Government Shutdown Could Be Boost to Bonds

I always think that the market can handle two or maybe three narratives at once. There is always a “main” story or two to drive the markets (be it AI, or Fed cuts). There are usually one or two “tells” – the market we all look to as soon as we wake up to figure out what is going on (it could be the yen, 10-year yield or something else).

Right now I’m not sure what the “obvious” tell is. What am I supposed to look at to get a quick “guide” to the market tone?

Similarly, there are so many narratives that it is difficult to identify what to focus on.

I had the opportunity to discuss many of these during the first half hour of Bloomberg Surveillance on Wednesday morning.

Having said that, let’s take a quick look.

The i-Shaped Economy

The concept that some subset of the economy (and markets) is doing extremely well, even exceptionally well, while the rest of the economy/market does “OK” is gaining traction. I think that image reflects the state of the economy better than the K- or k-shaped description often bandied about.

For me, this means that we can continue to see markets and the economy perform much as it has been. Leadership in the AI and tech space, but other segments can start to catch up.

Government Shutdown

Maybe we are all so used to last minute deals that no one seems that worried about the potential for a government shutdown.

While I am not convinced we get one, I am convinced that this administration will use it as an opportunity to makes some cuts that it couldn’t make under DOGE. I am not sure how it would do it, but I don’t think that will stop it from trying to reduce the size of government (and the deficit) as part of the shutdown. While that should be scary, I think stocks would ignore it, and bonds would do well.

Peace Through Strength

There are meetings in D.C. in the coming days among senior military leaders. By sheer luck, I’m in D.C. this week and have some meetings that could illuminate more.

My take is that we should expect even more clear messaging (it has already been quite clear) that the U.S. military is prepared to take a more aggressive posture, globally.

If we want “deterrence” to work, our adversaries need to be scared we will use our capabilities to their fullest. I expect that to be part of the messaging.

It also fits with my view that Europe is now seriously considering seizing some of Russia’s frozen reserves, which could push Putin towards a deal, but in the meantime helps European markets.

ProSec

"Production for security" is finally catching on, at least as a political agenda and investment thesis, even if the phrase hasn’t gained popularity.

Look for small- to mid-sized companies in areas that we “need” for security — commodities of all types, refiners and processors of commodities, electricity production, chips, AI, drones and pharma/biotech.

Also, don’t necessarily think of these as “one time” bumps as the president does like to win and is likely to do things to help companies that the U.S. (at his direction) has taken stakes in. I’ve taken some profits in names that I own like  (INTC) , but will continue to hold a position as the administration’s agenda continues to play out.

Circularity in AI

The virtuous circle of AI and data center investment has driven the “dot” in the i-shaped economy. Increasingly, I’m hearing chatter that it is becoming “too circular” and that we may be moving past the stage where it is a naturally occurring virtuous circle, into something that is almost required to keep the industry firing on all cylinders. That might be premature, but there is some chatter, which I haven’t heard much of until recently.

Tariffs

As we hit the fifth month of more serious tariffs (averaged just over $30 billion a month for the past few months) the cumulative effect is approaching $200 billion. We have also just launched a new series of targeted tariffs (though some have some pretty big loopholes). We should start seeing effects, though to the extent importers are taking a hit on margins, that may not be apparent until Q1 next year, when companies release Q4 earnings.

Bottom Line

I’m very comfortable with bond yields.

I think credit spreads will continue to be stable and range bound.

Both of those views lead me to remain heavily exposed to municipal closed-end funds in the “income” portion of my portfolio (though some of the near record cheapness of tax exempt yields to taxable yields has gone away).

On equities, I’m highly focused on stocks that I think fall into the production for security theme.

I don’t own any foreign stocks on that basis, but I do think some of these trends are going to become global in nature, so I’m trying to figure out what opportunities there are elsewhere on that front.

That does leave me with some exposure to China, primarily through  (FXI) , as it still seems “ahead” in terms of trying to proactively cultivate the areas encompassed by this theme.

At the time of publication, Tchir was long INTC and FXI.