Motley Fool Hidden Gems Investing - Ripple Effects of the Government Shutdown

Starting point is 00:00:00 We're taking a deeper look at the impacts of a prolonged government shutdown and discussing what investors need to know now, today on Motley Fool Money. It's Tuesday, October 28th. Welcome to Motley Fool Money. I'm your host, Emily Flippen, and today I'm joined by Fool analyst Jason Hall and Keith bites to dig into the government shutdown and some of the second order impacts that could leave investors spinning. As of today, we are on day 27 of the government shutdown. This is the longest running government shutdown since 2018 when the government was shut down for 35 days. There is,

Starting point is 00:00:44 as of right now, still no end in sight. Now, I know we've discussed some of the first order impacts of a government shutdown in the past, especially for what it can mean for consumer spending, confidence, and in the holiday season. But I want to dig into some of the deeper impacts that investors may be less familiar with. Jason, for me, what comes to mind most immediately is the lack of economic data. We are supposed to be getting yet another series of economic reports, things like personal income, GDP, and durable goods, all of which are canceled due to the shutdown. So how important are these reports to investors and what does it really mean if we aren't getting them? So I'm going to share a couple of quotes here. One may be less familiar

Starting point is 00:01:22 and one's probably pretty familiar for most of the listeners here. They also describe how I view what's going on. Danny Kahneman, Nobel winner for his work on behavioral economics, once wrote the following in his incredible book that I recommend to people. It's called Thinking Fast and Slow. The quote is, nothing in life is as important as you think it is while you are thinking about it. That's the less known one. The more familiar one is Peter Lynch. He once said, if you spend 14 minutes a year on economics, you've wasted 12 minutes. Now, I think there's two important lessons for those quotes, and they overlap here. Kahneman's

Starting point is 00:02:08 quote, it's about our tendency to overweight the importance of things that we're dealing with right now. If we look back in time, we almost never remember what was going on on a particular arbitrary date, even if it was things that felt really important at the time. I think that's part of it. But Lynch's point, which he made in that same speech where the quote was before he actually said the quote, is that you can study economics and macro data all that you want. It doesn't point you towards the opportunities or pitfalls ahead with any degree of accuracy. Let's be honest. Economists, they don't predict the future. They explain the past. But that's not to say the data is useless. I don't think it's directionally helpful for us as investors

Starting point is 00:02:53 trying to navigate markets in the near term. But it is really important and useful to thousands and thousands of organizations, whether it's state and local governments, multinational corporations, small businesses. They use that data to inform their near and long-term plans around things like hiring, inventory, acquisitions, expansions, ad budgets, a litany of other things. Data may not help us navigate the markets, but it certainly impacts the organizations, many of which that we invest in, operate in the real world and make important decisions. Yeah. That Peter Lynch quote really always hangs over my head as somebody who's been on the record numerous times saying, most people don't look or consider economic data for the most part for

Starting point is 00:03:36 long-term buy and hold investors. It's not really relevant. But Keith, I know it's pretty relevant for at least one organization. I mean, the Federal Reserve is supposed to meet tomorrow to decide on any changes to interest rates. And investor expectations are really overwhelmingly expecting a 25 basis point rate cut here. But with the lack of economic data for an organization that really needs that data to make decisions, do you think that rate cut still happens? Yeah, Emily, I do think that another modest Fed rate cut is likely. You're right that the government shutdown has very much limited the flow of economic data. But while it's a trickle, there's still some coming through. For example, there's a statutory requirement related to Social Security's

Starting point is 00:04:18 cost of living adjustment. And that forced the Bureau of Labor Statistics to bring some folks back in so that they could release the September inflation report. Now, it was later than it was originally scheduled, but the report did ultimately come out. And the main story from this report was that inflation is rising, but more slowly than expected. And I know the Fed is taking a hard look at that. Yeah, that's true that the inflation report, it was low, but it's still well above the Fed's long-term target, right? Which is closer to 2%. I think that that puts the Fed in a precarious position because as we saw last month when it did cut rates, the jobs data is the issue that's really has the Fed concerned. You're exactly right, Jason. While the Fed is concerned about

Starting point is 00:05:06 inflation, that's not its only focus. The Fed also closely monitors jobs numbers, which have not been reported because of the shutdown. And there's really a tension at work here. If the Fed cuts rates, it could cause inflation to soar or at least spike somewhat. But on the other hand, the rate cuts could bolster the economy and then foster job creation. At least that's the goal. So the Fed has this tension at work that it's trying to manage between these two different goals. So what will the Fed do since it doesn't have the latest jobs data? The good news there is that it does have some other ways to at least get a sense of how the employment picture is looking. For example, when news organizations report that a huge company like Amazon plans

Starting point is 00:05:49 to cut up to 30,000 jobs, I suspect Jerome Powell and his fellow FMOC members are taking note. Now, I think I saw news this morning that Amazon is saying it's going to be 14,000 jobs cut, But that's still huge. I mean, that's a lot of jobs. And so I think you're going to see Powell and the other Fed members looking at numbers like that and thinking, oh, great, we have a big problem with the job situation here. We might need another round of rate cuts. The market is betting that slightly better than expected September inflation numbers and the indications of this worrisome job scenario give the Fed a little leeway to reduce rates again. My guess, and it's only a guess at this point. We'll find out soon. My guess is that this is a good bet and we'll see

Starting point is 00:06:31 a rate cut along the lines of what Emily mentioned. Well, it would certainly be a shock to the market if the rate cut doesn't come through. But I agree, Keith, based off of some of the expectations here around layoffs that we're seeing, it would be shocking if the Fed doesn't decide to take action there for its dual mandates. Up next, we're digging into some of the publicly traded companies that are being most impacted by the continued shutdown. Stick with us. Welcome back to Motley full money. In addition to missing economic reports, there's also a handful of publicly traded companies that are really starting to feel the effects of the government shutdown, in particular, government contractors. Now, I know most of these government contracts are

Starting point is 00:07:08 forward-funded, but typically this only happens for months at a time, not quarters or even years. Government contractors and their subcontractors are faced with the decision of what to do with workers who aren't actively on a contract or whose contracts face federal funding limits in the upcoming weeks. We're talking in the order of north of 500, nearly a million furloughed workers here in the United States. Many of these organizations seem to be encouraging even more employees to take time off or furloughing until the shutdown ends. Keith, I live here in Maryland, so I see a lot of these impacts myself firsthand. Of course, this does have impact economically on consumers, but also for the companies themselves. What should investors

Starting point is 00:07:44 be watching out for? Emily, I think you hit on the biggest problem, and that is these companies securing new contracts. With federal government shutdown, few, if any, new contracts are being awarded. Now, that's not a significant problem for large federal contractors, at least for now. For example, a company like Northrop Grumman, they're not hurting at all. Their contracts are usually multi-year. A lot of them are pre-funded. I have friends who work with major defense contractors like Northrop Grumman, and these companies haven't skipped a beat due to the shutdown, and the contractors, their employees haven't skipped a beat. It's also not too concerning for federal contractors that have significant private commercial business.

Starting point is 00:08:22 Palantir is a case in point. Even though the company generates much of its revenue from the U.S. government, Palantir's commercial business is growing a lot faster than its government business. So, I don't think Palantir is a company that's going to be too terribly worried about all of this going on. The companies that will feel the impact, though, are the smaller federal contractors, and especially those that have minimal or no commercial revenue. Take Amenum, for example. This company has a market cap of around $5.5 billion, a little less than that. It provides engineering and technology services. Roughly 90% of the company's total revenue last year came from the U.S. government. So, a shutdown is a big worry for a company like this. I was

Starting point is 00:09:00 looking at their last earnings call, and a lot of the buzz during that call centered on this Golden Dome Missile Defense Initiative that was included in the GOP's One Big Beautiful Bill. with the federal government shut down, a minimum probably won't be receiving any new contracts, even though the general funding for that first part of the Golden Dome has already been approved by Congress. Yeah, it's this complicated relationship between approvals that have already happened, getting new approvals, but also at some point money for contracts are even prepaid do start to run out. And that does impact these government contractors really directly. But I also think it can have some of those second order impacts on things like big IT vendors,

Starting point is 00:09:35 right? The Accentures, Microsoft, and Oracles of the world, these businesses that service the government. Jason, when you think about these companies, I mean, how long would a shutdown have to go on for them to actually be substantially impacted? I don't think very long. We're starting to see some impact as we're going through earnings season and they're talking about forward guidance. But I think the thing to remember is that these are extremely, if you're talking about the the Accentures and Microsofts and Oracles. They're extremely diversified companies. But I think, if you start talking about technology, you see a company like Booz Allen Hamilton, tickers BAH, and some of its peers that are very, very focused on the government,

Starting point is 00:10:17 particularly the federal government. Here's an interesting little data point that I think reflects the importance of government contracts for its business compared to, say, an Accenture, tickers ACN there. In last year's annual report, Accenture mentioned the U.S. government 17 times. Booz mentioned it 264 times, while the word government appears more than 400 times in Booz's annual report. It's essentially a government contractor with a tiny little commercial business. Companies like Accenture and Oracle, they're commercial businesses with some government contracts. It's very, very different. Booz actually reported earnings last Friday and lowered its revenue and earnings guidance, in part because of the short shutdown

Starting point is 00:11:01 and said that it could get worse. It's a double whammy for booze because it's tiny, but its civil business is really, really struggling. It's certainly not big enough to offset the impacts of the shutdown. But I will say this, Emily, a lot of times, these are counter-cyclical opportunities, not reasons to run away from a stock like this, but to maybe look for opportunities to start a position or open a position. Cybersecurity, critical services they provide to the Department of Defense and other parts of the business. So, the other side of the shutdown, this is still going to be one of the most important government contractors out there. It's starting to get a little more interesting to me, actually.

Starting point is 00:11:42 They actually really like that take, Jason, because it's true that we should be expecting, I would expect fourth quarter reports for a lot of these companies to be impacted. Even with companies like Accenture that have great commercial businesses, when they're putting out quarterly guidance, they're baking in expectations for new contracts. And a lot of these government contracts have already been baked into guidance for many of these companies, not just government contractors, but any service provider. It's unlikely that these contracts get canceled outright, of course. It's more likely that they get delayed. And Wall Street can be so focused on the short term that they might sell off, say, if they post a

Starting point is 00:12:19 quarter that misses expectations because of a delay due to the government shutdown. But that doesn't actually change the long-term thesis. Well, we don't have to play the same game as the street. We get to play our game. And one of our biggest strengths is we know what our long-term financial goals are and when they are. And we can take advantage of those opportunities and play our game instead of trying to play defense in the near term. Look for opportunistics to buy great businesses that the market's turned on for very, very temporary reasons like what we're going through right now. Oh, classic rule breaker style investing. Thank you guys. Coming up next, we'll be closing out the show with a look into how the shutdown could impact industries

Starting point is 00:12:56 that most investors haven't even thought of. Stick with us. Welcome back to Motley Fool Money. As we wrap up today's show, I want to dive into some of the industries that investors may not think about when they're thinking about the impact of the government shutdown. Keith, you're our resident biotech expert, and I know you know this, but as of October 1st, the FDA has officially lapsed in government funding, and the only staffing is necessary activities to address what they call, and this is a quote from them, imminent threats to the safety of human life. I mean, thank goodness they're still doing that. But I mean, what downstream impacts can we expect for our biotech stocks? Yeah, when you see phrases like that and hear phrases like that, it sounds really scary.

Starting point is 00:13:33 But at least for now, the impact on biotech stocks should be relatively small, actually. That's thanks to the way the FDA is funded. A lot of people don't realize this. While the federal government pays for much of the FDA's budget, a little under half of it, I think around 45%, comes from user fees that are paid by drug makers, medical device makers, and other companies. So the FDA will be able to pay staff involved in approving new therapies and medical devices as long as there's money available from those previously paid fees. And I saw a recent report, I think around two-thirds of the agency's employees are actually still working because their jobs are funded by those user fees. Now, where the potential problem comes in, though,

Starting point is 00:14:16 Emily, is that the agency can't accept new regulatory filings during the government shutdown. That means the inflow of those user fees is completely cut off. If the shutdown lasts too long, the FDA's user fee account will be depleted. And after that point, the agency would have to send the folks home who are working now to keep the regulatory approval process going. As we talked about with the impact of the shutdown on federal contractors, the most pain, if this scenario unfolds, would be felt by smaller companies such as clinical stage biotechs. A big drug maker like Eli Lilly, ticker there's L-L-Y, Lilly wouldn't be affected much if one of its pipeline candidates doesn't win FDA approval quite as quickly as hoped. But smaller biotechs could. I will say, though, that I suspect the chances of things getting to the point where the FDA is forced to take these actions aren't very high.

Starting point is 00:15:08 The longer the federal government shutdown goes on, the greater the pressure will be for the two sides to reach some kind of compromise. And I think it's just a matter of time. I don't know if this is going to be the longest shutdown ever, but the longer it goes, I think the closer the light at the end of the tunnel is. I think that's exactly right. I mean, that's the reason we're talking about it today is because a lot of these first order impacts are not enough to actually catalyze the government and Congress to get together and make a deal. But as we start to see the second order impacts and start to roll down the chain here and

Starting point is 00:15:41 they start to impact more deeply, I mean, things that investors and consumers and just Americans aren't even aware of, like the FDA, that's what really puts pressure on Congress to make action. But I can also say this, Jason. I mean, again, living in Maryland, I don't know about where you are, but the housing market around here has basically come to a standstill. And I know that housing is an industry that you've followed for many years and you're generally pretty bullish on it. I mean, does any of the concern around these hundreds of thousands of furloughed workers cause you hesitation for

Starting point is 00:16:13 the housing industry? So there's a couple of reasons I wanted to talk about. And one is that while federal data plays a role in the federal government, obviously plays a role in housing because it's 16%, 18% of the economy. It's a massive, massive industry. I think it's interesting because there's some other parts of it. It's not regulated by the federal government, hardly at all. It's mostly state and local. There's a massive amount of private data that flows in, is going to continue to flow in from the private sector. National associations of realtors, existing inventory and sales data doesn't include new construction, but certainly reports the trends that are going on in markets. The NAHB, which is the National Association of Home Builders,

Starting point is 00:16:55 does multiple surveys of builders and has about a half a dozen different indices that include cost of housing, regional and national pricing, remodeling, single-family, multifamily data. All of that data helps inform for builders where they should target and what they should be working on. Now, again, it's a locally regulated industry, so I think the government shutdown doesn't directly affect it, but you're talking about first order, follow-on economic impacts of a protracted shutdown are only going to add additional headwinds to an industry that, like you said, has kind of been in a standstill and been struggling. Federal funds, they flow through to a lot of state and local governments, things like schools, first responders. So if the

Starting point is 00:17:38 economic impact continues to play out for months, it's going to start hitting a lot of other people's paychecks beyond just those frontline federal employees that are furloughed right now. Now, with that said, the other part of, you know, it's not, it's still definitely tied to the federal government, but the federal reserve cutting interest rates, you know, that helped pushing rates down a little bit. That could be a positive for, for the industry over the longterm and help rebuild some momentum and get affordability where it's a little bit more compelling for all of the people on the sidelines that do want to buy.

Starting point is 00:18:12 And that will just get further credence to watching to see what the federal reserve does tomorrow in terms of lowering rates. Either way, it sounds like a lot of the concerns that we're seeing coming out of the government shutdown, while very painful in the near term, aren't really changing the long-term thesis for many of the companies that we're invested in. So, despite all the pain that federal workers, contractors, and subcontractors, and the American people are going through right now, hopefully investors can take some heed in the assurity that this is likely to be short-term and unlikely to have great long-term impacts on the market and the companies we're invested in. Keith and Jason, thank you both so much for

Starting point is 00:18:52 joining today. Thanks, Emily. Thanks, Emily. Listeners, be sure to join us for tomorrow's show where Travis will be further discussing layoffs and the evolving deal between Microsoft and OpenAI. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows The Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For Jason Hall, Keith Spites, and the entire Motley Fool Money team, I'm Emily Flippen.

Starting point is 00:19:25 We'll see you tomorrow.

Motley Fool Hidden Gems Investing - Ripple Effects of the Government Shutdown

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