***Q4 Client Report***
While many events took place in Q4, none were more important nor high profile than the election. And certainly, we haven’t seen an election more anticipated than this past one. And I hope we don’t ever again although I know that is unlikely. Recall that coming into the election I offered that the single best outcome for your money and the markets was shared power, meaning neither party swept. That would force a number of grand bargains without a single agenda being able to be carried out. That outcome did not come to fruition.
The Republicans swept the election, and they will now own the next two years of successes and failures. We know that the enormous 2017 tax cuts will likely be renewed with some additional cuts and tweaks along the way. I do not believe there be another round of large cuts to juice the economy and markets. We know that deregulation will be a major theme, and that tariffs and protectionism will be front and center. Donald Trump ran on securing the southern border and cutting inflation. The electorate expects success in 2025.
Most people know that I am firmly against tariffs and protectionism. Just like I do not believe a country can tax its way to prosperity, it certainly cannot tariff its way there either. And while I do know that some countries do not play by the rules, I remain a free trader, favoring trade deals over penal actions. Given what has been proposed and analyzed, I also do not think the tariffs will send the U.S. economy into a tailspin or even recession. I think, worst case, GDP growth will be reduced by ½% to ¾% which is still nothing to sneeze at.
Countering the tariffs, deregulation will add to growth and corporate America’s bottom line. Additional tax cuts might result in a negligible bump in growth, best case. Assuming interest rates do not surge higher, one of the biggest beneficiaries of the election outcome will be in the mergers and acquisitions space. M&A has largely been stifled over the past four years by a very active Federal Trade Commission. There must be at least hundreds of billions in corporate deals like IPOs, mergers and companies owned by private equity waiting for the landscape to change.
With all that I still do not agree with consensus that animal spirits will be unleashed like 2017. The environment is just too different. The stock market essentially went almost nowhere in 2015 and 2016 with two 10%+ declines. Coming into the 2016 election, it was coiled up and ready to explode. 2023 and 2024 were strong years for the stock market with sentiment very greedy, giddy and euphoric, nothing like Trump 1.0. There are lots more I could write about the election, but I think you get the gist. I am not negative by any means, but I am also not wildly excited since I do not see a massive tax cut package to further juice consumers and corporate America.
Elsewhere in Q4, we saw a ceasefire in Lebanon as well as the tyrannical Assad regime fall in Syria after decades of oppressive rule. Locally, drones over NJ and other parts of the northeast became news that either aliens were preparing an invasion or China was spying again. As we since learned, neither was close to being the truth. Finally, tragically, despicably and disgustingly, United Healthcare CEO, Brian Thompson, was gunned down in cold blood as he entered a conference in Manhattan.
Turning to the economy and markets in Q4, all clicked in with a relatively quiet and mildly bullish quarter. The stock market was up with the entire gain and then some occurring on the election outcome. However, that rally was very narrow with the mega cap stocks overwhelming the rest of the market. In other words, some like to say that 10 stocks were strong and 490 were not. Sentiment for equities became giddy, greedy and euphoric which is not something that lends itself to continued strong returns for stocks. In fact, behavior like this typically sees late comers punished sooner than later.
Bonds did not fare so well, yet again, with the yield on the 10-Year soaring a full one percent. That is a large move in bond terms. Gold and oil were very quiet, closing marginally lower. The biggest “risk on” security was Bitcoin and cryptocurrencies. That sector saw a huge surge after the election as Donald Trump became the crypto candidate, wooing the younger crypto investors with campaign promises of widely accepting the sector and even creating a national strategic cryptocurrency reserve.
Pivoting to the economy, GDP growth was a stronger 3.1% in Q3 and weakened a bit to 2.3% in Q4. I think Q4 had some crosscurrents with strikes that may have made it weaker than it really was. Employment remains very bullish, but this is among the most lagging of all economic indicators. The incoming administration has suggested a mass deportation plan which I do not believe will come to fruition. However, if that did, I do think that it would have the most negative economic impact of all policies suggested.
The Federal Open Market Committee (FOMC) cut interest rates in Q4 and then essentially went to a neutral stance at 4.25%-4.50%. That jibes very well with the 2-Year Note which was trading in the same zone. At year-end, the economy was not sufficiently weak enough and inflation was not close enough to the Fed’s 2% target to warrant more cuts. It is more important that Chair Jay Powell and the Fed continue with their plan to sell assets from their balance sheet although they are doing so at a reduced rate. They need to forge fully ahead and at least reduce their balance sheet from roughly $7 trillion to $4 trillion, where it was before COVID hit.
At this point in the report, I usually write about my barbell strategy for investing. If you picture a barbell from the gym, there is a long, thin bar with big weights on both ends. Think of those weights as our conservative strategies and aggressive ones, the exact proportions do not matter yet. In theory, your money would have higher weights to conservative and aggressive strategies, especially if you are in or very close to retirement, and lower allocations to the middle of the road strategies.
This barbell approach has also worked very well with monies being transferred in from 401K and 403b plans as those pre-packaged plans rely heavily on bonds for the more conservative approach and do not account for interest rates rising. Additionally, their aggressive choices do not usually reward the risk taken. If you would like to learn more about the barbell approach, we can set up a meeting, call, or Zoom.
With 2024 over, especially the election, focus now shifts to the Trump administration’s new policies and which campaign promises will become reality. I do believe that Trump will draw attention to the southern border in his first 100 days as well as rattling the tariff saber. As you know, I am very much against tariffs and protectionism. I prefer free markets and free trade with agreements being hammered out country by country.
Regardless, I do believe there will be tariffs announced in Q1, but they will have more bark than bite, more noise than substance. And while many people are very concerned about tariffs toppling the economy, I think that even the full tariff plan will “only” impact GDP growth by ½% to ¾%. Tariffs and potential deportations will have a negative economic impact that will likely be offset by massive deregulation, small tax cuts and a huge wave of mergers and acquisitions activity.
Last year, there was a common theme among investors. Trump was going to wreck the economy. Harris was going to crash the markets. Lots and lots of folks did not invest because they were worried about geopolitics. That was one of the worst decisions I have seen in my 35-year career. Coming into 2025, I hear similar but less vocal concerns about the new administration. And to be fair, I think I would have heard the same thing had Kamala Harris won. Presidents just don’t have the economic and financial market impact that the media credits and blames them for.
Markets hate uncertainty. The election is over and removed a major piece of uncertainty. Donald Trump can do much by executive order, but he cannot legislate. Although the GOP controls Congress, the razor slim margin in the House is going to prevent most major legislative changes. The GOP is going to focus on preventing the fiscal cliff that happens when the 2017 tax cuts sunset at the end of 2025. Most will be extended, and I think they will add a few minor cuts. That’s a far cry from 2017 when the Republicans unleashed animal spirits with across the board, massive tax cuts, putting trillions in the pockets of consumers and corporations.
The bull market in stocks is now in its third year. That’s where returns moderate and volatility increases. Given the narrowness of the rally and the overly bullish sentiment, I do not think Q1 will be celebrated for equity investors. It doesn’t have to be a poor quarter, but I don’t believe it will be an easy or fun period. Using my crystal ball, at some point in the first half of the year, I do see a 10%+ stock market correction that lasts 7-9 weeks. That would be the ultimate buying opportunity or perfect time to add portfolio risk.
Please remember that while I publish regularly on the blog and speak freely in the media, our non-emotional, quantitative models dictate how each strategy invests, not my personal feelings or opinions. It is sometimes difficult when one group of models reduces exposure while another group remains in full steam ahead mode. I just keep my head down and follow what we built as best I can.
Turning to the bond market, the 10-Year Note should exceed 5% in 2025, and it could be sooner than later. While the media will warn of impending doom, I would see that move as terminal and an excellent time to buy bonds. Gold still looks like it wants to go higher and energy prices should emerge from their sideways slumber to rally. Bitcoin has all the looks of an asset that wants to plunge 25-50% during the first half of the year.
The economy should stay strong for the next two quarters, growing 2.5% to 3%. If you want to watch one single indicator to warn of trouble, I would look at weekly jobless claims. When the four-week moving average exceeds 250,000, that’s a solid warning of a slowing economy here. I am much more concerned about China and even Europe than here. China has the look and feel of Japan circa 1990. That led to a 30-year malaise for the Japanese. Europe just cannot get out of its own way fiscally and the super strong dollar only hurts.
Please continue to share your feedback, positive and negative. Investing is a marathon not a sprint and the long-term future continues to look very, very bright. We look forward to sharing that with you over the coming years. And I am always interested in meeting, whether it is to create or update retirement projections on your financial situation, review the strategies in your portfolio, run social security analysis’ on when and how to file for the best benefit, discuss your estate or even smaller transactional-type issues like securing a mortgage or weighing insurance. Again, here is the link to my calendar to schedule a meeting in the office, call, Zoom meeting or Skype. https://schedulewithpaul.as.me/
Thank you for the privilege of serving as your investment adviser!
Sincerely,
Heritage Capital, LLC
Paul Schatz AIF
President
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