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by: Kenneth J. Entenmann CFA®, May 20, 2025
For the bulk of this century, it has been said that America was exceptional. It had the world’s strongest military. It had the world’s largest and richest economy. It had the world’s reserve currency. It had the world’s largest, safest, and most liquid financial markets. Most of the world’s largest and most innovative companies were American. The United States was a juggernaut. American Exceptionalism!
Yet, somehow, in just a few months, there are rumblings of the end of American Exceptionalism. Prominent financiers speak of damage to the “American brand.” The “Magnificent Seven” tech sector received a wake-up call when the Chinese Deepseek AI model was announced, which showed that the path to AI dominance would be competitive. And finally, Moody’s became the last of the major bond rating agencies to downgrade the last U.S. Treasury bond rating from AAA to AA.
Is this the beginning of the end of American exceptionalism? To paraphrase Mark Twain, the report of the demise of American exceptionalism is an exaggeration.
Apparently, several prominent financiers believe that the American brand has been damaged. Perhaps. They say our “Friends and Allies” can no longer trust the U.S. regarding military and trade. Certainly, the method of the Trump Administration’s demands for increased NATO military spending can be questioned. But the fact remains that many of our NATO “friends” are still significantly below the NATO minimum spending requirements, and even those who have committed to increased spending will not get there for several years. Given our fiscal challenges, the U.S. simply cannot afford to fund all of NATO. If calling for the end of our allies’ defense-free-riding ways is damaging to the U.S. brand, then so be it. Similarly, the rollout of the Trump trade program has been chaotic and has created great uncertainty. Our friends and allies are upset. That is understandable. But it is also very clear that these friends and allies are not free traders. They deploy a myriad of tariffs and non-tariff barriers to trade, such as a digital service tax on the U.S. tech sector, which are blatantly unfair. If calling this out is damaging our “brand,” then so be it. Regardless of the perception of the brand, the U.S. economy will remain the largest and richest consumer market in the world. Every country in the world still wants and needs to do business here. That is why there are so many ongoing trade negotiations. The hope is they will end with a freer and fairer trade environment with our Western allies.
As discussed in previous blogs over the last 12 months, we urged investors to “manage their expectations” for the U.S. equity markets. We were concerned that the U.S. equity markets were highly concentrated and highly valued. Indeed, the very idea of American exceptionalism in the U.S. equity markets drove these high valuations. After all, the U.S. equity market returns dwarfed the rest of the world since 2010. That outperformance was driven by the AI-fueled dominance of the U.S. tech sector. The “Magnificent Seven” mega tech stocks were the world’s envy. In addition, the U.S. Treasury bond market was perceived as a safe haven. The entire world was overweight U.S. growth stocks and U.S. Treasury bonds. When Deepseek was announced in January, U.S. tech dominance was questioned. At a minimum, the valuation of the Mag 7 was tested. The onslaught of the trade wars, combined with uncertain U.S. fiscal policy put pressure on the U.S. Treasury market. These factors all led to a great, worldwide rebalancing of investment portfolios. U.S. growth stocks led the decline in the equity markets, and U.S. Treasury bond yields spiked. It was a painful correction to an imbalanced world. But is it the end of the exceptional U.S. financial markets? Allocations to the U.S. markets may decline. On the margin, that suggests lower P/Es for stocks and higher interest rates for bonds. Capital may pursue some more reasonable valued equity investments and alternative bond markets. International equity markets have performed well year-to-date. Other bond markets have performed well, too. However, the U.S. equity markets remain home to the most innovative companies in the world. The valuation of the S&P 500 has declined, with the Price/Earnings ratio declining from 23 times earnings to a more reasonable and closer to the historically average P/E of 18 The difficult correction has wrenched most of the overvaluation out of the U.S. markets. The U.S. financial markets will remain the largest, best-regulated, and most liquid in the world. They will remain exceptional!
On Monday, Moody’s became the last of the major bond rating agencies to downgrade the last U.S. Treasury bond rating from AAA to AA. S&P downgraded in 2011. Fitch downgraded in 2023. What took them so long? Every politician, Wall Street strategist, and even Fed Chair Powell routinely state that the current debt level is “unsustainable.” Moody’s has finally gotten around to a downgrade, citing chronic budget deficits and rising interest rates. For long-time readers of this blog, they know this has been a frequent rant of mine. The catalyst of the downgrade seems to be the ongoing budget discussions in Washington. Admittedly, I also have been disappointed in the budget discussions. The focus seems to be on the extension of the 2017 Tax program and its impact on the deficit. The program’s extension would keep tax levels roughly the same, yet government accounting means that it would increase the deficit by roughly $4 trillion. Thus, the newfound concern for budget deficits. Apparently, the blowout spending of the first Trump and Biden administrations wasn’t a concern? Alternatively, failure to extend the tax program would result in a $4 trillion tax increase on an economy facing tariff uncertainty. Damned if you do, damned if you don’t. Either way, the current budget bill does not seem to be making much progress on healing the fiscal status of the U.S. government. But as previously discussed, Washington has a spending problem. Revenue as a % of GDP has averaged 18% over numerous tax policy regimens. Today, revenue is near record levels and hovers near the historic 18%. On the other hand, spending continues to grow, driven mainly by entitlement spending and interest rate expense. It is currently nearly 24% of GDP, unprecedented for a non-recessionary or non-war economy. The deficit was 6.4% of GDP last year and is projected to exceed $2 trillion this year. Houston, we have a spending problem! Unfortunately, neither party has demonstrated any interest in reducing spending. Witness the current debate over Medicaid spending. A proposal to require work requirements for able-bodied individuals or to charge them $100/month is met with outrage. This is “gutting” Medicaid! This morning, President Trump suggested that the entitlements are off-limits. Unfortunately, that is where the growth in spending is, and it is the largest line item in the Federal budget. This is fiscal irresponsibility. While Moody’s is late to the game, the Washington’s downgrade is well deserved. So, does the downgrade of U.S. debt mark the end of exceptionalism? The answer is yes, or mostly yes! But what does that mean? The reality is that there is a small list of AAA-rated countries. However, these countries’ bond markets have very small market capitalizations. Is it possible, on the margin, to find safety in Switzerland? Sure, their bond market is roughly $1 billion. Hardly suitable for the size of investments that sovereign nations and large institutional investors require. So, despite the downgrade, the U.S. Treasury bond market will remain the largest and most liquid in the world. Great! But it implies that, on the margin, U.S. interest rates will be higher. That is not a good thing for a U.S. economy that is already facing some challenges. At a minimum, it is a dent in American Exceptionalism.
Will American Exceptionalism remain? For the most part. Despite global military conflicts, trade war uncertainty, and fiscal challenges, the U.S. economy will remain exceptional in the long term. Our economy will remain the largest and richest consumer market in the world. It will remain the home to the world’s greatest companies. And our financial markets will remain the largest, best-regulated, and most liquid in the world. I would call that exceptional!
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by: Kenneth J. Entenmann CFA®, May 08, 2025
As summer approaches, it is time to debate once again: which form of ice cream is the best? Soft or Hard Ice Cream? Personally, I prefer soft ice cream. The markets are also in the midst of a soft vs. hard debate. Only, the market is debating the different messages of soft and hard economic data. When it comes to economic data, I prefer hard economic data.
Soft economic data is based on surveys of economic cohorts. For consumers, there is the Univ. of Michigan Consumer Sentiment Index, the Conference Board’s Consumer Confidence Survey, and consumer surveys on sentiment, jobs, and income. The CEO Optimism and Capital Spending surveys for corporations and the NFIB’s Small Business Optimism survey are also used. corporations and the NFIB’s Small Business Optimism survey. In the wake of the April 2 “Liberation Day” tariff announcements, these surveys showed significant weakness. The soft data reaction to the trade wars has been overwhelmingly negative.
What data should we believe? The soft data is forecasts doom and gloom, but the hard data continues to show an economy that is more than holding its’ own.
I believe the soft data is processing a worst-case scenario on the trade situation. Indeed, if the tariffs remain at the highest levels forecast by the Trump administration, it is likely a recession is in the offing. However, if the high levels of tariffs that were “paused” for 90 days (roughly July 4th) are negotiated away in new trade deals that result in freer and fairer global trade, then the economy should be just fine. The potential range of outcomes is astonishing!
Every day, the markets get conflicting messages from the Trump Administration. Today they announced that Treasury Secretary Bessent will be head to Switzerland to negotiate trade with China. Hooray! Then, later that same day, the administration announced that the 145% tariffs on Chinese goods would remain. Boo! This uncertainty will likely persist as trade negotiations proceed. Indeed, this uncertainty has and will continue to distort the economic data, both soft and hard, for the next three quarters.
Most importantly, it is difficult to believe that the Fed will be cutting interest rates any time soon. Today, the Fed kept rates unchanged and cited concerns for higher unemployment and higher inflation. That would be called Stagflation! But with the most recent employment data demonstrating strength, inflation still well above the Fed’s target and pressure on prices due to potential tariffs, the Fed is stuck between a rock and a hard place. Until the hard data weakens, the Fed will likely to remain on hold for the foreseeable future.
What is an investor to do? First and foremost, acknowledge the volatility. For long-term investors, the daily vacillations of the market should be ignored. The time frame of today’s traders and algorithms can be measured in nanoseconds. Let the traders trade every sound bite and news release. Second, keep an appropriate time horizon for your portfolio. For most, this time frame is measured in years and decades. Lastly, maintain diversification! Given the gloom and doom of this volatile year, many of our clients have called a bit panicked by the market gyrations. Most, if not all, are relieved to find out that their long-time horizon, diversified portfolios have posted modestly positive returns year-to-date. As we have often said in this blog, let the traders trade. Our job is to invest!
Now, I am going out for a large soft vanilla cone with chocolate sprinkles!
by: Kenneth J. Entenmann CFA®, April 10, 2025
It is said that the markets hate “uncertainty.” Well, we have much uncertainty! The Trump administration has created great confusion as to the end game of the tariff wars. Is the purpose of tariffs to raise “billions and billions” to help reset our “unsustainable” fiscal debt and deficits? If that is the case, the tariffs will need to be permanent. On the other hand, the administration is busy telling us that over 70 countries have approached the White House to “negotiate” new trade deals. Hopefully, that will be the case, as the world will have more free and fair trade, which is a good thing. However, it also means the tariffs and the “billions and billions” are temporary. Which is it? Are the tariffs a permanent income stream or a tool for negotiation? Adding to the confusion is that the answer you get depends on which administration official is speaking. Trade Advisor Peter Navarro and Secretary of Commerce Howard Lutnick are adamant that the tariffs are permanent. National Economic Advisor Kevin Hassett and Sec. of Treasury Scott Bessent are clearly in the negotiation camp (As am I!). And the President has demonstrated an ability to make both cases at the same time! Confused? Me too! And so are the markets!
The markets have responded harshly to the inconsistent roll-out of the Trump tariffs. The S&P 500 has been down 11.54% in the last five trading days, 13.65% in the previous month, and 15.28% year-to-date. The market is speaking loudly. But maintaining a long-term view is helpful. Even after the recent carnage, the S&P 500 is up 5.15% annually over the last three years, 14.37% annually over the last fiveyears, and 11.09% annually over the last ten years. That’s pretty good! Especially when compared to the “safe” three-year, five-year, and ten-year bond aggregate returns of .94%, -.61% and 1.35%! Yes, diversification still works!
Over the last few years, I wish I had counted the number of times people told me that the classic 60% Equity/40% Fixed income portfolio was dead. Diversification was a failed strategy. Technology was the place to be! Why diversify when everyone knows the AI phenomenon is going to dominate the world? International stocks have underperformed the U.S. stock market for 10 years! Why bother? And worst of all, why own fixed income with its paltry low yields?! Just level up and buy the “Magnificent Seven.”
Well, as the saying goes, stuff happens! Today, the uncertain end game of the trade wars and the recession risks are real concerns. And suddenly, diversification is once again proving to be a time-tested way to protect wealth. As of April 8th, the return of our NBT Select 60/40 strategy is -4.66% vs. the -15.28% return for the S&P 500. Interestingly, our fully diversified NBT Select portfolio outperforms a basic 60% S&P 500/40% Aggregate Bond portfolio. Year-to-date, our return of -4.66% compares very favorably to the basic portfolio return of -8.22%. What is generating the outperformance over the basic portfolio? Developed and Emerging Market International stocks are significantly outperforming U.S. stocks. Other asset classes like Real Estate, Infrastructure and Natural Resources are also providing outperforming diversification. I wish I could tell you that this outperformance was due to our brilliant market-timing capabilities. Boringly, it is our long-term commitment to proper risk management, something that gets bashed in go-go markets like the last two years. It is in times like these that diversification matters. While I hate negative returns, a low, single-digit return in the short run is hardly catastrophic for long-term investors.
For better or worse, we should be getting some clarity on the uncertain trade war in the coming weeks. If the tariffs are permanent, the market will adjust, as they already are. If a grand reset of freer and fair global trade is achieved, then the markets will also react, my guess , very positively. But, while we await clarity, the markets will remain incredibly volatile. The best defense in a volatile market is diversification. Being boring has its virtues!
by: Kenneth J. Entenmann CFA®, March 18, 2025
The financial markets popped after the election results last November. President Trump was elected to a second term on a platform highlighted by trade reform/tariffs and lower government spending. Indeed, the markets rose nicely in anticipation of better trade, lower taxes and less regulation. Until three weeks ago! Apparently, the equity markets are shocked, shocked, to see that Trump 2.0 is instituting tariffs and aggressively downsizing the federal government and its programs. Over the last month, the S&P 500 index dropped 7.98%. It is now down 4.33% for the 2025.
Of course, when the markets are rising rapidly, like they did in 2023 and 2024, investors cheer and congratulate themselves for their brilliant investment skills. When markets decline, particularly as quickly as this correction has unfolded, there must be a reason for the decline. It couldn’t possibly be the investor’s fault! The financial media fuels the finger pointing with a relentless stream of negative headlines. The media has declared that tariffs and DOGE are the culprits. Convenient. I say not so fast!
In our last blog, we discussed the potential impact of tariffs. The announcement of Trump 2.0 tariffs started in earnest 3 weeks ago. They have come fast and furious, have been through several on-again, off-again events. There have been tariffs on top of tariffs. As expected, our trade partners have begun to retaliate, and some have been withdrawn and reinstated. In short, it has been chaotic! The “uncertainty” spooked investors. Consumer confidence has swooned. CEOs are complaining; they acknowledge that the trade playing field is not level and support President Trump’s efforts to improve the global trade environment. They support tariffs…if they are “targeted.” That is code for tariff every industry except mine! Yes, economists hate tariffs. The question is, in a lop-sided trade world, what is the alternative? There appears to be few alternatives in the offering! To be clear, tariffs have the potential to slow economic growth and raise inflation. But the likely impact, as detailed in the previous blog, is modest and certainly manageable for a $28 trillion economy. The torrent of negative news regarding tariffs simply does not meet the potential economic impact of tariffs. Certainly, the chaotic tariff roll out is contributing to the market sell-off, but it is a convenient excuse for the recent sell-off.
Similarly, the DOGE (Department of Government Efficiency), led by the chain saw yielding Elon Musk, claims to have identified $115 billion (as of March 13) in spending cuts to our Federal government. There is a general agreement that our government is bloated and in need of rightsizing. It is the process that concerns everyone. Too fast, too broad they claim. We need to take a slow, methodical, surgical scalpel approach. OK, please show me when that has ever occurred? Government spending has grown exponentially since 1960 with every possible iteration of political control. Nonetheless, the spending cut back is being blamed for the market sell-off. Good excuse, but immaterial to the economy. $115 billion in spending cuts on a government budget of $6.7 trillion, with a $2 trillion deficit, $36 trillion in debt and $1 trillion in interest expense… is a rounding error! Indeed, as mentioned in this blog over the years, it will be very difficult to reset government spending without taking on the entitlement programs (Social Security, Medicaid, Medicare). Even President Trump has vowed not to touch them. As such, I doubt DOGE will have a major impact on spending and clearly will not have a significant impact on our economy or the financial markets.
While tariffs and DOGE are taking the blame for the recent sell-off, I believe it is simply a run of the mill, plain vanilla valuation correction. This blog has been imploring investors to “manage their expectations.” After two consecutive years of 20%+ S&P 500 returns, we cautioned that markets do not grow to the sky. The S&P 500 price earnings ratio, at 24 times earnings, has traded nearly one standard deviation above its historic average of 18, i.e. the market was expensive. Clearly, markets can remain expensive for long periods of time and that has been the case for two years. However, history demonstrates that when valuations are high, prospective returns are poor. Also, the market has been dangerously concentrated in the “Magnificent Seven” tech sector. These stocks represented nearly 40% of the total market capitalization and were richly priced. The Artificial Intelligence mania that drove the prices of these companies was dented last month when the Chinese AI model Deep Seek was introduced. Deep Seek was very effective, used fewer semiconductor chips and less energy and was significantly less costly. It is impossible to time when a correction will occur or what the catalyst will be. While the headlines would suggest that tariffs and DOGE are the cause, I would suggest that Deep Seek was the catalyst for the tech led sell-off.
Whether we like it or not, the correction has happened. The “cause” is debatable but immaterial. When evaluating stock prices, there are three primary factors; interest rates, earnings and the price paid for those earnings (P/E). In general, lower interest rates are better for stocks. Interest rates have declined modestly this year, and it is highly unlikely that rates will rise this year. So, interest rates were not the correction catalyst. The S&P 500 has been projected to earn $270 in 2025. That estimate has not budged in this correction. At least not yet! A decline in the $270 estimate is something to watch if there is going to be continued weakness. But so far, it has been stable and therefore not the cause of our correction. That leaves the price investors are willing to pay for that $270. At its recent high price of $6147 on Feb. 19, the S&P 500 traded at 23x earnings. Today, it trades at 20x earnings. It has been a market valuation correction, led by highly valued, dare we say, overpriced, AI mania Tech stocks. In short, a dull, boring, painful, ordinary correction. Ignore the noise (and there is lots of it!), stay diversified and remain invested!
by: Kenneth J. Entenmann CFA®, February 12, 2025
For better or worse, the first three weeks of Trump 2.0 have been fast and furious! A bit of an understatement! Overall, the financial markets have shown some volatility but have remained stable in the New Year. So far, the S&P 500 is up 4.06% this month and 3.1% year-to-date. That is a great start to the year, despite all the vitriol coming out of our nation’s capital, particularly as it relates to the potential impact of tariffs.
It is easy to fear tariffs. Economists of all stripes will tell you that tariffs are bad; they are inflationary and invite retaliation and distort world trade. They are correct! But they most often fail to include the second part of the full tariff comment…Tariffs are bad in a free and fair global market. Unfortunately, there is little evidence that there are many “free and fair” markets. Indeed, when tracking trade reciprocity, every major industrial country in the world except the U.K. and Australia is offside, meaning tariffs on U.S. goods are significantly higher than U.S. tariffs on our imports. Even our friends, the EU, Canada, and Mexico, are way offside and have significant protectionist tariffs. In some cases, entire industries are precluded from participating in a trade partner’s economy. The U.S. auto industry is priced out of Europe by tariffs that are ten times higher than U.S. tariffs on E.U. cars. Same for U.S. agriculture. U.S. banks are prohibited from doing business in Canada. Hardly “free and fair.” And then, there is China. China was permitted to join the World Trade Organization in December of 2001. The hope was China would evolve into a great global trade partner. It has certainly helped the Chinese economy become the second largest in the world. Sadly, they have been cheating global trade rules ever since. The debate over TikTok operating in the U.S. is interesting as U.S. software companies are prohibited from doing business in China. Yes, tariffs are bad, but global trade is hardly a “free and fair” market.
Yesterday, President Trump announced 25% tariffs on steel and aluminum, including on Canada and Mexico. This set everyone’s hair on fire! Mexico and Canada are our friends and our largest trading partners. How could we possibly pick this fight? True, we import large quantities of steel and aluminum from Canada and Mexico and this action has the potential to raise prices in the U.S. However, many of those commodities are made in China and shipped to the two countries to avoid direct China tariffs and exploit the friendly USMCA (U.S., Mexico and Canada Free Trade Agreement) tariff policies. Global trade gamesmanship at its worst, especially from our “friends” North and South of the border! Not exactly “free and fair!”.
With all of the doomsday tariff talk, it is interesting that the markets have held up so well. This indicates that the markets don’t believe in the worst-case scenarios. Perhaps some perspective on tariffs is warranted. The U.S. GDP closed in 2024 at nearly $28 trillion. Total goods imports were roughly $3.2 trillion. Let’s assume that after all the dust settles there will be a permanent 10% tariff on all goods from all countries. That would be $320 billion. As a percent of the total GDP, that is about 1%! Yes, on the margin, tariffs have the potential to reduce GDP growth and increase inflation. GDP could be reduced by .5-1% and inflation may rise by .5%. That is why economists do not like tariffs! But that is likely the worst case, which is far from catastrophic for a $28 trillion economy. But economists also love “free and fair” markets. And maybe, just maybe, the tariffs could begin to alter the trading behavior of our global trade partners. After all, having access to the world’s richest and largest economy is valuable. In fact, our trading partners need us more than we need them. U.S. global exports are just 11% of U.S. GDP, while exports represent nearly 27% of Mexican GDP and 20% of Canadian GDP.
For long-term investors worried about the impact of tariffs, take a deep breath! No one has any idea where the trade ward will end, including President Trump. Even if the negative aspects of tariffs prove true, they can be counter-balanced by more favorable tax policy, reduced government spending, onshoring of manufacturing, an improved regulatory environment and even “freer and fairer” global trade. That is a lot of moving parts! It is far too early to jump to dramatic conclusions. For the moment, the markets seem to be taking the Trade Wars in stride. The equity markets are off to a great start, and the bond markets have yet to price in any trade-induced inflation spike. As always, patience is a virtue of the long-term investor.
by: Kenneth J. Entenmann CFA®, December 31, 2024
2024 was a year of resilience. At the beginning of the year, expectations for 2024 were quite muted. The S&P 500 index began the year at 4769 and earnings were $217. The consensus Wall Street forecast called for meager returns in the low-to-mid single digits. The concern was the Fed’s aggressive rate increases in 2022-2023 would finally result in a “Waiting for Godot” recession. Inflation would come crashing down to the Fed’s 2% target. That would allow the Fed to ride to the rescue with a change in monetary policy beginning in March and followed by as many as 6 rate cuts in 2024. Well, we are still waiting for the recession!
Economic growth accelerated throughout the year and will settle at an annual growth rate of 2.5%, far from the pessimistic 1-1.5% consensus or even recession. The 2nd half 2024 GDP will exceed 3%! Better than expected growth led to better corporate profit margins and earnings. S&P 500 will end 2024 with earnings of $238, a very healthy 9.6% year-over-year improvement. Technology stocks led the way, driven by expectations for Artificial Intelligence (AI). The S&P 500 is ending the year near 5800, up more than 20% for the second consecutive year. However, this strong economic growth also resulted in inflation remaining “stickier” than expected. While the rate of growth in inflation did recede in 2024, it flatlined in the 2nd half of the year. Core Consumer Price Index (CPI) stuck above 3%, well above the Fed’s target of 2%. The Fed finally did change monetary policy direction in September, not March, and cut rates only 3 times in 2024. In short, the 20% S&P 500 return was driven by earnings growth and investors willingness to pay a higher price/earnings ratio (P/E) for stocks. The P/E will end the year at a historically high 21 times earnings, or as this blog often says, “priced for perfection.” Maintaining a high P/E will require a cooperative Fed and earnings to come through as expected.
The Fed is looking to catch a rising star. “N Star”, or N*, is the theoretical interest rate that is neither restrictive nor stimulative to economic growth. Of course, no one knows the value of N*. At its December meeting, the Fed cut rates by .25%, the last of three cuts since September. The action brought the Fed Funds Rate down 100 basis points from its peak, to 4.25-4.5% range. Several Fed talking heads have justified the action based on their belief that rates are still restrictive, or above N*. Interesting! Maybe the Fed has a unique definition of restrictive. The economy is accelerating and growing well above long-term trend, inflation remains sticky, unemployment hovers at 4.2%, fiscal spending remains reckless, credit spreads are historically low, speculative assets such as gold and cryptocurrencies have spiked, the S&P 500 trades near record highs. And the yield on the 10-year Treasury note is 4.55%, up nearly 100 basis points since the Fed began cutting rates in September. If that is restrictive, I would hate to see stimulating! While they would never say it, perhaps the Fed knows this looks suspicious. At the meeting, they also “managed expectations” for additional rate cuts in 2025 down to two. The markets were forecasting as many as 4-6 rate cuts. It seems that N* is rising! Prior to the meeting, expectations for N* were in the low 3s, maybe even 2.9%. Now the estimate of N* is more like 3.5%. GASP! How is a stock market trading at 21x earnings going to go up without the Fed’s support? Ever since the December Fed meeting, the S&P 500 has lost nearly 2.5%. The market seems to be concluding that a rising N* will mean higher than expected rates in 2025. The idea that easy monetary policy would provide material support to record high valuations is fading rapidly.
If the equity markets are to sustain their remarkable growth, it will have to do it the old fashion way through earnings growth. The good news is the estimate for S&P 500 earnings for 2025 is $272. As noted above, 2024 earnings should be around $237. That is 15% growth! That’s great, but also well known. The P/E at 21x earnings have already priced the strong earnings projections. Without support from interest rates, those earnings better come through. Once again, the primary drivers of earnings optimism is continued strong economic growth and AI. At the moment, it does appear that the economy remains on solid footing. Growth may slow from its torrid above trend pace, but there is little talk of the dreaded recession. Economic growth should support earnings.
The big earnings uncertainty revolves around AI. There is no shortage of claims of the paradigm shifting impact of AI. AI will increase productivity across all industries and result in even better earnings. Recent productivity metrics have indeed been improving. The large, dominant Tech companies are spending billions on the AI race. The costs are certain. Yet very few companies can get specific as to when the return on investment will occur. “AI is going to be HUGE!” Maybe. But when, and by how much? Didn’t you hear, AI is going to be huge! Certain costs, uncertain profits. That is always true, but there is a fine line between “irrational exuberance” and reality. It’s going to be huge is proving difficult to quantify. At 21x earnings, the earnings estimates better be right.
I am not a fan of annual forecasts. They tend to be awful, and that includes any projections in this blog. That is why we never provide actual forecasts, but instead try to provide a simple assessment of where the economy and markets are at any given time. We remain unapologetic fans of long-term investing based on the risk profile of the investor. Market timing based on some brilliant market prognosticator has and always will be folly. Recalling 2024, the consensus Wall Street price target for the S&P 500 was 4800 to 4900, a forecast of a paltry 2% projected return. It will end the year at 5800, up nearly 23%. Investors who ignored the weak forecasts and stayed in the market were handsomely rewarded.
As we enter a new year, the economy is on solid footing and earnings estimates are robust. But rising N* is likely to be less supportive and the market has already priced in much of this optimism. As always, the world remains a contentious place. The governments of the West are, to put it politely, in disarray. Economic growth outside the US remains anemic. Military conflicts continue around the globe. There is always the certainty that something uncertain will come along.
2025 will be no different. Investors should reassess their risk profile. The strong equity performance and the late-year rise of interest rates have shifted the asset allocation of most portfolios. The weight of riskier assets is greater in most portfolios. Rebalancing the asset allocation is a time-tested way to control risk and manage returns. And by all means, stay invested, no matter what the talking heads say! Let’s hope for a third consecutive year of 20%+ S&P 500 returns. But beware of a rising N* and manage your New Year expectations!
by: Kenneth J. Entenmann CFA®, November 6, 2024
After an emotional charged election season (and way too many advertisements!), the nation has thankfully provided a clear election result…no hanging chads, no contested ballots or riots on the National Mall. Our President Elect will be Donald J. Trump, and the Senate will be under Republican control, with only the degree of control to be determined. At the time of this writing, control of the House of Representatives is still undetermined, but the Republicans are likely to maintain the majority. A Red Wave! Like it or not, the results appear to be definitive. We can now turn our attention to what this means for the economy and financial markets.
While every election provides myriad promises, threats and forecasts of booms and doom, elections rarely have an immediate impact on the economy. Even in the case of a clean sweep, historically it takes months and often years for campaign platforms to be codified into law and implemented. Our economy is a $24 trillion behemoth, and it takes much to materially move it in the short-term. Nonetheless, this election does have some interesting focal points. Tariffs, taxes, and regulation to name a few and they have implications for the equity and fixed income markets.
Economists don’t agree on much, but they uniformly do not like tariffs. Tariffs are an anathema to free market advocates. All things being equal, tariffs increase the cost of goods and invite retaliation from other countries and reduce overall economic growth. In short, tariffs are seen as inflationary and anti-growth. However, this assumes an actual free and fair market, something that rarely exists in the real world. We live in a world where all things are not equal! In particular, China is not a free or fair player in the global economy. Nor are many of our “friends” in Europe. Are Trump’s threatened tariffs simply a cudgel for future trade negotiations, designed to get better trade metrics for the U.S. economy? It remains to be seen. For those who oppose tariffs, they need to explain how they will get the rest of the world to change their anti-free trade behavior. Even if the tariffs are fully implemented and are inflationary on the margin, there will be other counter acting policies that may mitigate the tariff impact. For example, tariff revenue could partially help “pay” for lower taxes on corporations and individuals. One could expect less overall Government spending as well. And perhaps a most Orwellian Dept. of Government Efficiency spear headed by Elon Musk!
Tax policy was another major differentiator of the two candidates. Given the Red Wave, there is more certainty on the tax front. In the first Trump term, the Tax Cuts and Jobs Act (TCJA) of 2017 was a major overhaul of the U.S. tax policy. Many of the major tax cuts from that act are scheduled to expire next year. The Harris campaign was clear that they would let the TCJA expire, resulting in significantly higher taxes on corporate profits and investments. With a Red sweep, it is highly likely that most of these tax cuts will be renewed. In particular, the Corporate Tax rate will remain at 21%. Trump has suggested reducing the corporate rate to 15%, but even a Republican controlled Congress will have trouble with a 15% rate. It would be unaffordable, especially if one wants to include the smorgasbord of Trump tax proposals (no tax on TIPS, Overtime, or Social Security benefits, interest deductions for car and student loans and even the State and Local Tax deduction (SALT).) Regardless of the ultimate tax policy, it is unlikely that taxes will be increasing. Importantly, the proposal of an onerous “Wealth Tax” on unrealized gains is most certainly dead. Tax policy is likely to be a net benefit for equity investors.
The Biden administration unapologetically ramped up economic regulatory oversight. The alphabet soup of regulatory agencies…the FCC, FTC, OCC, SEC, CFPB, DOT, DEC…were given significant power over the last 3 years. Conversely, the first Trump administration put in place a rule that required any new regulation be met with the elimination of 2 other rules. It is likely that a far more constrained regulatory environment is upon us. The Biden administration has been quite hostile to merger and acquisitions, particular in the Tech space. More M&A, less regulation…this should be good for stocks in the long run.
Taken together, the concept of better trade and onshoring of manufacturing due to tariffs, lower taxes and less regulation sounds great. Today’s post-election equity market rally (the Dow is up 1,400 points at the time of this writing) suggests the equity markets like the election results.
However, all of the above comes with a cost. The prospect of higher inflation and greater debt and deficits has resulted in a significant increase in interest rates. The yield of the ten-year Treasury note increased 20 basis points…today…to 4.45%! It has increased nearly .60% since the Fed first cut rates in September! This creates a dilemma for the new President and the Federal Reserve. Tax cuts sound great, but increase the deficit, at least in the short-term. With debt and deficits increasing, can the Fed continue to cut interest rates? The market fully expects the Fed to cut rates by .25% on Thursday. But Fed action impacts the short-term interest rate market. Long-term maturities are influence by inflation and the demand/supply dynamics for long dated Treasury securities. “Term premiums” are increasing, and that is an expensive problem when there is $35 trillion in debt outstanding! As this blog has long noted, this is a significant problem that does not have an easy fix. While the Fed will likely continue to cut rates in the near-term, higher long-term rates could prove to be a major impediment for the Trump administration.
In the short run, the equity markets have reacted well to the election results. Perhaps today’s rally is a ‘relief rally” due simply to the clean result. The prospect for improved global trade, renewed manufacturing activity, a business-friendly tax environment and a more growth oriented regulatory regime is indeed cause for celebration. In addition, the economy is on solid footing, with decent economic growth, full employment, better inflation numbers and lower short-term interest rates. What is not to like? However, longer-term, the debt and deficits are likely to constrain the new administration’s economic flexibility; interest expense is problematic and growing. In addition, the equity markets are trading at record high levels and very high P/E valuations.
By all means, let’s celebrate a clean election. At the same time, the equity markets are priced for perfection in an environment where there is plenty to worry about in the world. Once again, the message to investors remains the same; manage your expectations.
by: Kenneth J. Entenmann CFA®, September 6, 2024
The markets have been sending conflicting messages. The bond market has seen interest rates plummet, and the yield curve flatten based on a heightened concern of economic slowdown and even, dare I say its name, a recession. Yet, at the same time, the equity markets are trading at record highs, convinced the Fed has stuck the soft landing. Both cannot be true.
Driving both markets is the belief that the Federal Reserve Bank is about to embark on a quick and significant interest rate cutting cycle. Even the Fed talking heads have indicated the rate cutting will begin in two weeks. The only question is how much rate cutting will occur. This has led the markets to conclude that the Fed will aggressively cut rates, starting with a 50-basis point cut in September, quickly followed by additional 75 basis points through 2024.
This morning, the Dept. of Labor released its all-important employment report. It was a mixed report, providing fuel for both pessimists and optimists. The non-farm payroll number was 142,000, pretty close to expectations. The unemployment rate decreased to 4.2%. The decline in the rate was due to changes to the Labor Participation Rate which increased by 120,000. Lastly, average hourly wages increased by .4% in August, and 3.8% year over year.
The 142,000 non-farm payroll number provided fodder for debate. Indeed, the payroll number, combined with downward revisions for June and July, provide evidence that the labor market is “cooling,” and a sign of a slowing economy. I would suggest that the labor market is “normalizing.” A monthly increase of 142k jobs is close to what is historically average rate of growth. However, the average hourly earnings number of 3.8% YOY hardly suggests wage inflation is dead. Yes, payroll numbers are slowing back to “normal,” but wage inflation is sticky. Is this a reason for the Fed to be “aggressive” with rate cuts? After the report, the expectation for a rate cut in September is now 100%. There is a 50%/50% probability between a 25 or 50 basis point cut.
Calls for recession have been around for the last three years and have failed to materialize. Yes, the economy is slowing, but from a robust level of 2.8% in the 2nd quarter. Small businesses continue to have difficulty finding new employees. At NBT Bank, our loan demand and credit quality remain strong, hardly a sign of recession in our geographic footprint. Inflation continues to recede, but also remains stubbornly higher than the Fed’s target. Consumer spending is slowing, but from torrid levels. Signs of imminent recession are hard to find.
I believe the markets should be careful with expectations for rate cuts. This economic environment is hardly a reason for the Fed to depart from its slow and methodic policy process. I fully expect the Fed to cut interest rates by 25 basis points. I would be surprised if they cut by 50 basis points. It would be a significant departure from their policy routine and may even send a message of panic, something the Fed desperately would want to avoid. Looking through 2025, the markets are calling for 6-8 rate cuts. Be careful, the last time interest rates were that low we experienced a financial crisis (2008) and pandemic (2021). The bond market is forecasting a recession. I am sorry, I have a tough time hoping for recession. More importantly, a slowing economy does not mean a recession is imminent or inevitable. The equity markets are hoping rate cuts may support higher valuations. Indeed, the S&P 500 index trades near its historic high, but so is its P/E. Hoping for significant rate cuts to justify that high valuation may not be a great long-term strategy. If the Fed fails to deliver on the significant rate cut expectations for 2025, the equity market may be susceptible.
Be careful about what you ask! I am not sure I want to live in a world with extremely low interest rates! Usually, it means bad stuff has happened, as our recent experiences have demonstrated. Be careful about what you ask!
Kenneth J. Entenmann, CFA®Chief Investment Officer & Chief Economist
Kenneth J. Entenmann is Senior Vice President, Chief Investment Officer & Chief Economist at NBT Wealth Management. Ken has over 33 years of investment experience. Prior to joining NBT Bank, he served as Director of Investment Management at Alliance Bank.
In his current role, he oversees more than $6 billion in assets under management and administration in Trust, Custody, Retirement, Institutional and Individual accounts.
Entenmann graduated from Cornell University with a bachelor's degree in Applied Economics and Business Management. He also graduated from William E. Simon Graduate School of Business Administration at the University of Rochester with an MBA. He has also earned his Chartered Financial Analyst (CFA) designation.
Ken is a former Board member of the New York Bankers Association and was the Chair of the Trust and Investment Committee. He has served on the board of the Central New York Community Foundation from 2006-2012. He currently serves on the Roman Catholic Diocese of Syracuse's Investment Advisory Committee.
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