The Restructuring of the U.S. Federal Government
Our last webinar was entitled “Cutting Through the Noise”. The fundamental message was that once you cut through the uncertainty DOGE, tariffs and all of the changes being instituted by the new Trump Administration you will find a strong economy. This underlying strength is what matters most for the markets to climb further, and the “noise” is just a distraction. Our strategy – which we believe has worked well – has been to avoid sectors most subject to potential negative outcomes from the “noise”.
As one Executive Order after another is turned out and President Trump’s cabinet nominees are seated, it is becoming increasingly apparent that a much bigger more radical restructuring of the U.S. Federal Government is underway. There is still noise but there is an emerging picture of how this restructuring could in turn alter the structure of the American economy as well.
The Restructuring Framework
Years ago, I was a restructuring advisor to companies that filed for Chapter 11 bankruptcy protection. Though each situation differed, the restructuring process had similar attributes. The goal in Chapter 11 is to stabilize a company’s profitability, reach an agreement on the company’s value and then re-capitalize the balance sheet to permit the re-emergence of a restructured business with sufficient liquidity to grow profitably into the future. To obtain this goal requires a business evaluation process that includes the following steps:
1. Cost Reductions – Right sizing the business’ cost structure is critical to enhance efficiency and profitability, so this is typically the first step. In doing so, there are material headcount reductions as well as renegotiations of unfavorable vendor contracts, particularly of key raw materials and inputs. Non-core assets may be sold or shuttered.
2. Train Finite Resources on Supporting Revenues – When a business is in Chapter 11 it is considered a going concern, which means that it will continue to operate and serve their customers in the normal course. Capital is often constrained, which means training these resources wherever possible to sustain or even grow revenues.
3. Revalue Undervalued Assets – In some cases, businesses own assets that are worth more to others or are simply misvalued. The classic example is real estate. Excess land in attractive metros may be sold to homebuilders or may hold mineral rights that can be monetized. Empty buildings may be sold or revalued through a sale-lease back agreement.
4. Restructure Liabilities – The primary reason for most Chapter 11 filings is that profitability can no longer service the debt and other liabilities on the balance sheet. The greatest benefit of Chapter 11 is a reset and reduction in liabilities although this occurs typically to the great detriment of shareholders. Once accomplished, however, the company is poised to re-emerge from bankruptcy with a clean balance sheet ready to compete.
Why is the restructuring process relevant?
The Trump Administration’s approach – when you take a step back – is to apply this restructuring template. If we view the Administration’s actions from this perspective, I believe it may create clarity and an investment edge we can use. Here's the process…note the parallels.
President Trump’s goal is to put American taxpayers first. What does this mean? In short, it means paying less in taxes and obtaining greater prosperity. How is his Administration going about this?
1. Cost Reductions – This is where DOGE comes in. Just as any CEO of a troubled company would bring in an elite consulting firm, DOGE is charged with the enormous task of finding wasteful spending and eliminating redundancies across the entire Federal Government. Their findings have already led to over 30,000 Federal employee layoffs in the Administration’s first 30 days, according to Layoffs.fyi. We have seen competing claims on the actual dollar savings but suffice to say that billions of pro-form savings have been achieved, and this is likely only the beginning of its impact. Reducing the operating cost of the Federal Government is critical to President Trump’s mission to reduce the tax burden and pay for the extension of the 2017 tax policies. Remember, in our view, the extension of the 2017 tax cuts is mandatory as non-extension could cause significant economic harm.
2. Raise Revenues – The most common way for the Federal Government to raise revenues is to raise taxes, however, President Trump is committed to extending the tax cuts he implemented in 2017 and may even try to lower taxes even further, such as a lower corporate tax rate or the elimination of the SALT deduction limit. Tariffs are the preferred source of new revenue. Tariffs on China have been increased 10%. Canadian and Mexico tariffs have been postponed but recent comments from President Trump suggest that they are likely to occur. Reciprocal tariffs appear to be the preferred framework. In other words, tariffs, or other structural financial barriers (e.g., the Value-Added-Tax) applied to US imports by other countries will be equally applied to their like imports. Other attempts to raise revenues may include bilateral trade deals, such as the rumored rare-earth mineral production agreement with Ukraine. We would expect more attempts at trade deals to sell American agricultural, energy and defense products. A further way to raise revenues is to create economic growth through lower regulations, which are difficult to measure in the near term but could have a material impact longer term. In sum, raising revenues could lead to lower taxes on Americans and a stronger economy.
3. Revalue American Assets – Throughout the campaign we heard the phrase “drill baby drill” from President Trump. U.S. energy companies are not going to drill for the sake of drilling unless it makes economic sense. To us, this phrase is more symbolic of his desire to monetize the physical assets that lie on and beneath American soil. The recent discussion around auditing Fort Knox raises the idea that its holdings which are on the books at $42 per ounce could be revalued to today’s price of approximately $2,900 per ounce creating hundreds of billions of dollars in value. While Treasury Secretary Scott Bessent has downplayed this idea, the suggestion alone reflects a level of financial engineering more common to Wall Street than DC.[1] The proposed EB-5 Gold Card visa is another example. The idea is that if wealthy foreigners wish to live in the U.S. and build a business or if U.S. companies want to hire highly qualified foreign workers to work and live in the U.S. legally, for $5 million they can purchase the EB-5 Gold Card which buys permanent residency and a path to citizenship. In effect, this idea is an attempt to “monetize” our country’s great asset: the right to live here. It may be possible to monetize America’s physical assets which could among other things bolster the Government’s financial condition.
4. Reduce Obligations – We recently caught wind of a radical proposal to restructure the federal debt. It is so radical that I will refrain from discussing it because its plausibility seems extremely low. However, less dramatic things can be done. According to the Peter G. Peterson Foundation, the Federal Government will pay approximately $952 billion in interest in fiscal year 2025[2]. That would equate to approximately 15% of the total federal budget. Hence, lower interest rates will lower interest payments on the debt. The Treasury Department favors issuing short-term T-bills[3] to: 1) pay a lower interest rate and 2) could refinance this debt sooner upon maturity into hopefully even lower rates. The lack of longer-term issuance may have the added impact of allowing longer-term interest rates to drift down if demand increases and supply remains muted. Other “obligations” are also on the table. For instance, recent White House rhetoric has challenged European NATO allies to increase defense spending. U.S. Presidents have long complained that its allies were shirking on their obligation to defend Europe and relying too heavily on the U.S. military. The U.S. spent $860 billion on defense in 2023 or 3.5% of GDP versus its European allies who spent $380 billion in aggregate representing well under 3% of GDP, individually[4]. Germany, for instance, spent just 1.7% of its GDP on defense in 2023, according to the CIA[5]. This mark is even shy of NATO’s 2% of GDP guideline[6]. Were European governments spending more on defense spending, it could reduce the U.S. “obligation” to defend Europe.
We do not claim to know how the Trump Administration’s restructuring of the Federal Government will turn out, but we think it will follow the framework above. Having a framework for understanding complex situations is critical. Recall our three-legged stool framework that we developed at the onset of the Pandemic that served to provide a foundation for knowing when to take more risk despite a highly uncertain environment. That approach worked then, and we think this current framework will likewise help us understanding the torrid pace of the Trump Administration’s early days. Importantly, what we face today is nothing like the Pandemic where the global economy shutdown for weeks and resulted in extraordinary societal changes. Nevertheless, a clear framework during periods of uncertainty is critical in determining what is “noise” and what needs to be taken seriously.
Portfolio Positioning
Market volatility continues to be alive and well. Most recently we saw a material pullback in momentum stocks, which includes the Magnificent 7 and other stocks that have experienced strong outperformance in the months prior. During the last two weeks, the economic data has come in slightly worse than expected and along with the political “noise” this provided investors an excuse to sell their winners. We discussed previously our concern that this area of the market had stretched valuations, and we too trimmed our biggest winners earlier this month. We also diversified our portfolios to other non-technology / AI stocks to absorb those unavoidable losses.
We have also seen a big pullback in Defense stocks as DOGE cost cutting has scared off investors in the short run. We mentioned in our webinar last month that we expected this sort of “shoot first, aim later” investor behavior and we got it. A little uncertainty when valuations are stretched can lead to large pullbacks as the “weak hands” (i.e., investors who do not do their homework) exit their positions. This sort of behavior is allowing us to buy great companies at great valuations and we have recently added exposure to this sector.
Our balanced approach to owning value and momentum as well as gold and fixed income creates a portfolio that withstands volatility well, particularly when it strikes certain parts of the market – like momentum recently. It also gives us the ability to take advantage of attractive opportunities as they arise. Some of the best investment opportunities are present when volatility increases. It comes down to this: many investors do insufficient due diligence and end up chasing the latest fad. These “weak hands” get shaken out when uncertainty arises and losses build; and when we find these situations and we understand the situation more clearly, we get an opportunity for future outsized returns. That is the sort of environment we believe exists today and is exciting for us.
Conclusion
This was not a normal market recap newsletter this month but rather a valuable opportunity to provide additional insight into why our investment process is so different. We apply deep thought and our decades of experience to make sense out of uncertainty. The “noise” starts to make sense and volatility yields opportunities. That said, we still believe that the underlying macroeconomic data remains supreme and are vigilantly monitoring inflation, the labor market, and other key data for signs to take less risk. For now, we remain optimistic about our investment holdings and portfolio construction but, nevertheless, poised to make data-driven tactical adjustments, if necessary.
Disclosures
LIM is an Investment Advisor based in Dallas, Texas and registered with the Securities and Exchange Commission. Registration does not imply a certain level of skills or training. LIM is a company with purpose, dedicated to creative and unique thinking. We focus on portfolio valuation and research, along with superior client experience. We seek to identify investment opportunities by looking at economic factors, security valuation and human behavior. We start with the fundamentals of portfolio management and valuation. Then we build on these fundamentals with unique thinking and creative intelligence gathering to form a viable investment thesis. We believe this approach leads to dynamic global portfolios with increased return and managed risk. LIM utilizes Charles Schwab & Co. Inc. (“Schwab”), a FINRA-registered broker-dealer, member SIPC, as its custodian of assets. LIM is independently owned and operated and not affiliated with Schwab.
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Definitions
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