CAPITAL IDEAS: Beer and the cost of brinkmanship
Dalton — Despite hundreds of thousands of federal workers missing their paychecks, unless you’ve had to go through TSA lines at the airport, the odds are pretty good that the partial government shutdown has just been background noise up until now. And it may remain that way. However, it’s not hard to craft a darker scenario.
Speaking of crafting, have you ever been to Austin, Texas? Great city—one of my favorites. “Keep Austin Weird” is their slogan. There is a craft beer brewery there called Jester King. And they’re lucky. They had made a lot of beer that was set for shipment across the country. But the shutdown wouldn’t allow them to receive federal label approval. Fortunately that’s not a problem for in-state sales, so they were able to find buyers in Texas.
Our more local friends at Samuel Adams aren’t as lucky. The same is true for a lot of smaller beer makers who had run production for national sales but can’t get federal label approval.
As of Sunday morning, at 22 days, the shutdown became the longest in modern U.S. history, eclipsing the 21 days under President Bill Clinton in 1995. President Trump and Congress have been at an impasse over Trump’s insistence of putting $5.7 billion in the budget to build a border wall along the U.S.-Mexico border. As a result, about 420,000 federal employees deemed essential are working without pay, while another 380,000 are furloughed.
Our friends in the beer industry are feeling the effects of diminished capacity in the Bureau of Alcohol, Tobacco and Firearms. Other industries with less delicious products are impinged by lapsed funding for nine of the 15 federal departments: Homeland Security, Agriculture, Commerce, Interior, Housing and Urban Development, Transportation, Justice, State, and Treasury as well as several agencies such as the ATF.
Negative effects will intensify and compound the longer the shutdown continues. Thus far, not to diminish the pain felt by some, the shutdown has had minimal impact on GDP growth. Having started Dec. 22, 2018, the shutdown will reduce GDP in the previous quarter by 0.1 percentage points. If the government were to reopen today, the affect for this quarter would be nearly tripled due to the impact from workers not receiving paychecks. It is almost guaranteed that the still-working essential employees will eventually receive back pay. However, the furloughing of workers will be a much bigger drag on the economy as they won’t be able to make up the lost hours.
Assuming the shutdown doesn’t end this quarter, the direct drag from less government output would be 1.2 percentage points shaved off of GDP. Additionally, a lapse in funding for food stamps would be a drag on consumer spending by 0.2 percentage points. Another 0.1 percentage point would come from homebuyers being delayed in financing from the Federal Housing Administration or Department of Agriculture. That would be a total reduction of GDP by 1.5 percentage points, and we think that’s conservative.
It’s not the shutdown itself that concerns me. Despite all the recent talk about recessions, that’s not enough to kill the expansion. The economy, both during this expansion and others, has stumbled only to reaccelerate. What concerns me is the timing of the shutdown.
The debt limit has been suspended to early March, and I am concerned that the shutdown raises the risk of brinkmanship over a decision to settle that matter. If an agreement can’t be met, the Treasury would have to step in to finance its expenses so that it doesn’t default on its debt. Economic impact and market damage increases significantly when there are political battles over debt ceilings. Instead of a second quarter rebound after a government shutdown, the risk is that momentum remains negative at a time when both monetary and fiscal stimulus is fading.
Stimulus may arrive in the coming weeks in the form of corporate earnings. Earnings season kicked off this week with an anticipated 35 S&P 500 companies reporting. When it comes to earnings, stocks generally respond to reported numbers relative to expectations. More or less matters more than high or low, as the market had already priced in that high or low expectation.
One great thing about a bear market is that stock analysts become pessimistic. Over the last month, analysts raised forecasts for 321 companies of the S&P 1500 and lowered forecasts for 711. That’s a net -390, or 26 percent of the index. You’d expect Wall Street analysts to know a thing or two more than they do, but the fact is that they’re often too optimistic or too negative at inflection points. That net -390 is the most negative spread reading of analyst revisions since July 2016. More often than not, when the expectation bar is set low, the S&P 500 generates a positive return over earnings season. If we see companies react positively this week, it would set the stage for further rallying of the stock market—that is, until early March when the debt limit talks get ugly.
Allen Harris’ forecasts and opinions are purely his own. None of the information presented here should be construed as individualized investment advice, an endorsement of Berkshire Money Management or a solicitation to become a client of Berkshire Money Management. Direct inquiries to email@example.com.