On the Home Stretch… Winding Down Through 2025
Written by Jeff Hanson
There can be too much of a good thing sometimes
Fall is finally here, as illustrated by the leaves changing and the temperatures dropping, though if you were looking at the major averages you would have a hard time seeing any signs of things cooling down. 2025, thus far, has been very good year for capital markets. Overseas stocks continue to lead the pack, while stocks at home have a chance to log three straight years of 20%+ gains something not seen in about 30 years and bonds have provided solid if not spectacular high single digit returns. With all the handwringing about policy, markets keep marching higher, at times scaling the wall of worry and at others seemingly jumping headlong without any care in the world. There are mixed signals from labor softness to firming inflation, concerns about dollar debasement and the talk of end of American exceptionalism so it's not surprising to hear people are a bit confused about what to make of the economic and market landscape.
Let's grab our pillowcase and wander the neighborhood looking at the tricks and treats that may be in store for us in the months ahead. As our body looks to carb load this time of year, the goodies around Halloween, Thanksgiving and Christmas don't make it any easier to remain disciplined around our diet and it's easier to find excuses to skip the opportunity to exercise. It's not to say we can't indulge from time to time, but much like binging on Snickers before bed, you can let greed and sloth spoil your hard-won gains in the portfolio if you can't use some healthy restraint. Let's look at what's worth digesting and what may be better served finding its way in the trash can.
THE TREATS
We'll start with the treats, because who doesn't want to eat their dessert before their dinner.
Fed Policy: Easy Money Returns
Despite some tick up inflation, related to tariffs mainly, the Fed embarked on their second easing cycle in as many years just last month. On the back of the 100 basis points worth of cuts in 2024, Chairman Powell described the recent decision to lower rates as an "insurance cut" as some signs of cracks in the labor market were enough to signal to the market that the Fed will prioritize jobs over inflation. With the belief that two more cuts are on the way this year and possibly 2-3 more next year, the market has latched on to the easy money narrative which is bullish for asset prices. Powell's run as the most powerful central banker in the world will wrap up in about 7 months, but President Trump will likely announce his nominee for the post in the weeks ahead and expectations are that the next Fed Chair will look to lower rates and perhaps work more actively with Treasury regarding the balance sheet composition and interest rates effect on the deficit. There remains an open question about how effective monetary policy is versus prior periods, especially since the highest rates in 30 years never led to a recession but suffice to say no one should confuse the current and near-term future state as restrictive.
Earnings Growth: The Market's True Driver
Time and again you have heard the phrase earnings drive stock prices, there is no better truism in the markets. Coming into the year earnings estimates were as high as 13%, only to be revised down as worries including those about the effect of immigration and tariffs resulted in a dent to GDP. According to FactSet, analysts are calling for full year growth for 2025 at around 10.4% having left Q3 and Q4 estimates a bit lower around 7-8% respectively. With Q3 earnings season about to kick off and the early indications suggest in fact it's likely that companies will hit the original 13% figure estimated around this time last year for the present year. Estimates for 2026 are about 13%. With the market trading at 23 times forward estimates, it's difficult to make the case for further multiple expansion, as that would mean a "fairly highly priced" market to quote Jay Powell would get more expensive. Perhaps an optimal scenario would be that equity returns were a more pedestrian 8-10% (sign me up) but based on the common valuation metric stocks would have gotten cheaper in the process as the denominator grew faster than the numerator. Bottom line, stocks seem poised to see earnings improvement, perhaps on the back of improving demand (housing) and efficiency (AI and cooling labor costs). The story is similar abroad though earnings growth estimates are higher in the US which is one of the reasons investors find it so hard to kick their US stocks habit despite the fact overseas stocks have done so well.
Fiscal Tailwinds: Tax Relief Ahead
Much like the candy sack at the end of the night, there is something for everyone in the recent tax legislation referred to as the "One Big Beautiful Bill Act" or "OBBBA". The combination of some corporate goodies mainly around expensing of capital goods and research and development costs and benefits to households suggest there is a fiscal tailwind for the next 2 quarters. Some of the key benefits to the everyday taxpayer are a higher SALT cap, a new standard deduction for seniors and exemptions on income tax for a portion of tips and overtime for eligible workers to name just a few.
THE TRICKS
All-Hallows Eve is also known for its tricks, but what may seem like good fun to some may be at the expense of others left to clean up the mess. Supply side policy also can be akin to the sugar highs from the Smarties, where the buzz is followed by the jitters and an upset stomach.
Deficit Dangers: A Growing Problem
As the fiscal year just wrapped up, the budget deficit looks nearly identical in comparison to the level of last year. So much for getting our house in order. With deficits of $2TT, of which $1TT is our interest expense, the costs of borrowing are likely to rise sucking resources away from more productive efforts. Eventually we'll have to show more discipline or the markets will start to price our debt like many of the banana republics that have needed bailouts from the IMF time and again and if you think interest rates are high now, you haven't seen anything yet.
Gold Bubble?: When Costco Sells Bullion
What could be a worse prank than owning an asset which "has no place to go but up" only to watch its value burst before our eyes. I won't pretend to know when something is a bubble, that's for the postmortem victory lap from the business news media far too late to provide any special insight. But if it looks like a duck, swims like a duck and quacks like a duck… Humans have had an on again off again relationship with gold since man stumbled upon the soft yellow metal in Mesopotamia in 4000 BC. Having shot up 50% this year, this seems like a whole lot of speculative behavior and when you are adding some gold bullion to your Costco carts it may be worth taking some profits here. If you want to have a small piece in your portfolio as a diversifier that's understandable, but for a heavy element, it's even less practical to use than crypto (that's the closest to a shout out you'll get from me for the digital assets) and I don't see any central bank looking to tie themselves to a gold standard any time soon.
AI Hype: Echoes of the Late '90s
Artificial Intelligence and circular transactions…Before I get myself in too much hot water here, let me acknowledge my limited capacity to see the massive benefits that will accrue to all of humanity from the next technological revolution. I am a believer in its potential having dating back to Ian Ayres "Super Crunchers" that was published in 2007 before the world got upended by the financial crisis. But, and a big but, the way figures are being thrown around today makes it seem like I am playing Monopoly with my 7-year-old or better my 3-year-old who thinks making it rain dollar bills is actually found in the instructions. As companies like Nvidia, OpenAI and Oracle enter into cross-party transactions it's hard not to recall the days of the late 90s when hardware manufacturers were happy to provide capital to their clients only to have that money be used to buy more of their goods. Seems like a lot of things need to continue to go right for this to not end up with someone holding the bag, which more often than not is the investor who got in too late and ends up being the last one to shut the lights off as the party is over. Many people are quick to wave off the fact that back then they were URLs without businesses or that we were laying fiber that just wasn't ready for primetime. For anyone who has taken a little one out for candy at some point there is a level of diminishing return and then exhaustion. Let's just hope to avoid the upset stomach that comes with having gorged ourselves. Maybe those apples and raisins that found their way into our satchel aren't that bad after all.
The views expressed represent the opinions of Breakwater Capital Group as of the date noted and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. The information contained has been compiled from sources deemed reliable, yet accuracy is not guaranteed. 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.
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