The Government Shutdown Showdown and Your Portfolio

In the wake of talks about a potential government shutdown due to Congressional disagreements over the debt ceiling, it is crucial to sift through the noise to understand its likely impact. Government shutdowns are nothing new and historically have not had long-term detrimental effects on investment portfolios. In fact, they tend to have the opposite effect, with the S&P 500 averaging positive returns of 4.4% during past government shutdowns. Even if lawmakers do not reach a deal in time to avoid a shutdown, it is essential to remember that the government has the ability to pay its debts. However, the landscape has been complicated by a recent U.S. credit rating downgrade by Fitch, citing concerns about rising debt, governance issues and political polarization. These downgrades serve as a sobering reminder that while government shutdowns are more of a political issue than a question of solvency, the nation’s fiscal health cannot be ignored.

As we divert our attention from the machinations of Capitol Hill, other economic indicators like the August CPI report also warrant additional analysis. Core CPI, which excludes food and energy, has been in decline, inching the economy closer to the Federal Reserve’s target inflation rate of 2%. In parallel with this, high-profile strikes in the auto industry highlight a tight labor market. The industry is already grappling with supply chain issues and rising material costs, so an escalation in labor costs could further squeeze corporate profits. Top line revenues could be reduced by a slowing economy and other negative economic factors, which may result in further impacts of corporate profits. This comes at a time when businesses are already navigating a high-interest rate environment — a situation that could result in companies facing the burden of rolling over old debt into new, pricier debt.

Despite these challenges, the S&P 500’s year-to-date growth of 16% (as of May 31, 2023) might seem noteworthy, but it’s crucial to recognize that this growth is disproportionately driven by a narrow set of tech stocks, often referred to as the Magnificent Seven. In contrast, broader indices have shown only modest gains. Given this context, it may be an opportune moment to diversify into high-dividend and value stocks.

On the fixed-income side, the bond market continues to exhibit unusually attractive yields. High-yield bonds are offering returns between 7% and 9%, and tax-free municipal bonds are hovering around 4% — yield levels not seen since 2007. These appealing yields are partly a function of the economic environment, which has seen a rebalancing of risk and reward due to factors like inflation concerns, geopolitical tensions and the aforementioned credit rating downgrades. As other economic indicators present a mixed bag, we believe the bond market presents a more compelling case for those seeking stable, predictable income because bonds come with the benefit of known yields.

If you have any questions about your portfolio, please feel free to consult your financial advisor at The Wealth Alliance today.