Finally, the day we have all waited for has finally come and gone. While the outcome may, or may not, have been the outcome you were looking for, it is clear… the US Economy just punched its ticket – or got its ticket punched – only time will tell. While these phrases may be similar, I should note the meanings can be quite different. Let me explain…

Typically the first means “an individual/entity puts themselves in a position to advance or to achieve a desired objective… in some cases to gain useful experience”. While the other version typically means “to die or be killed”. 

So which outcome is the future of the US economy as we head into 2025, and beyond? 

For nearly two years I have provided quantitative, and qualitative, data to showcase my concerns related to the health of the US economy, the average American consumer, the commercial real estate market, government balance sheets, and much more. During this time the disconnect between Main Street and Wall Street continued to widen, largely due in part to the “wealth effect” based on our research. That said, maybe our research is too academic; therefore let’s turn to the feedback from those who voted.

Twenty four hours after the polls closed voters shared some key concerns related to their personal situation:

1. 75% of exit poll takers indicated inflation was a Moderate to Severe hardship for them.
2. 45% of exit poll takers indicated their financial situation was worse than four years ago.
3. 69% of Red voters indicated the economy was “bad” as compared to 29% of Blue voters indicating the economy was “bad”.

While I acknowledge these polls may not be a complete reflection of the entire population, they do support the facts I have highlighted for the last two years.

Fast forward to yesterday’s (November 5, 2024) equity market rally, and the belief that under a Red Wave taxes will remain low, deficits will drop, national debt will decline, and the economy will enter long term prosperity. In an ideal world, that would be great! And yet, some comments/facts that have been shared over the past six months give me pause.

For example, if tariffs are increased 10% “across the board” for all goods brought into the US the cost of goods (to Americans) should increase (if companies pass the increased cost onto the consumer). That could lead to higher prices, which would be inflationary. Furthermore, if labor supply drops significantly (due to immigration reform) a number of underemployed, or unemployed, may be able to find a sorely needed full-time job as the job market gets tighter; and yet when a labor market is tight wage pressure typically increases which tends to lead to wage inflation. Let’s add on the fact that the government’s stimulus over the last four years has contributed, in many ways, to an imbalance in the US economy (i.e. a tight labor market, high inflation, high interest rates, low home affordability, and much more). If government spending is curtailed, to bring the deficit in balance, then government hiring (which has contributed to an above average percentage of newly created jobs over the last two years) will drop dramatically. If government spending and government hiring drop, and private sector spending continues to stagnate, then what happens to the US economy?

Well, let’s turn to the comments from a prominent individual, who could be put in charge of balancing the US deficit. This individual stated the US economy would experience a hardship and stock market would crash if Red won the election. I am not convinced this was a political comment, rather it was a hard truth… the US needs serious austerity to bring its financial house in order. This means raising revenues and cutting spending. Unfortunately, as you may know, whenever someone has to “tighten the belt” it typically means there is an uncomfortable period ahead.

If that wasn’t enough, analysts at LPL Financial looked at S&P 500 returns between 1950 and 2004 then compared the returns to the Executive and Legislative branch mixes during that period. The research showed a Blue Executive branch with a split Legislative branch performed the best whereas a Red Executive branch with a Blue Legislative branch performed the worst. But how did a Red Executive branch and Red Legislative branch perform? It wasn’t great… in fact it was the second worst performance while a Blue Executive branch and Red Legislative branch was the second best performance. The point being… the US stock market prefers gridlock, rather than a tilt to one side – or the other.

This leads me to this month’s Market Update and what I am calling “The Clearing Event”.

Summary Analysis:

At the start of the year pundits, analysts, and economists called for a thriving stock market with 5,500 (for the S&P 500) being a massively high bar – almost bull case scenario – to achieve. Today we look at closing in on an S&P 500 of 6,000 which no one at the start of the year could have imagined by year end. Of course as the days, weeks, and months went by the markets charged higher (based on the Mag 7’s continued growth story). However, in that time US equity market valuations have reached historically high levels, index concentrations have reached historically high levels, recession signals have been flashing red (possibly falsely), interest rates have remained higher for longer, and social unrest continues to build as the cost of living in the US, for a large portion of Americans, is becoming too much.

For much of that time our investment strategy has remained fairly defensive, with bright spots of opportunities being presented at varying times. In looking at October, historically speaking, it “bucked the trend” much like September did. As the Red Wave trade continued to build the US equity markets continued to grow to their highest levels ever.

Our investment strategies participated in some of the growth while also remaining defensive to a pullback. However, after the results of the election the time came for a shift in the portfolio strategy. This shift starts the overall rebalancing of the portfolio strategy as we head into the historically best six months of the calendar.

Recently the following changes were made to the investment strategies as a way to prepare for a new administration and new Congress.

1. Small 0.50% “toe hold” allocations were started in a few policy forward investments that support deregulation and AI expansion.
2. Approximately 10% of each investment strategy was shifted from short term fixed income to longer duration fixed income as the 10 Year Treasury neared 4.5% (as previously forecasted). Should the 10 Year Treasury reach 4.75%, and then 5%, additional allocations will be made to longer duration fixed income.
3. A few positions that derive a large portion of their supply chain from China were reduced until the pending “tariff threat” is better known.

Each of these changes support the belief that a “Clearing Event” is upon us. This could materialize in one of two ways. 

In scenario one, full fiscal austerity is enacted with broad spending cuts and tariffs imposed on a wide group of people/entities. These austerity measures lead to a very stressful time in the markets and US economy as businesses, and individuals, experience financial hardships. However, after the barn burning is complete new opportunities will arise which could lead to another decade of prosperity. Within the first 100 days of the new administration we will know where the priorities for the first two years will be focused.

In scenario two, additional fuel is thrown onto the smoldering US economy leading to a re-ignition of the fire over the prior two years. With additional government spending, global tariffs, a protectionist view point, and repealed tax cuts it is likely that America experiences higher inflation, higher interest rates, a wider/deeper divide between the Have’s and Have Nots, but additional expansion in wealth within select commodity, real estate and equity markets.

While we remain cautious we are beginning to evaluate how the new administration’s policies could help, or hurt, our investment strategies over the coming weeks, months, and years. Only time will tell if Americans punched their ticket to four years of prosperity, or got their ticket punched…

Detailed Analysis:

There is something to be said for the beauty and destruction that can be seen in nature. In fact, the circle of life application can be seen in many aspects of life… especially that of the business cycle. With every rise there comes a peak, and eventually a fall. However, what triggers the fall – or “Clearing Event”? 

In terms of the business cycle, it we look at the last couple of decades the typical trigger was Greed, with a pandemic thrown in… Greed can be attributed to the lofty, unrealistic, valuations in the Dot Com era. Greed can also be seen in the deregulation of the financial industry that lead to the real estate boom prior to the Great Financial Crisis. In both cases there was a clear peak, triggering event, and then dissension into chaos… unfortunately those points in time were only made clear when looking in the rearview mirror. As the saying goes, hindsight is 20/20.

Economically speaking, we haven’t seen a “Clearing Event” since 2020 – and maybe not since 2008 – if we are defining an equity market collapse as the aftermath of a Clearing Event. According to the National Bureau of Economic Research, if the average length of an economic business cycle in the US is four to six years (trough to trough or peak to peak) then we are right in the window where this cycle could be ending. Although, that assumes the COVID crash was the forced Clearing Event since the 2008 Clearing Event. 

In reviewing the last three complete business cycles (March 2001 to November 2001, December 2008 to June 2009, and February 2020 to April 2020) all three triggers for their respective Clearing Events were different. This tells me there is no way to predict when a Clearing Event will happen. Furthermore, if we look at every complete business cycle since 1854 we found the average duration of a downturn was seventeen (17) months. However, it should be noted that the length of downturns has shortened by nearly half over the last 80 years. According to the National Bureau of Economic Research the average length of a downturn between 1854 – 1945 was twenty-one (21) months while the average downturn between 1945 – 2020 was approximately ten (10) months… with the last rebound being only two (2) months. 

If we were to extrapolate this data and forecast one possible outcome for 2025, if the new administration triggers a Clearing Event (e.g. policy reform, budget controls, spending cuts, tariffs) any fallout could be short lived. While I wouldn’t imagine it would be as little as two months I wouldn’t be surprised if it was less than ten (10) months. Therefore, if the business cycle is nearing an end then any short term pain could lead to years of long term prosperity and gain.

But what if we have another 10 year bull market ahead of us? Would we skip a Clearing Event?

Our research indicates the Clearing Event would still happen but it would be a death by a thousand cuts. In other words, similar to what America has experienced over the last four (4) years the next ten (10) years would lead to mediocre growth/results. For example, if we look at the “Buffet Indicator” – coined for how Warren Buffett evaluates market valuations – the current market valuations (total stock market value divided by GDP) trades at a staggering 205%. This indicates, based on future earning growth and dividends, that the stock market’s return over the next 12 months should be approximately -0.30%. As a point of reference, the last time the market reached 199% was August 30, 2021 and a year later the same metric had dropped to 152% – as compared to the 20 year average of 119%. But maybe our research is biased?

Recently, Goldman Sachs published a research report indicating the forward 10 Year expected return for the US Equity Markets are projected to be approximately 3%. “Though Goldman didn’t specifically say it, the forecast likely assumes at least one bear market over the next 10 years”, according to Motely Fools. While any research report’s weight is measured by the paper it is printed on, the underlying tone in the Goldman report is pretty bleak… and they are not the only ones hinting at rough waters ahead.

So where does this leave Americans, and how should we think about the future?

Dusting off the crystal ball, putting on my glasses, and turning the lights off… I think it is clear to see a Clearing Event is in our future… but that event may not happen for awhile. This means rebalancing a portfolio strategy that leans toward a protectionist economy, with oil/energy production increasing, and a continued focus on AI derivative strategies will become a focus for our future investment strategies.

Bottom line, we will continue to keep a cautious outlook but are now beginning to learn toward a more optimistic strategy.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. You cannot invest directly in an index. Asset allocation is no guarantee of risk reduction. Past performance is no guarantee of future results.