Labor Day is behind us and that signals the beginning of the annual ritual of a federal budget battle between Republicans and Democrats.
The stocks most directly impacted by the decision on the federal budget and outlays are those of companies with the highest concentration of revenues coming from federal spending: government contractors.
Listed in descending order by market capitalization they are: Boeing (BA), Action Alerts PLUS holding Lockheed Martin (LMT), General Dynamics (GD), Raytheon (RTN), Northrop Grumman (NOC), Science Applications International (SAIC), and CACI International (CACI).
I started focusing on the potential for this year's budget battle last April, when the 2016 Department of Defense Budget Request was made public, in the column, "Government Contractors' Windfall Ahead."
As I noted in that column, there appeared to be bipartisan support for a substantial increase in defense spending, which was not being reflected in the stock prices of the contractors. That has continued since then, with mixed performance by the contractors consistent with the greater decline in large capitalization stocks than the broader market (the Dow Jones Industrial and Transportation averages have declined 8% and 7.5%, respectively, vs. the 5% decline in the S&P 500).
Large-caps pay higher dividends and have been hampered by expectations throughout the year that interest rate hikes by the Federal Reserve were imminent. The contractors are all high-yielding dividend payers and investors appear to be concerned about the negative consequences for dividend-paying equities if bond yields start rising.
That's a rational, prudent and cautious response by investors.
There are two important issues playing into this year's budget battle, however. The first one, which I wrote about yesterday, concerns the growing probability that the Fed will have to begin to communicate officially in FOMC statements that transitory/temporary issues that have hampered economic growth may be longer term in nature and thus immune to monetary policy.
I don't know if the Fed will begin to signal this next week, but if it does, the central bank will, in essence, be passing the baton of responsibility for public financial policy on economic stimulus back to the fiscal authorities.
I'm cautious about the Fed signaling this next week because for years it has maintained that the evidence of an imbalance between capital and labor caused by technology replacing humans is not robust enough. However, whether or not the Fed does so next week, it is inevitable that it will have to do so soon. And all of the FOMC members are aware of the issue, regardless of the official line.
If the Fed does indicate this next week, it will be a signal principally to the Republicans that they must allow for increased government spending in order to create jobs.
The second issue playing into this year's budget battle is actually a derivative of the first, and that is the growing detachment by the citizenship from the ideological constructs of the two main political parties. I recently wrote about this in, "Trump, Sanders and the '1-9-90' Rule."
Ideologies, whether political, economic, religious, or even personal, are luxuries that can only be afforded by those with the financial security to indulge in them. As concerns the budget battle, the most germane of them is the Republican Party's consistent refrain of budget and tax cuts to stimulate economic activity.
The problem for the Republicans on spending cuts, however, is that doing so when private sector job creation is low and has been for several years, and the budget deficit is at its lowest level in eight years, is nonsensical and risks alienating the electorate in need of jobs.
As for tax cuts, the belief that doing so will stimulate the owners of capital to reinvest for job creation after seven years of 0%-0.25% fed funds rates have failed to do so, is also nonsensical.
Both of these observations are implied in the increasing dissatisfaction with the government and political ideologies being espoused by both parties.
The Fed can't create jobs and the private sector isn't creating them. In that environment, the responsibility to do so falls to the government. I expect that once all is said and done that the budget for 2016 will be markedly higher than 2015's, along with an increase in the deficit again, by necessity.
The most immediate winners of this scenario will be the government contractors.
Lastly, none of this is offered as a personal political preference. These are just pragmatic observations of what is occurring and the state of the economy.