“It's tough to make predictions, especially about the future.”

― Yogi Berra

Back on January 5, 2022, I posted a blog asking: “Is the Government Contract World About to Melt Down.” See https://www.awrcounsel.com/blog/2022/1/4/is-the-government-contract-world-about-to-melt-down?rq=FEDX%20.  I focused on the EMLES Federal Contractor ETF (symbol: FEDX), of which I had purchased one token share so I could follow its performance. At that time of that earlier blog, my investment was down 5.42% since my date of purchase. I hesitated to predict the future in that blog, but then went ahead and did so anyway, and in hindsight I did note, somewhat presciently, that we were living in a new paradigm of higher inflation and that would weigh on contractor profits and result in possible underperformance. I said: “If you were thinking about quitting your day job, and living off your government contractor company stock options, now might be a good time to have a plan B if those options decline in value.” BINGO. Of course, earlier I had blogged about the ”steady eddy” nature of government contracting in a time of uncertainty. https://www.awrcounsel.com/blog/2021/2/17/t-is-good-to-be-king-riding-out-bad-times-in-the-government-contracts-profession?rq=FEDX%20.

So, you ask, where does the government contract investment world stand today?  My tiny one share of the FEDX ETF is now down a small 7% since my purchase on December 29, 2020 (after a supposed 3% positive bump this morning on low volume) . It has been a roundtrip to nowheresville for five months. I guess I can’t quit my day job and start trading government contractor stock. The procurement industry remains in a substantial and stubborn market underperformance when compared say to the S&P 500 index. But in this volatile age of crypto currency movements, it still looks downright reassuring. Reading my prior two blogs, I am satisfied I said nothing to embarrass myself and plenty that has panned out. I am still standing by my conclusion that “less profits and higher inflation mean more risks, and lower government contractor stock prices” going forward.

Perhaps the surprising thing to me is that the Ukrainian war has not really boosted the government contracting world that much. The biggest part of the FEDX ETF is defense contractors. And, if defense contractors can’t goose their stock prices during a European land war of uncertain duration, when will the good times roll? I guess the lesson is that inflation hobbles and eventually destroys everything in its path, even large defense contractors.  Meanwhile, the answer to persistent high inflation is high interest rates and recession, a different evil for the business community.

Accordingly, the takeaway is that if you are a fixed-priced government contractor, locked into the second year of a five year contract, good luck with that, especially if you only escalated your bid price by 2% annually each option year. You are now riding the inflation tiger, and you may yet be eaten alive. Of course, some important defense contractors, performing vital industrial base missions, may get economic price adjustments(“EPAs”) and some cost relief. See Memorandum of John M Tenaglia, Principal Director, Defense Pricing and Contracting, Under Secretary of Defense, dated May 25, 2022. https://www.acq.osd.mil/dpap/policy/policyvault/USA000999-22-DPC.pdf. As noted therein:

As a best practice, COs should request assistance from their local pricing and policy offices, the Defense Contract Management Agency, or the Defense Contract Audit Agency when contemplating using of an EPA clause. COs should also review the guidance contained in DFARS PGI 216.203-4. Of course, as is prudent in most cases, COs should consult their legal counsel before deciding to use an EPA clause.

But for the rest of the ordinary contracting community, not part of the defense industrial base, yet yearning to be made whole for inflation, get lost.  There isn’t going to be a new round of stimulus monies or PPP loans this time. You got your stimulus; now you get your medicine. Government contractors are mostly on their own now. Batten down the hatches. Winter is coming.