistics are currently furloughed. And what that means is things like the jobs report, things like the producer price index and the consumer price index, a lot of that information is not going to be released.

And like you rightly pointed out, we were supposed to get a jobs report last week, and we certainly did not get that.

So I think that is concerning. We do rely on government agencies to provide a set of statistics that help inform where we think interest rates are going, where the economy might be going. So not having that information means that we really do need to rely more so on private market participants to provide that data. And nothing against private market providers of that data, but what I would say is all private market participants have their own interests. And to be fair, that’s certainly true of all of us as human beings.

But at the end of the day, having government data as sort of a check on some of the data that we’re seeing elsewhere in the economy from private providers is certainly very healthy. And I think the longer, Josh, we go without this data from government agencies, I think we begin to increase the likelihood of a surprise. So in the event that these workers come back, they start generating economic data, sharing that data with the market, whether it be inflation, whether it be jobs. There could perhaps be a big gap in what we’re expecting versus what the data says. And that could ultimately make markets a bit unsettled.

What other market impacts are you watching should we think about for this?

I mean, again, like we’ve said, Josh, markets tend to look past shutdowns, at least when we look at market history. So I think from a US equity market perspective, I think in terms of interest rates, I’m not expecting any major impacts there at the moment, unless something material were to change.

You mentioned at the outset that there’s this current episode, which, based off our discussion, maybe we shouldn’t be all that worried about, certainly the markets not all that worried about, but there’s this broader question of US political dysfunction, which isn’t a new problem. This isn’t a comment about our current politics. We always talk about politics investing don’t mix, but rather this is something really longstanding where we’ve had a lot of trouble for an extended period of time, 25 years.

Congress has struggled to get together and have fiscal deals. And I’m curious what you make of that situation. Should we be more worried about these fiscal standoffs that keep happening in one form or another?

I think when you look at any single shutdown or fiscal standoff, that at the end of the day, those tend to be fairly transitory. And you’re right, markets look past that. However, the pattern that we’ve observed now for two decades-plus is that Congress and the White House continue to struggle to put in place the right combination of tax policy and spending policies such that we can put the funding of the US federal government on a long term, sustainable trajectory.

And the fact that our political system is struggling at the moment and has continued to struggle with this for decades now–

I mean, if you go all the way back to the 1980s, believe it or not, Josh, if you were to grab a copy of the New York Times from the 1980s, I will bet you that there will be some headlines in there about funding shortfalls projected for social security, about the rising federal deficit, and debt. I mean, these are problems that we’ve had for, frankly, a very long period of time.

The fact that our political system has been unable, or I should say, perhaps unwilling, to address this challenge means that the problem is only continuing to get worse. And what I fear is that at some point in the future that we will have some sort of crisis. I can’t tell you when. I can’t predict when. And I’m certainly not an apocalyptic person when it comes to my worldview, but I do think what is ultimately going to be required here is a very potent mix of tax increases and pretty draconian spending cuts.

At some point that we will have to be very draconian in spending cuts, and that we will have a steep increase in taxes just to be able to stave off any major economic crisis. And so I think that day is inching closer, Josh. It’s one of the things that I keep telling our advisors and our clients that let’s keep preparing for that through our financial planning, through diversification, and things like that. That’s how we prepare for that. And again, I’m not here to predict, I’m not here to be very negative or a doomsdayer in my outlook, but I do think that these are real problems that aren’t going away.

And the only way that I see us dealing with it is through a combination of inflation, big tax increases, and even bigger spending cuts.

As an investor, what do you do to prepare for that? What’s the step that you take or strategy that you follow?

It’s many of the things, Josh, that we talk about all the time.

Number one, it begins with having a well-designed financial plan that you are monitoring closely, that you’re updating. You still have a plan A, a plan B, and a plan C. Your financial plan should account for appropriate liquidity, your portfolio, your balance sheet, your broader balance sheet. Not just your investment accounts, but your balance sheet should be broadly diversified across both public securities, things like stocks and bonds, mutual funds, ETFs, but also private investments, private equity, private credit, private real estate, and things like that.

Life insurance, annuities, things like that. These are things that can help build what I like to call a fortress balance sheet to help protect families from pretty dramatic outcomes here in financial markets or the broader economy. With respect to portfolios that we’re managing for our clients, I actually think this is a very strong argument for continuing to allocate to non-US investments. The S&P is up about 15% for the year. Well, the reality is non-US stocks are up about 30% to 32% for the year.

And that’s because we’ve seen a very dramatic decline in the value of the US dollar thus far this year. It’s off about 10%. So I think ultimately, this is really a case for continuing to be broadly diversified, but also especially into non-US assets.

It fits your long-standing recommendation that international diversification is really important. And this is just another example, another reason for why.

Absolutely.

And it’s not to say that other countries are all hunky-dory and that everything’s perfect in other countries, but this is why we diversify. I mean, if you look at Germany. The German stock market is up 34% for the year. China’s stock market is up 42% for the year. Brazil is up 40% plus for the year. So by diversifying into these other markets, Josh, it helps us to hedge a bit against the political dysfunction here in the United States. But it also helps us to diversify beyond what’s happening economically here in the United States, and certainly to diversify beyond these economic policies that are hurting the US dollar.

And so I said the US dollar is down 10% year to date. How do we protect against a decline in the value of the US dollar? Well, we own non-US dollar assets. And so I think the argument for continuing to allocate to non-US investments remains fully intact and is actually quite strong.

So obviously, we’ll continue following this one. These shutdowns, you never know when they’re going to end.

We saw in 2018, it drag on a long time. We’ve also seen them get resolved quickly sometimes. And so we’ll continue to follow it. Don, thank you so much for being here today to have this discussion.

Thank you, Josh.

If you’re already a Mercer Advisors’ client, this is a great time to reach out to your advisor and talk about how you’re positioned for moments like this. And if you’re not a client, but you’re interested in more information, go to our website. Set up an appointment. It starts with a phone call. Thanks for being with us here today. This has been Market Perspectives.

[MUSIC PLAYING]

PLAYING]