Economy

Where do we go from here…  It would be understandable if you thought the market has already experienced a correction here in the first two months of 2025. It was just last week however that the market touched all-time highs, but over the last week the Standard & Poor’s 500 Index has traded down by about 4.2% with many popular stocks (Tesla, Palantir & Nvidia to name a few) down multiples of that amount. Concerns about a slowing US economy based on softening recent data and a torrent of policy announcements have contributed to the weight on the tape. It may turn out that this was the start of something more substantial or a healthy flush out of the excess enthusiasm ushered in after November’s election. Time will tell. Let’s take a short walk down memory lane to frame where we stand presently. After a brutal 2022 that saw double digit declines for both stocks and bonds, keep in mind only two other times in history have we seen simultaneous negative calendar year returns for both stocks and bonds (1939 & 1961), the combination of cooling inflation and more attractive valuations for both asset classes kicked off strong rally in the 4th quarter that year. Aside from a correction that started in the summer of 2023 that wrapped up around Halloween, the market has been on a tear, with only a few pockets of volatility flaring up along the way. Market concentration has been a factor with a significant source of the overall returns coming from a handful of stocks, though it is safe to say that the rising tide lifted most ships in that time. Heading into 2025, following back-to-back 20% return years, valuations hovered at 22 times forward earnings, more than 20% above their 30-year average and nearly 38% pricier than the p/e ratio over the last 95 years. A return to earnings growth was a welcome driver of higher stock prices, though truthfully much of the increase in the 2+ years since the bear market trough has come from multiple expansion. What makes that particularly interesting is that this is in spite of higher interest rates, where there attractive sources of alternative return would typically be a net negative for equities. Let’s be clear, higher valuations do not necessarily need to reset back to historical levels though that’s entirely possible. It is reasonable, however, to assume richer prices will impact future returns and leave little margin for disappointment when it comes to the data, whether we are speaking about the macroeconomic backdrop or idiosyncratic factors impacting individual companies. All this is meant to suggest the merits of diversification, which can and should be used as a tool to both possibly augment returns or reduce portfolio volatility. The early indications here in 2025 are illustrating those benefits. The MSCI EAFE index, the S&P equivalent for the developed markets outside the US, is up nearly 8%, perhaps finally looking to close a wide performance chasm that occurred over the last 15+ years. Similarly, bonds have offered a port in the storm, as the Bloomberg US Aggregate Bond Index is up about 2.50% year to date. More on the topic of bonds… As we spend the early part of the year commiserating about the news of premium hikes for our health, auto or homeowners’ policies it is not uncommon for us to question the value of those policies, especially when year after year we go without filing a claim. Insurance has been resigned to being a necessary cost to avoid a financial catastrophe in the face of some adverse event, but I am not sure it is appropriate to share the same perspective about portfolio insurance. There are a variety of ways to protect one’s portfolio from raising cash, to using structured products or derivatives, but as the saying goes the only free lunch in investing is achieved through diversification. 60+ days into 2025 spreading out your bets is paying off with the vaunted Magnificent 7 down about 8% while many other areas are positive if not materially positive in that time. Sure, we have seen a number of head fakes over the last 4-5 years where the luster was seeming to wear off only to see these hyper-scalers find their footing and catch investor’s fancy, but all good things must come to an end eventually. Whether or not that’s 2025 or at some point in the future, we’ll need to wait and see, but do not expect me to keep wagering on a handful of expensive stocks alone. The capital markets are vast and deep, odds are when we reflect back in 5-10 years the top performing assets likely will surprise us. With a 5-year annualized return of -.62% for the Bloomberg US Agg, it is understandable why investors may be disinterested in this asset class. Stocks on the other hand, as measured by the S&P 500, have averaged 15.15% over the same period, that’s a nearly 80% difference and if history was to consistently repeat itself it would be fair to ask yourself what’s the point in owning bonds. However much like car insurance or homeowners’ insurance they are there to provide some real value (protection) should something calamitous happen to the stock market. What’s unique here is that typically insurance, comes at a cost, in the form of a premium, but with bonds you actually get paid (interest) while you are holding them and the real downside is opportunity cost or foregone returns, which seems a lot better than a premium payment for a claim never filed or a 20% bear market for that matter. Back to the present, in the aftermath of the 2024 election, markets reflected an optimistic tone regarding President Trump’s return to the oval office. The thinking mainly focused on a pro-growth agenda where regulatory relief and further tax reform would support asset prices. While questions remained about the impact of tariffs and immigration policies, the administration was given the benefit of the doubt that any approach would be measured and hopefully well telegraphed. Now roughly 40 days into his second term, the President has issued innumerable executive orders, some of which will be challenged in court while the impact of others still needs to be flushed out and the rhetoric on tariffs has been far more bombastic when it comes to historic allies and perhaps less onerous on China where much of the political capital and energy was spent in 2017-2018. On balance, tariffs are a net negative as the costs are born by the importing country, possibly contributing to inflation at a time when there is little appetite for higher prices. A country that historically espoused the merits of free trade would be best served to limit tit for tat trade policy and instead source goods from nations that have been more aligned with our interests. In the end I am hopeful this ends up being about negotiating leverage rather than the start of something more painful for consumers and workers who likely would feel the second order effect of waning demand or strained budgets. While perhaps well intentioned, the fact is other countries may very well have ample capacity to ride out any policies that they find detrimental to their own economies. DOGE and the microscope on spending. Over 60 years ago, Lyndon Johnson who campaigned on the notion of the Great Society introduced legislation that created Medicare and Medicaid, the formation of the U.S. Department of Housing and Urban Development and Head Start among others embarking on a journey that would see the government’s role in society expand exponentially. These programs added to the social safety net that was initially created in the aftermath of the Great Depression where Social Security and the Supplemental Nutrition Assistance Program (SNAP) were born. In general, these programs have grown far faster than the rate of inflation, in some instances crowding out the private sector and creating ample opportunities for mismanagement, whether intentional or otherwise. To their credit, both Ronald Reagan and Bill Clinton instituted policy priorities to right size these programs, but other administrations have been willing to grow entitlements with little consideration to demographic dynamics, incentives or the capacity to cover these costs which eat up more and more taxpayer dollars with less and less accountability. The United States with a budget of $7TT, of which $2.8TT is attributed to deficit spending, finds itself with 60%+ dedicated to mandatory spending which is comprised of interest on our debts, some veterans benefits and the aforementioned Medicare and Medicaid programs along with Social Security. Discretionary spending, which makes up the difference, is where you’ll find defense spending as well as outlays for education, transportation, science, foreign aid etc.… We can all agree that any opportunity to eliminate waste or fraud or for programs that have limited benefit to our interests abroad should be heavily scrutinized and eliminated. Assuming a more measured approach around enacting reform should be welcomed and will likely have a positive impact on the economy and the markets in the years ahead. The public seems comfortable with the idea of reviewing expenditures, but the “move fast and break things” approach has been unsettling as witnessed by recent poor readings on consumer sentiment from both the Conference Board and University of Michigan monthly read outs. The irony of the “tough on everyone” approach, including our allies, may result in invigorating economic regions that have been prone to bouts of sclerosis. The Europeans seem particularly rallied around the idea that the United States sense of elitism is misguided which could foster some healthy competition though it could foment some ill will towards Americans and their corporations. The combination of less demanding valuations, more space for fiscal and monetary stimulus along with something resembling animal spirits would go a long way towards creating synchronized global growth which we have seen on a few occasions in the last several decades. Assuming you see something of a détente with China later this year so long as they allow for some modest currency appreciation and fiscal stimulus it could be off to the races for foreign stocks. Lastly, on the topic of interest rates, the real cost of money after all, the next few months will be rather interesting to watch unfold. March offers the February Nonfarm Payroll Report and a Fed meeting with the updated Summary of Economic Projections (SEP) where the possibility exists that they may shift from a slightly more hawkish posture to a more balanced tone, hinting at 3 rate cuts for this year, which would be well received. We are still likely 6-7 rate cuts or 1.375% away from neutral, but far less restrictive than we were just 6 months ago. If rates do head back down in an orderly fashion, it’s hard to envision a scenario where that’s not modestly bullish for risk assets. Away from short-term rates, which are really driven by Central Banks, Treasury Secretary Scott Bessent has been talking about the efforts to bring the 10-year Treasury yield lower. The rate has dropped about .50% since the start of the year though perhaps the fact that it’s been a somewhat rapid decline has served to spook the market somewhat as after all the bond market has been considered the smart money versus the stock market but we won’t get into that today. Since the 10-year rate has more influence on long-term borrowing costs, including mortgage rates, it was welcome to hear that there is extra attention there, though government policy is only one component of the pricing behind that security. If rates remain rangebound this year somewhere between 4-4.50% it bodes well for the economy and markets, rates falling too sharply would likely be the result of a risk of trade perhaps related to an exogenous shock and rates going too high (5%+) would start to put more pressure on equities and high yield bonds. To come full circle, there is a lot going on and perhaps a bit more uncertainty than would be the case with a newly elected administration that controls both chambers of Congress. Until there is further policy clarity and businesses are able to show their ability to grow earnings and improve margins, we would be well served to prepare for more volatility than we experienced in the last couple of years. Over the last 25 years the average intra-year decline for the stock market has been 15.4% so while we will not ask you to enjoy something like that we should be prepared for the possibility. Diversification seems like as good of a tool as any to provide you with a little insurance if there are a few more bumps along the way. Sources: WSJ, Barron’s, AMG, FRED

We have all heard the adage… “Don’t fight the Fed.” That was sage advice back in 2022 as the Fed embarked on the most aggressive tightening cycle dating back 40 years. That year both stocks and bonds withered, ending the year down by double digits, you would have to go back to 1941 the last time both asset classes showed losses for the year when you use the 10-year Treasury as a proxy for the bond market. Now with the pendulum shifting from tightening monetary policy to “easier money” everyone is trying to understand what that means for the economy and their portfolio in the months and years ahead. Lately the narrative has shifted a bit, there is a growing chorus that believes that monetary policy and by that we are really referring to the Fed’s setting of overnight interest rates in an economy dominated by bits and bites versus the more tangible attributes of yesteryear has less impact today. Or perhaps, it’s those long and variable lags Milton Friedman was referring to as higher rates are still making their way through the economy. If that is the case it stands to reason that even if liftoff is September it may take time for lower rates to exert their influence. In this piece we are going to explore rates from a few different perspectives. One thing to make clear, we are not market timers and market rates are a byproduct of not just Fed policy, but numerous other factors, like growth and inflation expectations, fiscal policy, the state of geopolitics etc… We can use the past as a prologue have been taking and will continue to take some steps on behalf of our clients whose assets we are managing for important life goals.  Equity Investing U.S. Stocks When the Federal Reserve cuts interest rates, it typically has a positive impact on US stock markets. If that is to play out again now, making sure that your portfolio is allocated properly when the Fed is inclined to cut rates is critically important. Here are some key points on how and why this occurs: Lower Borrowing Costs : Reduced interest rates make borrowing cheaper for companies and consumers. Newly lowered rates can lead to increased spending and investment, which often boosts corporate profits and, consequently, stock prices. Increased Consumer Spending : With lower interest rates, consumers may be more prone to take out loans for big-ticket items like houses and cars. Increased consumer spending can drive higher sales and earnings for companies, positively affecting their stock prices. Improved Corporate Earnings : Companies with existing debt benefit from lower interest payments, which can improve their profitability. This can lead to higher stock valuations. Shift from Bonds to Stocks : Lower interest rates typically lead to lower yields on bonds. Investors seeking higher returns might move their investments from bonds to stocks, positively impacting stock prices. Economic Confidence : A rate cut is often seen as a proactive move by the Fed in support of the economy. This can boost investor confidence, leading to increased buying activity in the stock market. Sector-Specific Impacts : Certain sectors, such as technology and consumer discretionary, often benefit more from lower interest rates due to their reliance on borrowing for growth and consumer spending patterns. Sectors that are highly capital intensive or with significant fixed costs stand to benefit more than asset light business historically. Financials tend to see their net interest margins or “NIM” shrink as rates come down, though a protracted period with an inverted yield curve may be less make lower rates less of a headwind if the curve returns to its normal sloping relationship where longer rates are higher than shorter rates. Manufacturers could see a benefit if lower rates mean a lower dollar making their goods more competitive when it comes to global trade. Small Cap Stocks With the incredible rise of the Magnificent 7 stocks, small cap stocks have been overlooked. A change in outlook by the Fed may create an environment for small cap stocks to continue to climb. Lower Borrowing Costs : Small-cap companies, which often have higher debt ratios than larger companies, benefit considerably from reduced interest expenses when rates are cut. Lower borrowing costs can improve their profitability and support expansion efforts whether it be adding to their workforce or expanding research & development. Growth Potential : Small-cap stocks are typically seen as growth-oriented investments. Afterall, companies that are now among the largest companies in the world like Amazon, Apple, Nvidia and Microsoft all started as small caps! Lower interest rates can spur economic activity, benefiting smaller companies that may be more agile and able to capitalize on new opportunities. Increased Risk Appetite : Rate cuts can increase investor confidence and risk appetite. Investors may be more willing to invest in higher-risk, higher-reward small-cap stocks during periods of lower interest rates. Access to Capital : Lower interest rates can make it easier and cheaper for small companies to raise capital, whether through loans or equity offerings. This can help them invest in growth initiatives, leading to higher stock prices. Overseas Equities Yield differentials may narrow : Foreign capital has been lured into US assets for many years dating back to the European Debt Crisis in the early 2010s. If US interest rates look less attractive by comparison than foreign capital may be onshored and find its way into local stock markets. A weaker dollar may ease inflation and lower borrowing costs : A more common phenomenon in the emerging markets where consumption of commodities represent larger percentages of overall spending may allow for capital to be directed more productively and as foreign companies and countries often offer dollar bonds to institutional investors to hedge the currency risk the cost of that interest could drop if the local currency strengthens vs. the dollar. Foreign assets may offer a store of value : Should the dollar weaken, it stands to reason that it’s losing ground to some other currency; that relationship can serve as a hedge to offset the diminishing purchasing power of local assets. After a long run with a stronger dollar, if there is a secular shift underway that will unfold over the years ahead, having some additional exposure aboard would be valuable from both a risk and return perspective. The combination of more attractive valuations should provide a little extra incentive to increase the ex-US holdings in the portfolio, even if it is just at the margins. One thing to keep in mind, in the past monetary policy has generally been pretty well coordinated, but if that is to change in the years ahead it will be that much more important to have some professional oversight to help navigate what could result in a little more short-term volatility. Stocks historically have fared well when the easing cycle begins, though it’s not always the case, especially if the easing is in response to a shock to the economy or deteriorating fundamentals. The latter does not appear to be the case today though there are signs of continued cooling in the labor markets where with the former, a shock, well, that’s tough to predict, after all it wouldn’t be considered a shock. It’s those known unknowns or unknown unknowns, that get you in trouble to quote the late Donald Rumsfeld.

As has been the case for 3 years running, August has been a difficult month for the markets and as we type, we are in the midst of a sharp increase in volatility and the selling pressure that often accompanies it. The proximate cause changes from year to year, in 2022 it was Fed Chairman Jay Powell’s “pain” comments about what lay ahead for both Wall Street and Main Street, while 2023 was a concern that the economy may in fact be overheating and the next move for the Fed was perhaps another hike. In 2024, it’s been about rising unemployment and the Sahm rule, along with some other data points that show the economy is slowing.  While all real concerns, then or now, generally the market follows a familiar script where emotion meets some disappointing data results in a narrative shift and the worst possible scenario comes to the fore. A weekly unemployment claims report on Thursday morning that showed higher than expected new filings, was followed by a disappointing Manufacturing ISM survey which showed that part of the economy was contracting, though interestingly enough the NonFarm Payroll report for July, released on Friday, saw employment increases in construction, transportation, and warehousing. The “Jobs Report” as it’s often referred to, is an important data point, one of many, and the combination of a lackluster headline number (114K new jobs versus 175K predicted) along with 29K of downward revisions for May and June left people worrying that the labor markets were rolling over. Aside from the tepid job growth (growth being the operative word here) itself, a decrease in hours worked and an increase in the unemployment rate from 4.10% to 4.3% seemed to be enough to get the market convinced that it was time for the exits. We have had a couple questions related to the report, as you might imagine, one of the more common inquiries is how are we adding jobs yet seeing a jump in the unemployment rate. That phenomenon relates to an increase in the participation rate where more people actively seeking employment versus prior months means a larger pool of workers came into the survey vs. the total number of new hires. There are other wonky features to these reports, the other reports from the Bureau of Labor Statistics where they try to smooth out the data. The summer and winter months tend to be rather noisy related to weather patterns along seasonal employment trends (i.e. new college grads entering the workforce or students working summer jobs.) There has been much hand wringing about the Fed behind the curve, but they have no record of ever being accurate ex ante, we could be talking about Bernanke whistling past the graveyard when referring to the subprime risks being contained back in 2007 or the March 2022 liftoff of the most recent tightening cycle where inflation was already well on its way to peaking at 9.2% later that same year. The Fed, like all of us are human beings and prone to the same failings and we are somewhat misguided to put them on a pedestal as some clairvoyant policy mechanism. James Mackintosh’s piece in today’s Wall Street Journal does a nice job in summarizing several instances where market structure contributed to the big market moves in 1987 and 1998 where an otherwise lousy headline may have just meant a day’s decline morphed into something a bit bigger. It is safe to assume the economy has slowed down from the blistering pace we saw in 2021 and 2022 and saw some hints at in the back half of 2023, but we should expect the economy to go through periods of acceleration and deceleration from time to time. You’ll hear the word recession even more and more, partially because it seems intellectual to seem bearish, but the fact is there is always the possibility of a recession on the horizon whether due to an exogenous shock or the ebbing of the business cycle as animal spirits are exhausted and the credit cycle shifts. We sympathize with those of you spooked by the chatter about a more uncomfortable period ahead though there is no guarantee that is what transpires. In the last 48 hours, you may have heard multiple references to the aforementioned Sahm Rule which suggests that by the time the unemployment rate has jumped by .50% in the span of 6 months we are already 3 months into a recession or Goldman Sachs ratcheting up the prospects for a recession in the next 12 months from 15% to 25%. Ms. Sahm, an economist, acknowledged the limitations in her model and the obvious fact that we are at a time where there has been a good deal of distortion related to the pandemic and its aftermath, especially related to the unprecedented policy response. You may recall hearing about the inverted yield curve’s undefeated record when it comes to predicting recessions back in 2022, though 24 months later it seems that record may no longer be unblemished. To quote George Box, the famed British statistician, “all models are wrong, some are useful.” There are a number of important data points ahead, and while the next Fed meeting is not until September 18th, if the policy makers see a reason to act prior to then, they will. It likely will be in response to the “growth scare” versus proactively addressing pernicious events a few quarters out but we will have to wait and see. Further evidence of the market wanting to look for the negative news flow, it shrugged off the Service Sector ISM which accounts for 70%+ of the economy and was firmly in expansion mode. As long term investors, it’s best to take any and all data in stride and consider it in a broader context, the bright spot is for investors with diversified portfolios, the last month you have seen the benefits of holding bonds to offset the equity declines, something that we didn’t see in 2022 when both assets classes ended the year down sharply. Over that same timespan we have seen sharper declines in technology or technology adjacent industries (communication services, and consumer discretionary sectors) whose stocks had gone up an eye watering 48% since last October when looking at the Nasdaq composite. Despite the selling pressure many stocks still appear fully if not overvalued given the fundamentals, so it does not appear a massive snapback rally is in the cards as was the case in 2020 or early 2023 when various ratios came back to levels in line with historical averages. Your instincts may suggest to sit this one out and go to the sidelines for a little, but some of the markets’ better days are often in the midst of volatile periods like this and after having already realized some of the declines you may very well be making a poor decision to compound those losses. Citing a slide from our recent market update, courtesy of the folks at Schwab & Bloomberg, if you missed the ten best trading days over the last 2520 days (20 years) you would have captured only 60% of the market’s long run return. Actions like this have a meaningful long-term impact on your results. It’s not to say times like these are to be dismissed, and you should go about your summer plans. And in one of the few instances where I disagree with Warren Buffet who in 2015 said “if you are worried about corrections, you shouldn’t own stocks.” It’s okay to be worried, you have worked hard for your money and have goals associated with it. Perhaps better stated he might have said that if a correction makes you want to sell your stocks, you may need to revisit your allocation. Periods of episodic volatility can be extremely valuable in that they allow you to be better informed of your risk tolerance. If you feel like the last few weeks are untenable, be sure to schedule some time with your advisor to review the merits of your approach or any change that may be appropriate. Sources: Bloomberg, Charles Schwab & Co, Barron’s, WSJ, CNBC

Avoiding the stock sunburn: How shifting narratives influence markets and investor behavior.

With markets experiencing their own heat wave, will the summer rally sizzle or fizzle

Japan is back… Where were you in 1989? It is a welcome sight witnessing the Japanese stock market get back to levels it last touched when I was wearing tube socks and playing Nintendo. In the first quarter the TOPIX was up 10.05% matching the S&P 500 torrid start to the year. But it’s not just in the capital markets that are buzzing. You could stay up late watching Bloomberg Asia during market hours but since that should be time to wind down, you won’t be disappointed taking in two of the best series on television right now… Max’s Tokyo Vice and Shogun on FX. The world’s third largest economy as measured by GDP deserves some love. Between pop culture and higher stock prices it’s a new dawn in The Land of the Rising Sun.We are in the midst of March Madness, the pinnacle of excitement in “amateur sports” it’s hard to replicate something so immersive and exciting, but I worry the combination of the NIL and sports betting has irreparably damaged the purity of the tournament. We are all aware by now that the pandemic ushered in new era of gamification and gambling providing a much-needed distraction and some excitement in those dark days of lockdowns and masks. When it comes to wagering it’s common knowledge the house always wins. All you need to do is look at the gambling stocks which have been on a tear as they quietly pick your pockets. I have my thoughts about legalizing drugs and making gambling more accessible, but rather than pontificate, I have a more compelling suggestion. On any given day, the stock market chances for an increase is no greater than a coin toss. Alas if you buy a stock or fund you get to play that same wager over 240 times a year and rather than the “house” ending up ahead in the long run you likely have a lot more to show for it.The death of Nobel prizing winning psychologist Danny Kahneman last month had me reflecting on a true intellectual giant’s contributions to the world of behavioral finance and its value to the everyday investor. Even for someone who has spent more than two decades honing my craft, I am often surprised/amused at the tricks our minds play on us when it comes to investing. Dr. Kahneman’s seminal work Thinking, Fast & Slow is a true masterpiece, but many struggle to make their way through it. Michael Lewis’s 2016 Undoing Project is a wonderful tribute to Danny and his best friend Amos Tversky, and is a really approachable read for those unwilling to commit to the intellectual density of T, F & S. Any investor would be well served to learn about loss aversion recency bias or the endowment effect to name just a few of those blasted biases.  Just when you thought people were coming to their senses and the crypto bust of 2021-2022 rid us of the daily digital data dump, here we are again with the biggest grift in modern times. I have to give it to them, despite lacking a compelling use case the Bitcoin believers have talked their way into one of the most epic executions of the greater fool theory in the history of man. Happy to have Wall Street get in on the rouse, the SEC and the sponsors of the various Bitcoin ETFs should be ashamed of themselves. Making it easier for people to lose their hard earned money is not why we are in this business and anything to “legitimize” an endeavor that has funded terrorism, human trafficking and the drug trade all for some basis points is an embarrassment. While we are on the topic of dereliction of duty, has anyone spoken with a family trying to navigate the FAFSA process this year? It’s bad enough that it costs $90,000 for a year at a prestigious liberal arts college, but to think we are making it more difficult to apply for and receive aid. You wonder why the younger generations are fed up and both sentiment levels and the government’s approval rating is at historically low levels despite a stock market at all-time highs and an unemployment rate under 4%. Applications for aid are down 57%, you read that right while the costs of college skyrocket. And those that applied were working with incomplete data. I can’t make this stuff up. We are supposed to be taking care of those in need, but we are more likely to see students take on more debt. If there was ever a better reason to start plowing money into the 529 plans now then let me know. It’s not to say we shouldn’t take the aid available to us, but perhaps it’s best to be in a position where we don’t need to count on it. George Carlin may have been thinking about another dirty word when he heard someone mutter the word inflation. It’s surely making the current administration cringe with the election less than 7 months away. While the rate of price changes have dropped markedly from their peaks in the summer of 2022, recent data suggests the victory lap for Fed which kicked off in October coinciding with this strong rally, may have been a bit premature. Coming into the year the market was pricing in 6 or even 7 rate cuts but a combination of better labor data and price stickiness has reduced the probability of aggressive easing getting under way. Just this week, on Monday, the ISM Manufacturing Survey showed we entered expansion territory in March for the first time since the Fall of 2022 and now the odds suggest just two cuts may be in the cards for 2024. It’s becoming increasingly more evident that we are in a period of fiscal dominance, I am not sure that monetary policy is having as much of an effect outside of residential and commercial real estate. The former is holding up fine in the face of limited inventories while the latter is holding on for dear life; they stare down the barrel of a gun in the form of refinancing. Always good to zoom out a little. I am not sure we will see those prices come down without a deep recession, but before we do too much hand wringing it’s important to put things into the proper perspective. For the last 30 years, dating back to 1994, CPI has average just below 2.50% including the recent the elevated inflation, that’s less than half the inflation for the 30 years from 1966 through 1995 where prices grew at a clip of over 5.4%. Magnificent 7, 6, 5 4, 3 , 2, 1… Aside from Meta and Nvidia the latter of which has somehow managed to add an 80% return on top of a truly breathtaking 2023 performance, we have seen quite the dispersion in the returns and what appears to be a case of returning from orbit for high flying Apple and Tesla. With the group trading at a forward P/E ratio of 31 times there is no room for error as they trade at 50% premium to the S&P itself over which they have a great influence given their size. What is even more amazing is that they trade at a 100% premium to the equal weight index. Something has to give, is it that Amazon, Microsoft, Meta and Alphabet starts to resent buying GPUs from Nvidia with 80% gross margins and they start in house fabrication much like Apple did with ditching Intel in 2020. Rent seeking behavior is usually short lived as competitors look to take share as well. Or perhaps it’s all that enterprise spending that doesn’t yield the earnings growth forcing multiples to contract. Much like the upcoming NFL draft there rarely is a can’t miss story out there. Much like “retired” Bill Belichick did at the helm of the New England Patriots for 20+ years, perhaps trading down and having more picks allows you to build a better roster versus needing everything to go right with your one great idea. Diversification and identifying mispricing is a consistent path to wealth even if it takes you a little longer to get there. Common prosperity or conciliatory China? Polishing off the old playbook and rebranding communism by using some more gentle words like common and prosperity doesn’t mean your people have to like it. History suggests that there is nothing common about prosperity when the state dictates distribution of resources as was the case for the 30 years under Chairman Mao until Deng Xiaoping ushered in market based reforms in the late 1970s and early 1980s. Clearly Xi Jinping’s admiration of Mao Zedong’s emphasizes his cult of personability and despotic tendencies while minimizing the fact his policies resulted in the deaths of millions of Chinese whether by famine or the Cultural Revolution. But the Chinese have had their taste of capitalism it appears they like what they experienced. While the property problem persists, efforts to cool tensions between the US and Chinese relations along with more aggressive and targeted stimulus may break the years’ long malaise. The last pre-pandemic slowdown in China required about 2 years to run its course and then set up a period of synchronized global growth from 2016-2019 a similar recovery would be welcome as trade may provide further disinflationary pressures as they compete with Mexico and India for labor and any increase in consumption is bound to help US multinationals grow earnings after the US consumer eventually slows down. We are not ready to pivot away from our view China is practically un- investible but this is modestly constructive and worth monitoring. Virtuous cycles of asset allocation based investing. Whether the calendar dictates adjusting your investment mix or there is more discipline based on drift and data, the fact we have spent 30 of the last 40 years in one heck of a bull market has meant that there has been an unquenchable demand for fixed income. At one point the bond market in the US dwarfed the stock market but stocks have caught up where both pools of capital valued at about $51TT. Globally the bond market is a bit bigger than the equity markets, $133TT to $110TT. Rates have been coming down since the early 1980s only to have increased a bit in the middle of the 2000s and again most recently. Higher rates should attract more buyers, yet $6TT is parked in money market funds. The average bond buyer has become much more price (yield) insensitive, buying bonds in something resembling rote behavior. If the market continues to go up and likely at a rate of change that exceeds the bond market, and it should given the uncertainty associated with owning stocks and the natural inflationary forces that drive asset prices higher, then we should more often than not have a bid putting something of a lid on yields and not needing to implement a Japan style yield curve control. Mark Twain’s famous quip about his death being an exaggeration seems fitting for all those folks. Please join us April 18th for our Quarterly Market Review and Outlook. Register Now Sources: Baron’s WSJ, BLS, ISMForbes, JP Morgan Asset Management Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website, www.adviserinfo.sec.gov. Past performance is not a guarantee of future results.

Getting pretty technical here aren’t we…  How using charts can improve your investing and worsen your eyesight. At one time or another we have all found ourselves on a quest for the next great investment idea or to identify the next bubble before it bursts. For some of us it’s a lifetime endeavor while for others it’s a fleeting moment of excitement fueled by someone else’s success or failure. It’s safe to say that much of Wall Street is focused on the less glamorous field of fundamental analysis where valuing companies, industries or sectors is based on using traditional metrics like free cash flow or price to book ratios among countless others. This is a rigorous and helpful process but requires the use of assumptions sometimes on a single variable, but more often than not assumptions with multiple variables. This makes trying to estimate the earnings of a company 2 quarters out difficult, let alone 2 years or 10 which seems next to impossible, frankly. That is supposed to be one of the preferred methods to arrive at a price to pay for a security. This isn’t to suggest this effort is futile, but to acknowledge its limitations therefore incorporating additional information into one’s investment process would seem to make sense. Schumpeter described the concept of creative destruction, which posits that the state of constant change is filled with innovation and destruction. We have all borne witness to this over the course of our lifetimes whether we are talking about iPhones or Uber. Companies disrupting the incumbents or creating an entirely new market from scratch makes capitalism so dynamic and exciting, but it also makes using past economic models challenging at best or worse, outright obsolete. I don’t foresee that changing any time soon so if we are trying to identify something constant in all this it may be as easy as looking in the mirror. After 300,000 years on the planet, humans have more or less wired themselves through the evolutionary process and that “hard coding” can be really valuable to understand. Everyone is familiar with the “fight or flight” concept, which is about survival in its simplest form. Safe to assume flight is the better bet most of the time when it comes to physical confrontation but that same reaction function can wreak havoc on our portfolios triggering ourselves to sell out when the market is troughing. The same can be said about herd mentality, where behavior becomes something akin to a mania and totally dispels the idea of the wisdom of crowds. I am essentially talking about behavioral finance, something we have been writing about on occasion for the last couple years and following for the last couple of decades. Assuming we can (or can’t) control our inner impulses, that will provide us with an edge, especially since it’s apparent that most people are incapable of that level of discipline. How best to exploit those human inefficiencies you ask? Sometimes it’s as simple as picking up anecdotal evidence like the stock tips from the shoeshine boys of yesteryear, but not everything is as obvious an outlier as Bored Apes NFTs and Meme stocks or subprime housing bubbles. Incorporating technical analysis is a tool that may be able to help. So what is technical analysis really? It is the use of price and volume data to inform one’s investment decision making process. Perhaps better said, fundamentals tell you the what, while technical tell you when and how far. With the troves of data out there, patterns and trends often emerge that are a reflection of investor’s sentiment and expectations and identifying them early on may allow you to augment your returns or cut your risk exposure. Here are a few indicators that traders and investors look for when employing technical strategies: Price Trends confirmed by trading volume: Price movements may be random or noise, unless they are accompanied by surges in activity at which time they like represent a signal Momentum: Much like Newton’s famous first law of motion which states an object in motion, stays in motion the same has often applied to stocks. The momentum effect or factor is a bit controversial in that it seems to suggest chasing returns but academic research has found it to be a helpful tool when paired with other factors (size, value, quality etc…) Moving Averages: Looking at price over varying time series reveal inflection points for markets, common measurements are the 50, 90 and 200 day moving averages. When prices move above or below the moving averages it suggests the stock may have broken through a resistance point and are headed higher or lower as a result. There are countless techniques dedicated to this field of investing, many of which are more detailed or complex and outside the scope of this piece. We’ll admit there are surely some short term elements to this approach but incorporating this information into your thought process means you are adding an extra layer to what is hopefully a sound long term strategy. We surely think it’s valuable at Breakwater even if it makes our eyes blurry by the end of the day.

It’s February already, thankfully. The sun seems to be on extended holiday in the Northeast. Perhaps Punxsutawney Phil will be more accurate than economists and strategists alike as this morning he indicated an early Spring is in store. As for us market watchers experiencing something akin to Groundhog’s Day would be nirvana and the first month of the New Year was a continuation of the final two months of 2023. So far, so good for February too. With the S&P logging a return of 1.68% for the month, that annualizes out to a 20% return, ahh, if it were only that easy. There has been a lot to unpack, so we’ll meander across a number of topics to share our thoughts and what we are looking at right now and in the months ahead.  Central Banks: As we have joked about recently, Federal Reserve meetings have become must-see TV. For the last 6 months, since the last hike in July, the meetings have been less about the rate announcement itself and more about trying to get inside Chairman Powell’s thought process. With markets hanging on every word and probing the quarterly Statement of Economic Projections (SEP) for any insights, it’s no surprise that two of the Fed meetings in 2023 corresponded to the most volatile trading days of 2023. The presser earlier this week augured the worst day since September when Powell seemed to take the March cut off the table. Data since then only strengthened the case for May as the lift off date for their easing cycle. That seems to be reasonable enough, in acknowledging that they have come a long way in taming inflation (rolling 6 month PCE is around 2%) they can start to shift focus to the other part of their dual mandate, which is full employment. Bringing both inflation and jobs into a more balanced weighting is a good thing and a far cry from the pain Powell mentioned in August 2022 at Jackson Hole. While Chair Powell and the Fed are the most important game in town, central banks in the UK, Europe and Japan are worth monitoring. The UK and Europe are dealing with more of the stagflation dynamic we witnessed in the late 70s, though there have been some recent signs of easing inflation. The ongoing impact of higher energy prices has more impact there where they rely heavily on imports and the fact their mortgage rates tend to be much more variable in nature have meant higher monthly payments not just for new buyers but even those who have purchased homes 5 or more years ago. In the States, it’s far more common for borrowers to term out their debt for 30 years. Many folks with a mortgage today have locked in rates of 4% or below. Monetary policy likely will have some impact over the next several years and I would expect the trough of their easing cycle to be below that of what we see in the US. The ECB seems likely to wait for the United States to move first, but they won’t be far behind. Japan has witnessed sustained inflation for the first time in more than 30 years but at a much more palatable level. They have thus far maintained yield curve control policies which suggests that they are in no rush to start raising rates. If they do it’s likely to be modest at best as with households having sizable exposure to the JGBs any drop in price brought on by higher rates may impact consumer behavior. Higher rates would also have some real impact on the carry trade, but that discussion is for another day. Labor: As the frequency of layoff announcements hitting the headlines have increased over the last 12 months the Fed needs to be very careful about how much softening occurs before it becomes difficult to reverse that trend. Fortunately after a blockbuster January Nonfarm Payroll Report, the unemployment rate ticked back down to 3.7% after rising the prior month albeit slightly to 3.8%. It’s becoming ever more obvious that so goes the labor market so goes the economy. When the unemployment rate jumps by .50% in a short period of time, it’s likely to rise another 1.00% in a hurry as we have seen in prior cycles leading to a recession. Allowing the labor market to get untethered is the quickest path to a hard landing. We have seen new weekly unemployment filings increase to 224,000 in the most recent week and continuing claims remain around 1.8MM. Hardly worrisome levels unless you are one of those impacted, but the direction itself is worth watching. It was good to see job openings surprisingly increase in the most recent JOLTS report and especially in sectors like manufacturing. Another bright spot is that the “quit rate” has dropped sharply since the height of the pandemic where workers bounced to new opportunities at an unprecedented rate speaking to labor tightness. This probably has an added positive effect on productivity as fewer new workers have to adjust to unfamiliar surroundings. Continuing the soft landing narrative the Bureau of Labor Statistics just released their quarterly Employment Cost Index which showed further moderating, which is a good sign when it comes to inflation and margins. Nominal wage growth is around 4% back to levels we saw pre-pandemic. Inflation: With CPI trending down, and PCE following a similar path perhaps the debate over transitory can be put to rest. The stickier shelter component will start to show signs of disinflation or outright deflation in the coming months as softer housing data and a glut of new multi-family housing comes online. While there has been much hand wringing over financial conditions easing (whether directly or indirectly), there is little evidence that higher asset prices are inflationary when it comes to consumption of goods or services. In the post Global Financial Crisis(GFC) world of Zero Interest Rate Policy (ZIRP) inflation consistently undershot the Fed’s target. I am not convinced this time is different. The situation in the Red Sea is worth monitoring, but that shipping lane has less impact on goods that come into the US versus other countries and the case for strong case for continued globalization means large export driven economies like China, Vietnam, Mexico and increasingly India are able to provide disinflationary if not deflationary pressures at a time when that may not be a bad thing. Consumer sentiment surveys have for the last couple of years suggested inflation expectations had become anchored somewhat higher, but some better responses over the last couple of months are encouraging. Earnings & Margins: As we are in the midst of 4th quarter earnings it would be best to describe the current numbers as “meh.” Profits are likely to be up quarter over quarter for the second quarter in a row, but have thus far come in lower than estimates going back a few months. Some of that is a byproduct of companies being very cautious and not taking on excess inventory, worried about their end consumer and some margin pressures remain. According to FactSet’s Earnings Insight as of Friday January 26th of the 25% of companies that had reported roughly 70% of companies have beat on both earnings and revenue, below 3 and 5 year averages respectively. This week we have seen some better than expected earnings from names in the Technology, Consumer Discretionary and the Communication Services sectors which have an outsized weighting on the market so the overall numbers are likely to improve but all in all it’s hardly been a blowout quarter. Given present lofty valuations, meaningful moves higher from here will need to be supported by improving earnings growth. While the consensus estimate called for as much as 14% YOY growth for the S&P 500 as recently as last Fall, those numbers have come down now to about 10% for 2024. That figure may still be a bit ambitious with GDP forecasts for the year roughly around 2% and inflation moderating. We know companies have a number of levers to pull to improve earnings from buybacks to layoffs, the former an accounting maneuver while the latter likely having more negative intermediate impact on the economy as a whole, so be careful what we wish for here. The good news is that margin pressures are likely to abate given further improvement in the supply chain, improved productivity and slowing wage growth. We may not see peak margins like we saw in 2021 however they remain historically high which makes sense in a less capital-intensive economy. Global Economy: As we alluded to the challenge of central banks all around the globe to find that happy balance on policy, it’s safe to assume some positive developments abroad would be a positive for the US economy which has run above trend for the last couple of quarters. While there was hope for an improving China in early 2023 and the possibility of a real slowdown in Europe could be avoided, that was not the case. As China continues to wrestle with a housing crisis that has been going on for nearly 10 years, structural reforms have been delayed as Xi Jinping focuses on the common prosperity initiatives which have hurt markets at home. At this point the base case should assume very little help from China in supporting global growth and that seems to be well priced in. If there is some improvement it would be welcome, though I wouldn’t bank on it. Europe, China’s largest trading partner, sees it’s trajectory far more closely tied to developments in the Middle Kingdom, they may not move in lockstep but it’s unlikely that you’d witness a reacceleration in growth in one and not the other. Fortunately, valuations abroad are far less demanding, though markets likely exceed expectations. The likelihood of lower interest rates and possibly a weaker dollar would be a positive for US investors investing abroad as well as remove some near term headwinds on emerging economies that still very much rely on dollar funding for their credit markets. In summary, a repeat of the last couple of quarters would be great where it’s been upside surprises for both the economy and the markets here in the US. As inflation continues to head lower, that’s a positive even if growth may have peaked in the 3rd quarter of 2023. Growth above trend (2%+ in real terms) is supportive of the labor market and asset prices and if some of the encouraging data regarding manufacturing is not in fact a false start we could revert back to synchronized global growth like we saw in 2016-2017. They say we’re young and we don’t know We won’t find out until we grow Well I don’t know if all that’s true’ Cause you got me, and baby, I got you -Sonny & Cher Get In Touch Sources: WSJ, Barron’s, Factset, Bloomberg, YCharts, FRED St. Louis Fed, Bureau of Labor Statistics