Hunstad: Risk Cases Around a Shutdown are Pretty Benign

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00:00It's nice to have you visit from the states because I think we need a little bit of a

00:03of a little bit of an American reality check. We are 48 hours away, less than 48 hours away

00:08from a U.S. government shutdown at the moment. What happens if we hit that deadline? What happens

00:14if we don't get the payrolls report on Friday? Give us our give us your doomsday take.

00:18You know, our assessment is there's a fairly reasonable probability of a shutdown. But

00:23historically speaking, there have been a lot of shutdowns since 1976. There have been, I believe,

00:28about 20 shutdowns. The average duration is about 14 days. During those shutdowns, there has certainly

00:35been equity weakness, but by and large, it's been fairly mild. So when we look at the risk cases

00:41around a shutdown, they're pretty benign overall. Plus, when you add to the fact that if you look

00:47at the 30 days after the shutdown ceases, you actually have very positive equity returns. So

00:53it's not impacting our tactical asset allocation. We do have concern on the labor market front

00:58in that if there are layoffs as a result of the shutdown, that, you know, obviously is not well

01:04timed. But on the other hand, when you look at federal employment, overall is about 2% of total

01:10employment. So not a huge part of the employment picture. Still potentially adding to some weakness

01:16on the employment front. Obviously, that's front and center for the Fed right now.

01:20It absolutely is. But even if we do, say, come out of the shutdown in 30 days, which at the moment

01:25feels very optimistic, we're right back in this position come Thanksgiving slash right before

01:30Christmas as well. It feels like these conversations are getting more and more frequent. They're now

01:35every couple of months with the same pressing issues. Are we going to have the same conversation

01:40in three months, Michael? I think we might. And that's going to contribute materially to equity

01:45market asset market volatility overall. Again, we're not suggesting or discounting the fact

01:52that it's going to be a material drag on equity prices. But when you look at the volatility of

01:57equities, you know, these kind of things trigger big volatility events. And that's certainly something

02:02to take into account for the downside riskier portfolio. How are we thinking about the fixed income

02:08markets then in that environment, given how much has been done on bonds up about, what,

02:14five percent or so year to date? The market's getting it right in terms of weighing up the

02:21inflationary risks with a little bit of softness in the labor market and now some risks and concerns

02:26about government shutdowns that, as you make the case, you can look through that to some extent.

02:30Yeah. But in terms of pricing that all in, does it, a bond's looking, a treasury's looking fairly

02:34priced at this point? You know, I think what this does is it adds to the potential specter of a term

02:40premium across the board, meaning that any time that you have any kind of government issue,

02:47credit issue, longer term volatility issues, that's going to impact the risk premium inherent

02:53in U.S. Treasuries. Now, when we look at the treasury market right now, we do see a positive

02:58risk premium that has grown over the last several months. Will the government shutdown materially

03:03impact that? Our expectation is no. But as these things mount, as Fed independence is also an issue

03:10front and center, that will have a positive impact on the term premium, pushing that long end of the

03:16yield curve even higher than it is today. Where do you stand on that Fed independence question?

03:21And you said it becomes more of an issue in 2026, potentially. Of course, the Fed chair steps down

03:25in April, I believe. How salient are those risks? You know, I think there is a lot of headline risk

03:33associated with this. The reality is something different. Now, in the last Fed meeting, we had,

03:39I would say, broad consensus. There was one dissenter, but because they wanted 15. Pretty notable,

03:44pretty notable dissenter. But in general, the consensus has been for, obviously, cuts overall. So

03:52when we think about Fed independence in that regard, it's really hard to say one governor is,

03:58you know, very impactful of the overall Fed position. That's not really realistic. I think

04:04overall, again, contributing to market volatility and these headline risks around Fed independence.

04:10The reality, though, has not changed our tactical asset allocation at all.

04:14Michael, I see that you've recently added to your U.S. equity exposure. Is that because you think

04:19we're in inning one of this AI trade and has still a lot of room to run?

04:24There's a few reasons. You know, when you look at the U.S. economy right now, there's what I'll call

04:29fat tails on both sides. There's a lot of downside risks to tariff to Fed independence. There's a lot

04:35of upside risks, and AI certainly is one of them. Are we in inning one? I think we're probably in

04:40inning two or three. But the reality is that when you look at AI and technology stocks in general in the

04:48United States, this is nothing like the dotcom era. You know, we have the strongest free cash flow and

04:54free cash flow margins of all of the equity market in the stocks. Highest capital expenditures in

05:01general, balance sheets, very, very good profit margins, very, very healthy. So if you're betting

05:06against AI, if you're betting against U.S. tech right now, you're betting against the highest free

05:11cash flow sector of the entire. Well, I think I think maybe the bears would argue that regardless of the free

05:16cash flow from those hyperscalers, they're still going to have to borrow a lot of money to fund this

05:21investment build out. Does that does that worry you at all how they're going to raise this cash?

05:25Yeah, it's a great point. Debt financing is something relatively new to these kind of stocks. But again,

05:31when we look at their earnings and their again, their free cash flow positions, that added debt is not a

05:38huge concern for us in terms of their ability to pay it off going forward. Their debt to equity ratios in

05:44general is very favorable relative to the rest of the market. So yes, there's some staggering numbers

05:49out there in terms of the debt accretion on their balance sheets. But at the same time, you know,

05:55these are massive balance sheets to begin with. Is there one part of the debt market you think is

05:59likely them to tap harder? Is it going to go into the private market, for example? There's there's some

06:04possibility of that. I think there's some real possibility of that, that you see private credit take

06:08much more of a front and center stage in this sort of situation. I think it'll be a mix of public and

06:14private. But more and more, as we see across the entire economy, there's been a general shift toward

06:19that private credit cycle. Michael, before you were in the second or third innings of how many innings

06:24are there? This is baseball, right? How many innings in baseball? Nine innings. Nine? In a regular game.

06:28I needed to know that. You can go extra innings as well. Yeah.

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