The third quarter of 2025 was another good period for the equity markets with the S&P 500 gaining 11.2%. Breadth also expanded with smaller companies, represented by the Russell 2000 Index, finally participating. The standouts were  the semiconductor companies, as most of the hyper-scalers announced major investment plans for AI data centers. Even healthcare, and particularly bio-techs, appear to have turned a corner.

As we go to print, it would appear that the U.S. Congress will not be able to pass a continuing resolution bill to keep the government open. Normally, government shutdowns create all sorts of gyrations in both the stock and bond markets, primarily due to the government reaching its debt limit and being unable to fund its obligations. Fortunately, the passage of the “One Big Beautiful Bill” in July of this year increased the debt ceiling by some $5 trillion, which will allow the government to pay all its mandatory obligations and continue issuing debt.

At their September meeting the Federal Reserve Board lowered its federal funds rate by 25 basis points, continuing a pattern of lower rates, which had been suspended for twelve months. The primary reason noted was a deterioration in the labor markets. We expect at least one further cut this year and further cuts in 2026.

While there are still many unknowns, one of the hallmarks of 2025 has been the steady increase in corporate profits. Current estimates are for S&P 500 earnings to increase about 8% in 2025 and 9% in 2026, and even these estimates may be low. We like the fact that corporate earnings are going up while interest rates are going down, and credit conditions are mostly benign. Provisions in the 2025 tax bill should help spending broaden in 2026 with tax refunds starting in February and full depreciation of corporate investments a major plus for corporate cash flow. Deregulation will also help. Some have referred to the recent advance in the equity markets as a bubble, but bubbles of the past are usually “popped” by a Fed tightening cycle and investor preference for staples. This is not the case today.

                                                                                                                                    October 2025

Click to Download

Stocks continued their roller coaster ride in the second quarter of 2025. Having reached a high on February 19^th, they declined to a low on April 8^th. This was a 19% decline and slightly exceeded 20% on an intra-day basis. The primary reason for the April decline was the introduction of President Trump’s tariff policy, which at its onset seemed punitive and recessionary. As visibility on U. S. policy improved, however, stocks recovered with the S&P 500 closing at a new high, in part anticipating the passage of the One Big Beautiful Bill, which was signed into law on July 4^th.

Provisions in the bill allowing for full expensing of capital investments in the U.S. coupled with tariffs are a powerful incentive for CEOs to invest in plants and equipment. Mega cap tech companies had already been investing hundreds of billions of dollars in an Artificial Intelligence  arms race. This spending means strong sales for companies across diverse industries from semiconductors to data centers to utilities, their equipment suppliers and beyond. Further clarity on the final level of tariffs should increase capital investment intentions from here.

Stagflation concerns morphed into soft landing optimism. Inflation has not accelerated as feared, as companies have chosen to absorb some tariff impact in their margins rather than increasing prices.

While there is evidence of some softening in the labor market, the unemployment rate remains low at 4.1% and is not signaling recession. Jobs continue to support spending. Some durable goods purchases were likely pulled forward ahead of tariffs. Though that may have altered the basket of goods consumers buy, aggregate retail sales continue to increase, growing 2.8% from year-ago levels in May.

Risks for the second half of the year start with current market valuation. The aforementioned  positive developments are not lost on the market with the S&P 500 trading at a historically expensive 24 times earnings, making the market vulnerable to a corrective pullback. The sluggish housing market is a risk to employment and household balance sheets. High mortgage rates are dampening activity and moderating home sale prices. Potential policy changes reducing the independence of the Federal Reserve could frighten the bond market, sending long-term rates higher if investors fear a future Fed Chair would trade short term monetary largesse for long term discipline on the inflation front.

As we enter the third quarter, generally considered the weakest part of the year, both the corporate and consumer sectors have proven resilient in the challenging evolution of U.S. policies. Corporate earnings are still growing, and this earnings growth supports a continuation of the current bull market, even if the robust recovery from April lows requires a digestive period.

July 2025

Click to Download

After an initial burst of optimism at the turn of the year, stocks and bonds started to weaken as Inauguration Day took place. Right after the election, the Small Business Index surged as business owners thought tax cuts and deregulation were coming their way, but this quickly reversed as the quarter ended and “Liberation Day” revealed the largest tariff increases the country has ever seen.

By their very nature, tariffs are inflationary and must be offset to maintain economic stability. Adding to the problem is the way the current administration is applying them with an on-again, off-again approach which leaves little confidence for business planners who must think years into the future. As of this writing, excluding those levied on China, all tariffs have been suspended or are under negotiation except for a 10% universal tariff, still a massive increase. 

In 2017 the first Trump administration signed into law The Tax Cuts and Jobs Act (TCJA) which lowered marginal tax rates, capped the Alternative Minimum Tax (AMT), doubled the standard deductions and child tax credit, created a new deduction for small businesses, and raised the estate tax exemption. At the same time, the bill capped the state and local tax deduction, the mortgage deduction, and personal exemptions. All these provisions revert to pre-TCJA levels should Congress not act to extend or make them permanent by the end of this year. The cost to consumers alone would be about $400 billion over a ten-year period.

With so much uncertainty, equity markets have sold off sharply. From a technical perspective we have seen negative sentiment extremes, indiscriminate selling, and capitulating price action. It is quite possible that we have reached the market lows but we do not think that a sustainable rally is possible at this point and that, instead, a trading range is more probable. First, we must have clarity with regards to a sensible tariff policy. Second, we must have tax relief, rather than a tax increase to offset the effects of the tariff increases. Finally, we must have some cooperation from the Federal Reserve, which has so far maintained a restrictive policy. 

                                                                                                                                      April 2025

Click to Download

The S&P 500 returned 2.4% for the fourth quarter of 2024 and over 20% for the year. Once again, most of the outperformance was in a handful of stocks known as the “Magnificent Seven”. On an equally weighted basis, the S&P 500 rose 13%. Unique to the year was the weakness during the last two weeks, or the lack of the “Santa Claus Rally”—primarily caused by an apparent shift in Federal Reserve policy, and a rise in interest rates.

At the Federal Reserve’s December meeting interest rates were lowered by 25 basis points, as expected. However, the statement and accompanying forecast of future rate cuts was anything but dovish. While only several weeks ago forecasters were expecting three or more rate cuts in 2025, the Fed forecast only one, indicating a renewed emphasis on fighting inflation, rather than unemployment. Could the Fed’s policy change be frontrunning the new Administration’s tax and revenue proposals, which are perceived to be more inflationary?

The U.S. economy appears to have grown at a 3% annual rate in 2024—a healthy rate, if sustainable. While stable growth is always welcome, we believe there are several reasons to be cautious about the outlook. Rates on 30-year fixed-rate mortgages are now well-above 7%, causing a sharp falloff of residential construction activity. Manufacturing has been struggling for quite some time and manufacturing capacity utilization has been contracting since 2022. State and local spending, which has lifted GDP growth over the last year is poised to moderate, and the U.S. Dollar exchange rate has surged, making U.S-produced goods less competitive.

It is too early in the year to hold firm convictions about 2025. Most market forecasters believe S&P corporate profits will advance on the order of 12%, yet most economists see a slowing in U.S. GDP growth to around 2%. A lot depends on the passage and ultimate success of the new Administration’s tax and spending policies. High interest rates are not good for the economy or corporate profits, and the growing budget deficit eventually must be addressed. There is great promise, however, in the concepts of reshoring, infrastructure spending, increased domestic production, and artificial intelligence applications. We expect 2025 will be a positive year for investors, but with more volatility than the one just ended. 

January 2025

                                                                                                                                  

Click to Download

The third quarter of 2024 may well be remembered for the dramatic shift in Federal Reserve policy. With a fifty basis-point interest rate cut, Chairman Powell made it quite clear that rising unemployment was more worrisome than inflation, which was gradually falling towards the Federal Reserve’s 2% goal. In addition, most market observers now believe that there will be two more policy cuts this year and several more in 2025. After an initial hesitation, the markets have responded positively to this change, in spite of significant risks such as the escalating war in the Middle East, a structurally imbalanced Chinese economy, and uncertainty around the U.S. presidential and congressional elections. We attribute this apparent contradiction to the wave of liquidity from elevated fiscal stimulus measures and central bank easing both here and abroad.

To say market forecasts have been subject to change is an understatement. Since the Fed’s policy change, past economic data has been revised to show significantly more robust growth than previously estimated, and the latest jobs numbers blew past economists’ projections. Rather than falling, the September numbers showed that non-farm payroll increased by 254,000—more than 100,000 above the consensus among economists—and the prior two months tally was increased by 72,000. As such, the unemployment rate, which was expected to rise, fell to 4.1% in September from the prior month’s 4.2%. These types of numbers make one want to question the perceived scenario of steadily falling interest rates through 2024 and 2025.

Despite evidence that low-wage earners in the U.S. are having a difficult time, overall consumer spending and confidence have held up remarkably well. In addition, the world economy may be getting a welcome shot in the arm from a just-announced massive stimulus program in China. While few details have been announced, it would appear to target not only China’s faltering housing market but also consumers themselves. 

With the popular equity indexes recently hitting record highs, earnings and earnings guidance become more important. Consensus numbers are for the S&P 500 earnings to rise 8% this year and 14% in 2025. While we believe a “soft landing” is possible this year, we also think 2025 earnings estimates are quite aggressive, and may leave the markets subject to a pullback early next year.                                   

October 2024

Click to Download

While the major averages again performed well during the second quarter, breadth continued to narrow. In early June the number of stocks outperforming the S&P was at its lowest level since 1980. We believe this type of market action cannot continue, and is usually resolved by some sort of correction or at least consolidation in the current market leaders.

The Federal Reserve’s interest rate hikes have now begun to slow the economy. On July 5^th it was reported that the unemployment rate had climbed three months in a row to a fresh high of 4.1%. The last time the unemployment rate rose for three consecutive months was in 2016, when the Fed backed off from interest rate hikes. Payroll growth has slowed with the three-month moving average of nonfarm payrolls at 177,000—the slowest in over two years. The risks are in one direction, and the Fed ought to lean against those risks. It is questionable, given recent rhetoric, that the Fed will cut in July, but it can use the July meeting to strongly signal a cut is coming in September. We believe any further delay risks losing the Fed’s hoped-for “soft landing”.

While Federal Reserve policy and the direction of interest rates are paramount in our thinking, there are many reasons to believe this is still a decent environment for stock returns. Economic growth may slow in the coming quarters, but we are not looking for an economic contraction, and although the unemployment rate has ticked up, there are still 161.2 million people working in our country, close to the record amount of 161.8 million attained last November. There is also ample liquidity in the system with money market funds reporting a record $6.4 trillion in early June. Nor are we seeing any signs of stress in the banking system, with credit spreads acting well and the stock prices of most major banks near all-time highs. In addition, analysts are still projecting S&P 500 earnings growth of 9-to-10% this year and next.

We are at that time of year when some weakening can be expected in the popular averages, and recent winners in particular. But stocks have finished positively in every election year since 1944, with average returns of 16%. With the long-term drivers of stock returns, earnings and interest rates going in the right direction, we expect that any pullbacks will likely be a contraction in an ongoing bull market.

 July 2024

Click to Download

U.S. stocks rallied in the first quarter of 2024 in anticipation of strong corporate profits and the Federal Reserve cutting interest rates. It is notable that the market’s breadth increased, something that was lacking for most of 2023. Towards the end of the quarter, however, some weaknesses developed as several Federal Reserve officials pushed back against the aggressive rate cuts many on Wall Street were predicting.

The U.S. has appeared to be unique versus a more sluggish performance abroad, with several foreign countries entering recession. As a result, numerous global central banks are planning on cutting policy rates in 2024. The U.S. picture, however, appears much stronger. As an example, U.S. non-farm payrolls surged 303,000 month-over-month in March, a notable upside surprise. Average hourly earnings were up by 0.3%. The U.S. labor participation rate rose to 62.7% while the unemployment rate fell to 3.8%. Job growth has been expanding for over three years.

The Federal Reserve faces a core inflation stuck above 2% annually with increasing government deficits, and there have been well-documented historical mistakes of “stopping and going” monetary policy. Notably, the University of Michigan’s survey of long-run inflation expectations was 3.0% in early April. In the end, the Fed wants a soft landing, and recent Atlanta Fed data would keep this possibility as wage growth is slowing. While goods inflation is down significantly from COVID-induced supply chain disruptions, services inflation remains more persistent. So, a longer pause (before cutting rates) makes sense at this point.

The weaknesses in equity prices that showed up at the end of the first quarter has continued, and we believe it has further to go. We also have commented in the past about the uniqueness of the election year cycle, wherein stocks tend to bottom around Memorial Day and then rally into year-end. This scenario could be upset by international events—and there are enough uncertainties around to advise holding a near-term higher-than-normal cash position—but the bigger picture is one of stronger corporate profits and eventual falling interest rates.

April 2024

Click to Download

Stocks performed well in the fourth quarter and for the year 2023, with the S&P 500 advancing more than 20%. However, practically all the action was in the so-called “magnificent seven,” a handful of primarily large cap technology issues. The remaining 493 companies in the S&P 500 appreciated 14% collectively. The number of stocks, or market breadth, substantially increased in the fourth quarter, a good sign for further progress in 2024.

While U.S. economic growth has been resilient, inflation staying well-anchored is the more important determinant for future Federal Reserve policy and the hoped-for soft landing. In December, the U.S. Consumer Price Index was a bit above expectations, but the Producer Price Index (PPI) was well below. We have now had three consecutive months of negative PPI readings. Separately, the New York Fed’s survey of one-year consumer inflation expectations fell to 3.0% and the three-year dipped to 2.6%. The domestic labor market appears to be overheating less, with fewer people leaving their jobs and better skills-matching at businesses. In sum, the U.S. labor market appears to be normalizing by cutting job openings rather than jobs.

At their most recent December meeting, Chairman Powell of the Federal Reserve Board hinted quite strongly that the Fed was finished raising interest rates, and the most likely path towards “normalization” would be rate cuts. This was greeted by some equity investors promptly penciling in five to six rate cuts during the course of 2024. We think this is excessive, and that three-to-four rate cuts are more likely. The last thing that the Fed wants is a repeat of the 1970s when they were forced to adopt a stop-and-go monetary policy due to reoccurring bouts of inflation.

Election years are generally good years for equity investors, but unique from other years in market patterns. We would not be surprised, therefore, to see weakness in the first half of the year, as investors muddle through the political process and its economic implications. We are optimistic, however, that with interest rates and inflation on a downward path and corporate profits increasing, 2024 will be a good year for both fixed income and equity investors. 

January 2024

Click to Download

The S&P 500 lost 3.3.% for the quarter ending September 30th, and while positive for the year, this is entirely due to a handful of large-capitalization companies. On an equally weighted basis, that index is now negative for the year.

In our July commentary, we emphasized the importance of interest rates, and rising rates are the major problem today. It would be easy to blame the Federal Reserve for the market’s weakness, but the Fed has been signaling “higher for longer” for many months. U.S. consumer confidence has weakened but retail sales continue to surprise on the upside as jobs and asset values are still supporting consumer spending. It would appear that interest rates haven’t been high enough for long enough to fulfill the Fed’s aim of bringing inflation back to 2%. We would expect, therefore, that a “data-dependent” Fed will continue their restrictive policy until there is clear evidence that its objective will be met. The downside of this approach is, of course, that the economy could suffer a sharp slowdown.

At least some explanation for the economy’s resilience lies with the wealth of American households, which are estimated to have increased by some $40+ trillion since the start of 2020. We can thank a good stock market and booming housing market for a substantial part of this increase. The downside is that this was all made possible by unrealistically low interest rates and massive government deficit spending.

While interest rates are beginning to normalize, government spending continues and deficits continue to rise. This latter factor is important for bond investors as they will demand a higher interest rate for holding a longer-duration instrument.

As we enter the fourth quarter, we are optimistic that we will see a year-end rally, and historically the third year of a presidential cycle is the strongest. There is increasing evidence, moreover, that the Federal Reserve may be done raising interest rates, at least for this year. For the market to move appreciatively higher, however, we must see increasing corporate profits and a decreasing cost of money.
October 2023

Click to Download

Contrary to many predictions at the beginning of the year, stocks have advanced nicely for the first half of 2023. While gains in the second quarter were still concentrated in large technology companies, market breadth broadened. On an equally weighted basis, the S&P 500 total return was 7% for the first half of the year.

Financial markets react not only to the level of economic data, but also to the direction and rate of change—and a lot has improved in the U.S. this year. To date, the percentage of people employed increased by 1% to an all-time high of 156 million, while unemployment hovers near the multi-decade low of 3.5%. With inflation falling, real disposable income increased 2.5% through May. Contributing to the current robust employment situation are many areas of the economy that are thriving, including fossil fuel production, new homes under construction, reshoring of manufacturing, and the beneficiaries of the $280B CHIPS Act and the $437B Inflation  Reduction Act.

There are risks this current economic strength could diminish. The U.S. Bureau of Labor Statistics reported 209,000 jobs were created in June, which fell short of estimates. More importantly, the rate of growth in private sector job creation continues to slow, reaching 159,000 in June. This figure has consistently slowed for the past 12 months. The U.S. labor market does not appear to have rolled over enough to remove concerns about wage inflation yet, and the Federal Reserve has forecast additional interest rate increases.  Price inflation likely peaked in mid-2022, however core inflation was still 4.8% on a year-over-year basis in June.

For these and other reasons, aggregate earnings expectations for both fiscal year 2023 and 2024 have been revised significantly lower since early 2022. The U.S. Treasury yield curve remains inverted, and the Conference Board’s Leading Economic Index has been in decline for 14 consecutive months, all while interest rates have been rising.

We believe the stock market is trading at one-year highs based upon the assumptions that there will only be a mild economic slowdown, a consistent drop in inflation, and the Fed will not hike rates more than expected. To extend the gains meaningfully from here, however, we think we will have to see interest rates falling, economic growth re-accelerating, or an increase in S&P 500 earnings estimates.  As to earnings and interest rates—both continue to matter.

July 2023

                                                                                                                                                

Click to Download