Did the U.S. Economy Have Its Ticket Punched?

The election has come and gone. Whether the U.S. economy punched its ticket or got its ticket punched, and what a “Clearing Event” could mean for markets.

The day we have all waited for has finally come and gone. While the outcome may, or may not, have been the one you were looking for, it is clear the U.S. economy just punched its ticket, or got its ticket punched. Only time will tell which. While these phrases may sound similar, their meanings can be quite different. Let me explain.

Typically, the first means “an individual or entity puts itself in a position to advance or to achieve a desired objective, in some cases to gain useful experience.” The other typically means “to die or be killed.”

So which outcome is the future of the U.S. economy as we head into 2025 and beyond?

What voters said about the economy

For nearly two years I have provided quantitative and qualitative data to showcase my concerns about the health of the U.S. 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 to the “wealth effect,” based on our research. That said, maybe our research is too academic, so let’s turn to the feedback from those who voted.

Twenty-four hours after the polls closed, voters shared some key concerns about their personal situations:

• 75% of exit poll respondents indicated inflation was a moderate to severe hardship for them.
• 45% of exit poll respondents indicated their financial situation was worse than four years ago.
• 69% of Red voters said the economy was “bad,” compared with 29% of Blue voters.

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.

Policy questions after the election

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, the national debt will decline and the economy will enter long-term prosperity. In an ideal world, that would be great! And yet, some comments and facts shared over the past six months give me pause.

For example, if tariffs are increased 10% “across the board” on all goods brought into the U.S., the cost of goods to Americans should increase (if companies pass the increased cost on to 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 people may be able to find a sorely needed full-time job as the job market gets tighter. Yet when a labor market is tight, wage pressure typically increases, which tends to lead to wage inflation. Add to that the fact that the government’s stimulus over the last four years has contributed, in many ways, to an imbalance in the U.S. economy (a tight labor market, high inflation, high interest rates, low home affordability and much more). If government spending is curtailed to bring the deficit into balance, then government hiring (which has contributed 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 U.S. economy?

Well, let’s turn to the comments from a prominent individual who could be put in charge of balancing the U.S. deficit. This individual stated the U.S. economy would experience hardship and the 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 U.S. 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 and compared the returns with 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. The point being, the U.S. 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.”

The year in markets

At the start of the year, pundits, analysts and economists called for a thriving stock market, with 5,500 on the S&P 500 seen as a massively high bar to achieve, almost a bull-case scenario. Today we are closing in on 6,000 for the S&P 500, 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 on the Mag 7’s continued growth story. However, in that time U.S. equity market valuations have reached historically high levels, index concentration has 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 U.S. is becoming too much for a large portion of Americans.

For much of that time our investment strategy has remained fairly defensive, with bright spots of opportunity presented at varying times. Historically speaking, October, much like September, “bucked the trend.” As the Red Wave trade continued to build, U.S. equity markets continued to climb to their highest levels ever.

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

Recent changes to our strategies

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

• Small 0.50% “toehold” allocations were started in a few policy-forward investments that support deregulation and AI expansion.
• 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.
• 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 supports 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 and entities. These austerity measures lead to a very stressful time in the markets and the U.S. economy as businesses and individuals experience financial hardship. 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 U.S. economy, reigniting the fire of the prior two years. With additional government spending, global tariffs, a protectionist viewpoint and repealed tax cuts, it is likely that America experiences higher inflation, higher interest rates and a wider, deeper divide between the haves and have-nots, but also 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.

The business cycle and clearing events

There is something to be said for the beauty and destruction that can be seen in nature. In fact, the circle of life can be seen in many aspects of life, especially 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, if 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 of the dot-com era. Greed can also be seen in the deregulation of the financial industry that led to the real estate boom before the Great Financial Crisis. In both cases there was a clear peak, a triggering event and then a descent 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 define an equity market collapse as the aftermath of a Clearing Event. According to the National Bureau of Economic Research, if the average length of a U.S. business cycle 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. That assumes, though, that 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), the triggers for their respective Clearing Events were all different. This tells me there is no way to predict when a Clearing Event will happen. Furthermore, looking at every complete business cycle since 1854, we found the average duration of a downturn was 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 downturn between 1854 and 1945 lasted 21 months, while the average downturn between 1945 and 2020 lasted approximately 10 months, with the last rebound taking only two 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 10 months. Therefore, if the business cycle is nearing an end, any short-term pain could lead to years of long-term prosperity and gain.

What if the bull market continues?

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 death by a thousand cuts. In other words, similar to what America has experienced over the last four years, the next 10 years would bring mediocre growth and results. For example, if we look at the “Buffett Indicator,” named for how Warren Buffett evaluates market valuations, current market valuations (total stock market value divided by GDP) stand at a staggering 205%. This indicates, based on future earnings 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%, compared with the 20-year average of 119%. But maybe our research is biased?

Recently, Goldman Sachs published a research report projecting the forward 10-year expected return for U.S. equity markets at 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 The Motley Fool. While any research report is only worth the paper it is printed on, the underlying tone of 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 a Clearing Event is in our future, but that event may not happen for a while. This means rebalancing toward a portfolio strategy that leans into a protectionist economy, rising oil and energy production, 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 lean toward a more optimistic strategy.