This month, Peter and Jeff discuss two trending topics — the government shutdown and the likelihood of a recession — and the impact they’re having on the markets. Plus, hear smart money moves to consider implementing before year-end.
Hosted by Creative Planning’s Director of Financial Planning, Jeff Stolper, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Transcript:
Jeff Stolper: I’m Jeff Stolper, Director of Financial Planning at Creative Planning, and with me is Peter Mallouk, President of the firm, and we are Down the Middle. Peter, there are always going to be headlines that temporarily drive markets up and down, and right now there are a few trending. I thought today what we could do is go through a couple of them and the impact they’re having to markets. The two I’m seeing most often right now are the government shutdown and the likelihood of a recession. So, starting with the government shutdown, it’s been about a month since Congress was unable to enact legislation to further fund federal agencies, and that’s impacting a lot of Americans, whether it’s the people that work at those agencies or they receive services from them. And that impasse on the funding bill is related to a number of different things, whether it’s healthcare subsidies and spending levels or executive influence. But as we think about the shutdown, how do you view it impacting markets?
Peter Mallouk: I think the key to the question is the very last part, impacting markets. I mean, there’s no question that government shutdown impacts families, right? Families that work for the government are obviously directly impacted in a very negative way. But let’s just focus on your question, which is what does it do to the investment markets? There have been, and I think the surprises people, over 20 government shutdowns since the ’70s. So we have a government shutdown every couple of years, not unique at all, and the average market pullback during a government shutdown is about one and a half percent. So nothing dramatic. So the short version is the market couldn’t care less if there’s a government shutdown. And the reason is the market is focused on only one thing, and that’s future earnings. So we hear a lot of things about, well, don’t tariffs impact the market?
Well, they do because they impact earnings of a company. If you’re a U.S. company and you’re competing with people bringing in goods from other countries, and those other competitors of yours now have to pay more to bring in goods from other countries, you can raise your prices. That helps your earnings. If you’re importing things from other countries and now you have to pay a big tax, that’s going to hurt your earnings. So tariffs help the earnings of some companies, hurt the earnings of some companies. People say, “Well, interest rates go up and down. That impacts the market.” Not directly. It impacts earnings. If a company’s debt costs less carrying costs, just like a home mortgage, if the interest rate goes down, you’re paying less per month. Of course the family has more earnings. Same thing with the company. If interest rates go up, the company has less earnings, they’re paying more in interest.
So when we look at the government shutdown, well, how does that impact earnings? And the short answer is, in a short-term government shutdown, it doesn’t impact earnings at all. No one’s less likely to go to McDonald’s, no one’s less likely to fly on Southwest Airlines. No one’s less likely to go Disney World because the government is shut down. Over the short run, the answer is not at all. Over the long run, different story. The government is a very, very big employer — one of the largest employers in the United States. And just like if five or six of the biggest employers in the U.S. stopped working, of course that’s going to have an implication to the economy. You can’t have one of the biggest employers in the United States, the federal government, shut down for too long. So this is the kind of thing that it becomes a different ball game if it goes on for five months, six months, seven months.
Now, why is the market doing so well now? Because it doesn’t believe it’s going to go on for five months, six months. If the market really believed there was going to be a government shutdown while we’re doing this podcast in March, it would be down 15%, because that would be extremely negative for the economy. But it thinks we’re going to get a resolution, and you could see the intensity build up and the pressure from all of these different groups hitting Republicans, Democrats very, very hard. I think the market’s basically saying, “Look, this is going to get resolved sometime in the next 30 days, very high probability, or before the end of the year, like a 99% probability.” And that’s why we’re not seeing the market react to this at all. In fact, the market’s up. It’s not up because the government shut down. It’s up because the big tech companies’ earnings are just absolutely going crazy. And that’s really been driving the market’s day-to-day during the shutdown.
Jeff: And even further, a lot of those essential services, the Social Security administration is still sending checks out. The workers are expected to receive back pay. I think that the impact, certainly short-term, is smaller than the headlines say otherwise.
Peter: Totally agree.
Jeff: So in typical news fashion and trying to get as many eyeballs as possible, you’re actually seeing government shutdown and recession risk in the same headline pretty commonly. It’s highly unlikely, as you just mentioned, that this one event will lead us into a recession, but also isn’t the only indicator that people are looking at. The other areas that people look at, one of which being the bond market, is maybe signaling something like a recession currently, which is counter to equity markets. Equity markets are at an all-time high, but the bond market is signaling a recession. What’s going on? Help make this make sense.
Peter: So it is really fascinating to watch. You have the stock market at all-time highs, and not just at all-time highs, but double-digit growth this year. You have the foreign markets, blockbuster record year, best year so far this decade. Gold at an all-time high, signals a strong concern about inflation. And speculative assets that don’t produce earnings like cryptocurrencies near all-time highs too. So you usually don’t see that headline and then say let’s lower interest rates, because you lower interest rates when you think the economy is weakening. But there are some indications that that’s the case. So one of them would be stock market breadth and performance. If we look at this past week, the stock market hit an all-time high, largely driven by Nvidia getting very big contracts. And so we saw it go up in market cap. Let’s just use an example from this past week.
We saw it go up in market cap by 300 billion. Well, that’s more, that market cap is more than a few hundred publicly traded companies put together. And on that very day, we had an enormous number of the S&P 100 stocks were negative. So what we’re seeing is a record this year of the market going up, but with a majority of the stocks going down. So a few very big tech stocks, largely big tech stocks, are hiding what is a signal of some economic weakness. That’s part one. Second is the tariff thing. I think the market has concluded this is a negotiation. It’s not a war. We’re not going to have these be permanent, and Trump has now signaled it’s no longer permanent. It’s going to be a negotiation. But there’s no question it’s taking longer than expected. It is impacting some company’s earnings. It is impacting when people go to Walmart and they want to buy stuff, it is costing them more now.
We’re seeing those costs passed on to consumers, and it’s impacting how much money those people are willing to spend. That also indicates we may go toward a mild recession. We’re also seeing massive job cuts from employers that tend to be what we call in economics leading indicators, something that tells us where things are going. Amazon laying off tens of thousands of people. UPS laying off tens of thousands of people. Well, that means they are expecting a UPS slowdown. We don’t have driverless UPS trucks yet. We don’t have robots delivering the packages to your door. So those layoffs are an expectation that they’re overstaffed for demand, and you’re seeing that across dozens of companies. And now we’re starting to see some concern about the housing market too. Now, all of these are very early indications of some general softness. Most of the time when this happens, the market writes itself before there’s a recession.
We’ve been talking about a recession for five years, and it hasn’t happened, and it might not happen now, but there are some indications it may happen. On top of that, you have massive political pressure from President Trump really hammering the Fed in the background at lower rates. The Fed’s saying they’re independent and they don’t listen to Trump. Very hard to believe this isn’t influencing the decisions day to day, and the bond market is predicting, you could tell from the bond market that the bond market believes there will be a few more rate cuts next year.
Jeff: Is the bond market usually right with its predictions about where interest rates are going, or maybe the economy as a whole?
Peter: It’s interesting to look at, because if you look at the Federal Reserve, the people that follow the Federal Reserve, the economists, they make predictions on where interest rates will be over the short run and the long run. Over the short run, the bond market is incredibly predictive. It tends to get what’s going to happen at the next Fed meeting right the majority of the time. But when you go out more than six months, nine months? Completely worthless, actually completely worthless. If you look at economists predicting what interest rates will be over a 10-year period, they have actually been not just wrong, but wrong in the opposite direction. Rates don’t stay neutral. They tend to go the opposite direction that the economists expect they will. And the reason I think for that is the market’s very dynamic. I mean, there’s all kinds of things that can result in lower interest rates.
A terrorist event like 9/11, a pandemic like COVID, a bubble bursting like the tech bubble or ’08-’09. No one has that in their calculus of what’s going to happen with rates a year from now. The AI revolution going the other way, right? No one has that in their calculus. There’s just too many factors going in to make a prediction of what interest rates are going to be like 18 months from now, but over the next month, two, three, four, the market tends to be very, very predictive. The main thing here for our listeners is there’s nothing actionable here. The stock market’s doing well partially because of inflation. Inflation is reflected in stock prices. If Disney World’s going to charge more, McDonald’s is going to charge more, you could expect the stock price to eventually follow, because it has inflation built into the stock price.
We’re seeing strong corporate earnings still, and we’re in the middle of a technological revolution, which tends to drive economic expansion. Those are things going one way. Yes, there are things going another way. Tariffs, layoffs, housing, things like that. Too many factors. This is not like the conversation I was able to have with Jonathan in January where I was like, hey, the market’s down 20%. If you have cash, absolutely invest it now. This whole tariff thing is going to go away within a month. This is a big opportunity for you to really take advantage of that.
That’s not the situation we’re in here, but it’s a good thing to be paying attention to because we’re seeing this dichotomy, as you pointed out, Jeff, at the beginning of — stock market sending a signal, everything’s amazing. Bond market’s sending the signal we might be heading into some weakness. Things are amazing. We do have a tech revolution. We do have a lot of strong earnings, and there are indications that we might have a breather here at some point, but not enough information to be predictive.
Jeff: In there you said that we’ve been talking about a recession for five years, and it makes me think about a college football and college basketball rankings, where at the end of a season, they release the rankings for the next season. I feel like at the end of the last recession, they start talking about the next one. All right, let’s go to our tip of the month. Peter, what do you have for us?
Peter: So we’re approaching the end of the year, and if you have a portfolio of investments and a taxable account, it’s a good time to start looking at things that might be negative for the year and doing something called tax harvesting. Sell those things. Buy something similar. That allows you to put the loss on the tax return, but you stay invested in the market. For example, if you own Hershey stock and it was down 5%, you could sell it and buy Nestle stock. 31 days later, you can go back and buy your Hershey stock, so you’ve stayed in the market, but you’re able to put the loss on your tax return. That’s a very powerful technique. Those of our listeners that are Creative Planning clients don’t need to worry about this. We do it for you. But if you’re a listener, and you’re not a Creative Planning client, it’s time to start to look at your statements.
Jeff: My tip is related to year-end and writing down a list of financial things you want to accomplish before December 31, and I think you should write that list down and put it somewhere that you will see it very consistently. A couple examples that might be on there would be making sure you’ve maximized the contributions to your 401(k) or taken full advantage of an employer match. Maybe you need to take a required minimum distribution, do charitable gifting that you intended to do, use remaining FSA dollars. And actually, I find this is a great time to go through and look for any unused subscriptions or things that you’re recurring paying for, and cancel those if you don’t consistently use them.
Peter: Good tip.
Jeff: Lots of things you can do before the end of the year. It doesn’t have to be a rush all the time, so try and do it now. Peter, thanks so much for spending time with us. I’m Jeff Stolper, Director of Financial Planning at Creative Planning. With me has been Peter Mallouk, President of the firm, and we are Down the Middle.
Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk. And there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.
