I hope this letter finds you well. Julia, the boys, and I are headed up to North Carolina this week to enjoy the change in fall weather since we don’t exactly get to experience seasons here in Florida. Much like the weather, I find it ironic that in contemplating the recent capital markets performance, I am reminded of the old proverb that, “the more things change, the more they stay the same.” While markets continue to anxiously anticipate the end of the Federal Reserve rate hiking cycle, the underlying economic data, though somewhat mixed, has been better than I had anticipated.
In summary, we are witnessing three trends:
Corporate revenues and earnings continue to grow.
Inflation is cooling; however, it remains elevated, and I suspect it will be more persistent and pervasive than many believe.
Continued relative (and somewhat to my surprise) strength in housing, consumer spending, and labor markets.
These trends reinforce what I refer to as our ‘base’ case for the next six months; where we witness a slowing, albeit still positive, U.S. economy and inflation moderates but persists at a higher level than pre-pandemic averages. In this environment, we still anticipate a range-bound equity market that should improve over time. Paying attention to yield/income is an important component of investment strategy.
Speaking of yield, there were only two things this summer hotter than the record temperatures – Taylor Swift tickets and the demand for short-term investments. The latter should come as no surprise given that investors have been starved for income for over a decade. Rates exceeding 5% appear compelling for money market funds, treasury bills, and certificates of deposit.
While I remain constructive and optimistic on the capital markets in the shorter term, I have significant longer-term structural concerns. As I have mentioned, I think we are transitioning from a twenty-five-year trend of higher growth, low inflation, and low interest rates, to one that is diametrically opposed – lower growth, higher inflation, and higher interest rates.
This changing environment has significant investment and governance implications, which have recently come into focus with the federal debt ceiling debate and debacle in the House of Representatives. The United States is on the cusp of some large and significant budget challenges.
The federal government has not balanced the budget since 2001, when President Clinton was in office. The prior economic growth cycle, with its persistently low inflation and cost of capital, has allowed this deficit spending to continue unchecked for greater than twenty years while we proverbially ‘kick the can down the road.’ This is no longer the case.
President Clinton and his predecessors were successful at balancing the budget through a decade-long approach of pragmatic and controlled discretionary spending, not enacting new entitlements, and essentially growing our way out of the problem. Growing our way out of the current budget situation will be much tougher simply because of the demographics involved. The Baby Boomer generation, which fueled the economic growth of the late 1980s and early 1990s, is now is now drawing on Social Security and Medicare and leaving the workforce, putting persistent upward pressure on federal spending.
I contend that we have even greater headwinds in dealing with the federal debt and deficit because we have witnessed a crisis management government that has focused solutions on spending prolific sums of money. This occurred both during both during the Great Recession of 2007 – 2009 and again during the COVID-19 pandemic. I do not want to detract from the severity, suffering, or loss of either crisis; rather, I would contrast how America has dealt with past crises on economic terms relative to how we have dealt with these more recent ones.
Between 2000 and 2007, non-defense federal spending averaged 15.3% of GDP, between 2008 and 2019 it averaged 17.6% of GDP, and now from 2020-2023 it is 24.5% of GDP. For perspective, non-defense government spending was just 10.1% of GDP in the five years between 1965 and 1969. The federal government has grown about 10 times more than the economy in aggregate. Debt is at a record high and with higher interest rates and rapidly rising entitlement costs, we are on an unsustainable path. The cost of big government needs to be reversed.
The government is not the economy, although it seems many of our elected officials in Washington believe it is. How we as an electorate deal with these issues and hold our political representatives accountable should have significant influence over the longer-term investment opportunities here in America.
Thank you for your business and your continued confidence. If we may be of service in any capacity, or answer any questions you may have, please do not hesitate to reach out to us.