Video Update: What a Government Shutdown Would Mean for Fortress

A gridlock in Congress means we’re headed toward a government shutdown. And this is causing panic in the headlines.

But here at Fortress Portfolio, we have no reason to panic. That’s because we guard ourselves with research, reasoning, and historical precedent.

In today’s video update, Chief Analyst Adam Galas puts this possible shutdown scenario into context. He’ll cover all the details, including:

Educating yourself on the truth behind government shutdowns will help you keep your cool… and remain confident in our resilient Fortress Portfolio picks through it all.

Click below to watch the video or scroll down to read the transcript.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Fortress Portfolio

Welcome Fortress Portfolio members to a special government shutdown edition of your weekly video update.

Now, the government is set to shut down at midnight on Saturday as the fiscal year ends… unless 12 spending packages or a continuing resolution gets passed.

Right now, it looks like a shutdown is likely… if not completely inevitable.

Now, the good news is 27% of government spending is considered discretionary. The rest is mandatory.

This means that not the entire government is going to shut down.

For example, Social Security is going to keep being paid. So will disability. So will Medicare. So will Medicaid. So will the Veterans Administration.

TSA (Transportation Security Administration) says screeners will be working without pay – as they're considered essential – as is the military.

And even the IRS has said that they will continue to work.

But of course, I'm sure most Americans would wish they would not.

Now, this doesn't mean that there's not going to be some disruption.

For example, the EPA (Environmental Protection Agency) will pause, permit reviews and safety inspections… as will the FDA (Food and Drug Administration.

Similarly, the early childhood education program by Head Start and the Women, Infants, and Children (WIC) food stamp program will run out of funding within a few days.

Hundreds of thousands of government workers will be furloughed… but will get their backpay because after the 2019 shutdown, Congress passed a law saying that everyone gets backpay except for government contractors.

Now, as you can see below, we have actually had 22 shutdowns since 1976, averaging one every two years.

(Source: LPL Research, Strategas Research Partners via The Daily Shot)

Now (including this shutdown), that's four within a decade or once every two and a half years – basically the historical norm.

You might be wondering what does the stock market do during shutdowns?

Well, as you can see below, 60% of the time it dropped. But the biggest decline was in 1979, which was just a 4.5% percent decline.

(Source: LPL Research, Strategas Research Partners via The Daily Shot)

Now, of course, this doesn't mean that stocks can't fall a lot more.

And we'll talk about the possible and potential reasons behind why that might happen… because we're facing a bit of a perfect storm of risks right now.

But the point is that the actual cost of a shutdown – at least according to the government – is rather small.

For example, Bloomberg estimates it cost $3.7 billion for the last three shutdowns combined and $2 billion for the last shutdown alone, which was 34 days long. That was in 2019 when the budget was $4.4 trillion… meaning that basically it added 1/2000 to the cost of the government for that year.

Now, that doesn't mean that shutdowns are not bad for the economy.

As you can see below, Goldman Sachs estimates that the combined effect of student loan repayments after a 2 to 3 week government shutdown and a potential very long strike at the UAW (United Auto Workers)… could reduce U.S. growth by 1.6% this quarter and push us into recession.

(Source: Goldman Sachs Global Investment Research via The Daily Shot)

One of the reasons for this is because government contractors (there's about 2.4 million of them) will not get back pay.

So imagine that you are restaurant, and government workers are your main customers.

Well, during the shutdown, they're not coming to your restaurant. And even after the government reopens, they're not going to catch up on missed meals.

So that business will experience the same things as the airlines did in 2020 and right after 9/11. If people are not booking tickets and catching a flight, that money is gone forever.

And so that's why it's bad for the economy.

It's also potentially bad for the U.S. credit rating.

Moody's just came out and said that if there is a prolonged shutdown, they will cut our credit rating from AAA to AA+ or its equivalent.

Now, Fitch, of course, did that recently. And the S&P did that in 2011. Now, losing an AAA rating does not actually mean something as terrible as many people envision.

As you can see, AAA simply means a 0.07% chance of default over 30 years. And an AA+ is 0.29% chance.

(Source: S&P)

So wouldn't a credit downgrade cause interest costs to increase?

Well, it could theoretically, but just a tiny amount. We're talking maybe 0.1% or 0.2% at most… if that.

The reason for this is that under current regulations, banks, insurance companies and even pension funds have to have risk free assets. And they primarily choose U.S. Treasuries.

The same thing applies to global central banks. The U.S. is the global reserve currency, including at most central banks, and that's not actually held in cash… that's held in the form of U.S. Treasuries.

Now, you may have noticed that long term interest rates, such as the 10-year yield, have been surging higher in recent weeks.

(Source: The Daily Shot)

That is not because the markets are worried about the government shutdown.

Rather, they're worried about what the Federal Reserve just did.

The Fed didn't increase rates… but it did say that it plans to increase rates to 5.5% one final time in November. And then hold rates steady for a year.

Now, the issue is – the bond market is now losing confidence that the Fed can get us back to 2% inflation.

As you can see below, the bond market currently is pricing in 2.3% to 2.6% long term inflation. And this is between 15% and 30% higher than the Fed's official target.

(Source: YCharts)

Now it's important to note that we have to be calm, and not panic.

At Fortress Portfolio, we got your back.

For example, since 1790, the average 10-year yield (the long-term average interest rate in the United States) is 4.5%... with average inflation being 3% or a 1.5% real interest rate.

(Source: GFD, Deutsche Bank via The Daily Shot)

Well, right now we just got back to 4.5%.

So we’ve had below average interest rates for the past 20 years.

But now we're back to the historical norm.

Now, of course, the reason this can be so destructive to so many investors is that they get suckered into thinking this time is different.

15 years of zero interest rates. We thought that was the new normal.

Now we're back to the old normal.

But you here's why Fortress Portfolio members don't have to worry…

We focus on safety and quality first and – prudent valuation and sound risk management – always.

We're utilizing the world's safest ultra-high yields such as Enterprise Products (EPD), Altria (MO), and Toronto-Dominion (TD).

These are time tested dividend growers with great risk management. They are profit minting machines.

For example, Altria has been raising its dividend every year since 1969. Over that time, it’s succeeded through long term interest rates of 16%, a Fed funds rate of 20%, and corporate borrowing costs of 20%.

Toronto-Dominion has never cut its dividend since it began paying it 166 years ago. And it kept paying through the Great Depression.

Allianz (ALIZY), a German insurance and asset management company, hasn't missed a dividend payment to investors since 1890 – not even during WWI and WWII… when we were at war with Germany.

Now let's consider how we measure long term risk management. This includes how the companies in our portfolio would deal with a financial crisis, rising interest rates, a future pandemic, and supply chain disruptions, etc.

We use the S&P Long-Term Risk Management Framework, which they have been working on and perfecting for 20 years. It's the most comprehensive one I've ever seen. It has over a thousand fundamental metrics across 30 major categories and 130 subcategories. And 50% of these metrics are industry specific.

These have been included in every S&P credit rating for the last 20 years.

Here is just a small sample of what the S&P looks at: supply chain risk management, crisis management, cybersecurity, privacy protection, efficiency, research & development (R&D) efficiency, innovation management, labor relations, talent retention, worker training and skills improvement, customer relationship management, climate strategy adaptation, corporate governance, brand management, and about a thousand other metrics.

If there's something that can go wrong, the S&P has thought about it and figured out how to quantify it.

And that is what we plug into our 3000-point Safety & Quality model.

Now, I’ll give you an idea of how good the risk management is for your Fortress Portfolio.

Fortress averages 68th percentile for the entire portfolio. That means that these companies aren't just in the top 32% of their industry peers.

No, no - these are global percentiles, meaning the top 32% of all companies the S&P rates that cover 90% of the global market cap.

Below you can see how good the risk management is for just a few of our portfolio picks:

And Allianz comes within the top 100 companies on the planet for risk management in the 99th percentile.

Remember, all this data goes into our 3000-point Safety & Quality model that is designed to catch 95% of dividend cuts before that they happen.

That's how we know that we have one of the safest 7% yielding portfolios on earth with a five-year dividend growth rate of 8% per year.

This is how we can tell you that Altria's 9% yield – one of the highest it's ever had – is very safe with a 1% risk of a dividend cut… even in the case of another financial crisis, global recession, or pandemic downturn.

Even if a crazy meltdown occurs in the economy, there is only a 1% risk of a dividend cut.

And what about the average recession? How will Altria perform in the mild recession expected in 2024?

There is about a 0.005% of a dividend cut from Altria.

For the entire Fortress Portfolio, it's about 1.96% risk in a severe recession.

And 0.67% risk in an average or mild recession.

This is all based on data from seven rating agencies, the Bloomberg terminal, the FactSet Terminal, the bond markets, real time bankruptcy risk estimates, and about 3,500 analysts covering all of these companies for a living.

We put it all into a model that's taken eight years, 20,000 man-hours, and about $1 million in R&D to create – all so you can sleep well at night no matter what the idiots in D.C. are doing… or how much the Fed is messing up.

I want to thank you for joining us for this week's video update.

I hope you join us next week when we help demystify the world of Wall Street.

As a reminder, please send us your questions and feedback so I can respond to them in these videos and our monthly issues.

Just remember, I can't provide personalized investment advice.

Until next week, this is Adam Galas, wishing you and your family safe investing and a healthy, relaxing weekend.