“Freedom is never more than one generation away from extinction. We didn’t pass it to our children in the bloodstream. It must be fought for, protected, and handed on for them to do the same.”
– Ronald Reagan
Happy New Year to all our clients, friends, and loyal readers of our Quarterly Insights. I apologize that our insights have been slightly delayed. I was traveling out of NJ in early January with my son while he played in a soccer tournament. As he gets closer to graduation from high school, our trips of traveling together for soccer over the last 10 years are ending. As my son and I close one chapter in our lives as he enters college in the fall, he begins the next chapter in his journey of life.
On January 20th we will have a new President to lead our country and for the first time in quite some time we will have a Republican majority in the Legislative Branch of the government. Will this Republican administration usher in an economic boom and create a great four-year boom for our economy? Will President Trump make the next four years about his legacy and seek to make these the strongest four years of any other President? Only time will tell but it seems like he is moving very rapidly assembling his team and will be running at full speed on Inauguration Day.
During the last quarter of 2024 we witnessed a calming down of escalated wars in the Middle East which is exceptionally good for world peace. We also witnessed a continued boom in AI technology reinforcing our view of the 4th Industrial Revolution. But what we also witnessed is a Federal Reserve that lowered the federal funds rate (FFR) by a full percentage point. To most that sounds great, cheaper mortgages, car loans and other cheaper financing options to make America more affordable again, but that did not happen. Let us step back a bit to our previous Insights where we discussed that the Federal Reserve has dual mandates. First is price stability and second is maximum employment. What has happened is the exact opposite of lower interest rates and affordability for the American consumer. We have seen 30-year Mortgage rates now averaging over 7%, the highest level in more than six months and applications for mortgages dropping to exceptionally low levels. The 10-year Treasury yield has risen over one percentage point and has made financing more expensive for just about everything. And lastly, it has resulted in stickier inflation that has started to get hot once again. As a risk manager, it seems odd that the federal reserve would be cutting FFR into a strong labor market and as well as stoking inflation. The US Treasury market, as well as the US Dollar, seem to be losing confidence with Jerome Powell and the Federal Reserve Board’s recent monetary decisions. In our view, the biggest risk to the economy and markets is more stimulus, a higher US Dollar and higher bond yields for the long end of the market making everything more expensive once again.
Pros and Cons:
Pros:
- The Fourth Industrial Revolution led by AI and Technology will transform our economy, financial markets, and lives for years to come.
- The labor market is stable, productivity growth is supporting wage growth.
- Small Business optimism post the election.
- Deregulation and headwinds from antitrust legislation worries will diminish.
- The Trump Put
Cons:
- The Department of Government Efficiency (DOGE) could be too effective in reducing government spending and hurt GDP, Gross Domestic Product.
- Long-dated US Treasury Yield continue to push higher, the 10-year Treasury Yield increasing to 5%.
- Valuations on the S&P 500 Index are historically high.
- Un-inversions of the 3-Month Treasury Yield and the 10-Year Treasury Yield curve has a perfect record of predicting a recession.
- The rising popularity and use of volatility selling strategies.
Conclusion
As we head into the First Quarter of 2025, we are more constructive about the long-term prospect of the US Economy, Financial Markets, and the large amount of US Debt. However, we do see a reason to be cautious in the short-term and reasons to be optimistic in the long-term. We are entering a period called the terrible twos for a bull market, which is the second year of a bull market. This is where, from a statistical point , returns tend to be lower, and volatility tends to increase quite a bit. With valuations stretched, the possibility of a pause in reducing the FFR and a significant increase in selling volatility strategies, opportunities could start to present themselves in a meaningful way.