Market Commentary – Staring Down a Possible Government Shutdown
By: Eric Sterner, CFA, CAIA, FRM, CIPM
Chief Investment Officer, Apollon Wealth Management and Apollon Financial
Investors’ focus this week will be on a possible government shutdown and the release of several labor market reports. Since 1950, there have been 21 government shutdowns. Most of these occurrences lasted only a few days and had limited economic impacts. However, this potential shutdown may have a bigger impact. A good rule of thumb in government shutdowns is that 40% of workers will be furloughed, at least initially. Historically, those workers receive back pay once they are on the job. In the event of a shutdown this week, the Trump administration is advising federal agencies to consider permanently firing some of those workers. This possibility is coming at a time when the Fed is expressing some concern on the moderating labor markets. The other impact from this possible shutdown would be the delay in the release of the September’s nonfarm payroll report and other government statistics. The Fed is already dealing with a challenging macro environment as inflation remains above its 2% target and the labor market is weakening. If inflation and labor market reports are not available during a potential extended government shutdown, that lack of transparency could possibly cause a slight selloff from the recent market rally.
Labor Markets
We should still be able to view the ADP Private Payrolls report on Wednesday. The recent trends in that report have led me to believe that the Fed was falling behind the curve in cutting rates. When policy rates are elevated, small cap earnings tend to suffer more than larger companies. These struggles have been evident in the ADP reports over the past several months. According to ADP Private Payrolls reports, larger companies (more than 500 employees) have added 93,000 jobs since April. Small companies (less than 50 employees) have shed 34,000 jobs in that same time period. Small businesses with less than 50 employees account for more than 40% of private sector employment based upon ADP data. Therefore, struggles within these businesses can have major impacts on the overall US economy and consumer spending.
Of course, the struggles of smaller companies earlier this year were not solely due to restrictive rates. Back in the spring, there was a large cloud of uncertainty hanging over the markets concerning the new White House administration’s trade policies as well as negotiations for the One Big Beautiful Bill (“OBBA”). Some of those clouds are dissipating now that OBBA has been signed into law and trade agreements are being finalized, which allow companies to better plan ahead. However, there will always be the possibility of new tariff announcements, such as last week when President Trump announced a new round of tariffs, including a 100% on brand-name pharmaceuticals unless companies are building plants in the US, a 25% tariff on large trucks, and 30%-50% tariffs on certain home furnishings.
Inflation
Inflation has continued its slow downward trend this year, and we have not yet seen any major inflationary consequences because of tariffs. I believe many of the reinflationary fears may be a bit overblown. Inflation spiked after COVID due to massive fiscal stimulus, tight labor market conditions, and high money supply growth, which do not apply to today’s macro environment. Yes, we may see some small bumps in inflation over the coming months, but tariff-induced inflation is a one-time-tax-driven adjustment. Temporary import price increases do not merit restrictive policy, especially when it is not associated with tight labor markets or monetary expansion.
Additionally, core goods represent roughly 35% of the Personal Consumption Expenditures Price Index (“PCE”), which is the Fed’s preferred inflation report. Approximately only one-fourth of those goods are imported, so about 8% of PCE is directly affected by tariffs. Therefore, any core goods price changes need to be large enough to overcome the smaller weighting in the inflation basket to offset the disinflationary trends that remain underway within services components. July’s shelter costs, one of the stickiest components of CPI, trended below 4% for the fifth month in a row. This is the first time it has held this level in approximately five years.
Outlook
I remain bullish for several reasons with the health of the US consumer near the top of the list. Consumer spending in August was up 0.4%, higher than most expectations. Additionally, retail sales was up 0.6% in August and there were small upward revisions to previous months’ gains. August rounds out a third month of strong gains in retail sales, following outright declines in April and May, indicating that consumer spending has rebounded quickly from the initial shock around the timing of the Liberation Day announcement. Finally, the household debt ratio is 11.3% currently, which is below the 11.8% average rate between 2012 – 2020.
US Consumers Continue to Show Strength
Corporate profits also remain very strong, and it’s currently estimated that S&P 500 earnings will grow 7.9% in the 3rd quarter, which would be the ninth-straight quarter of earnings growth. S&P 500 2nd quarter profit margins were 13.6%, which is near highs for this century.
I’ll be watching the 3rd quarter profit margins since the 2nd quarter margins did not capture the full impact of tariffs. We know that some portions of the tariffs are being absorbed by companies, so I would not be surprised if those profit margins come under a bit more pressure, but the good news is they are coming from a point of strength.
I expect Communication Services and Technology to continue to be sector leaders for the remainder of the year and going into 2026, as the AI revolution is still in the early innings. The good news is that the market rally broadened this year with Financials, Industrials, and Utilities stocks also witnessing strong returns.
- Financials is one of 3 sectors which reported a year-over-year increase in their profit margins in Q22025 compared to Q22024. This sector should also benefit with potentially more M&A activity this year as well as deregulation polices from the White House. There have been 46 IPOs greater than $25 million YTD, totaling $24 billion. This represents an 18% increase in the number of IPOs vs. the same period in 2024 and puts 2025 on pace for the strongest year since 2021 (261), although still well below the historical median of 104 deals since 2000.
- Utilities typically is one of the most highly leveraged sectors, so that sector should benefit from interest rates dropping. After a decade of anemic growth in power demand of roughly 1% to 2% annually, the AI revolution is propelling power demand growth estimates for utilities up to 6% to 8% annually over the next 10 years. This growth in power demand has the potential for improved earnings growth and durable multiple expansion for utilities. Over the next few years, investors’ view of Utilities may change from a defensive strategy to an offensive strategy out of the AI playbook.
- We have also seen strong rallies in Mid and Small Cap stocks as rate cuts are priced into the market. These asset classes are more interest rate sensitive than Large Cap stocks and also have more attractive valuations. This rally will only be sustained if earnings growth follows in the coming quarters.
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