If one of the most famous economists of all time could not profit from top-down economic forecasts, then how in the world could the average investor do any better? It is far easier to analyze a company and determine whether it is a good business worth investing in than to try to figure out what economic growth will be in a year and what that means for investing today. This may sound counter to what Wall Street says, but investors need to remember that Wall Street is in the transaction business.
One of the keys to a successful life is to keep one’s focus on what he or she can control. We cannot control what this administration does or the reaction of the masses that are wreaking havoc on the markets; We can control how we react, and in the long term, that will be the most important factor.
Will tariffs be the end of us? I am reminded of my college microeconomics professor, who liked to say that the economy was stronger than any government. I would add that both the economy and the market are stronger. Tariffs and the threat of tariffs have caused uncertainty, and contrary to the motto, they have actually put America last. On the surface it would seem that my good professor and I are wrong; however, one needs to look deeper.
It seems at least one of Trump’s economists is telling him that tariffs are a wonderful way of stimulating domestic growth and raising revenue for the government simultaneously. This is a protectionist’s dream. The problem with dreaming is that eventually one wakes up. Tariffs have never been a good idea and they still are not. The laws of economics are what they are; trying to fight them never works out well.
We limped to the finish but 2024 was still a good year. What does that mean for 2025? There is lots of talk about the low odds of the market having three big years in a row, but that is all talk; no one who has actually looked at the data would come to that conclusion.
My wife and I went to Scotland for our honeymoon. One evening in a pub in Edinburgh, we noticed a plaque on the wall beside our table with a quote I will never forget: “Good judgment comes from experience. Experience comes from poor judgment.”
John Maynard Keynes is remembered primarily as an economist. In many ways he was the father of macroeconomics, or the study of the larger economy from the top-down. He died in 1946, but to this day his theories on how government policy can shape the economy still hold weight with many economists: the Keynesian and neo-Keynesian schools of economics. Less known, however, is that Keynes was also a legendary investor. From 1921 until his death, Keynes ran the endowment at King’s College, Cambridge. His theory on balancing risks is largely credited with creating what we now refer to as the hedge fund.
One of the things I have always admired about Keynes was his ability to change his mind. A great example was in his investing career. When he first started investing, he felt, as many investors still do today, that having insight into the larger economy should give him an advantage, and he arguably had more insight than almost anyone else of his generation. He quickly and painfully learned that his knowledge of economics was not of great use when investing. He did much better when he invested from the bottom-up, getting to know the companies in whose stock he invested.
He quickly abandoned trying to invest based on economic trends and instead invested in a concentrated portfolio of stocks in which he felt he had some knowledge. While his portfolio remained concentrated, he paid close attention to managing risk. I have written about Keynes as an investor in the past, but the recent market activity brings this to mind.
We, like many others, have spent a great deal of time discussing tariffs and their negative impacts on the economy. I look forward to the day when we can stop talking about tariffs. We have also made the point, hopefully, that investment decisions should not be based on speculation of what final trade policy will be when the dust settles; Prudent investing is done from the bottom-up.
If one of the most famous economists of all time could not profit from top-down economic forecasts, then how in the world could the average investor do any better? It is far easier to analyze a company and determine whether it is a good business worth investing in than to try to figure out what economic growth will be in a year and what that means for investing today. This may sound counter to what Wall Street focuses on, but investors need to remember that Wall Street is in the transaction business. At the end of the day, Wall Street cares little about whether those transactions are sells or buys, and it really doesn’t care if they are profitable for the investor. It simply cares about the number of transactions.
Political and economic headlines change much more rapidly than the actual business of companies in whose stocks we invest. That rapid change leads to rapid transactions. Wise investors know better. The market has bounced back, partly because the tariff rhetoric has softened, but mostly because companies have reported earnings and those earnings are good. With 72 percent of companies in the S&P 500 having reported, earnings per share has grown 12.8 in the first quarter. This is after 14 percent earnings growth in the fourth quarter of 2024. We began the year with a very expensive S&P 500, but between the market correction and back-to-back double-digit earnings growth announcements, those valuations have come down more quickly than most would have thought possible. This has led the market to bounce back from the April selloff.
Will the rally continue, or will it fizzle? I don’t know, and the truth is no one else knows either. They may tell you otherwise, and they might sound very confident while doing so. I know, because 25 years ago I was one of those very confident prognosticators. Today I have the better judgment that comes from experience, and yes, much of that comes from poor judgment.
Experience has taught me, as it taught Keynes and countless others before, that knowing what you own and managing risk are the keys to long-term investing success. Prudent investing is done from the bottom-up, and from that perspective, things look pretty good.
Warm regards,
Chuck Osborne, CFA
~Good Judgment
The past week has been traumatic, and it may not be done yet. Times like this are always frightening, and this one in particular is frustrating because this is a self-inflicted wound. However, this too shall pass.
One of the keys to a successful life is to keep one’s focus on what he or she can control. We cannot control what this administration does or the reaction of the masses that are wreaking havoc on the markets; We can control how we react, and in the long term, that will be the most important factor. It is precisely at times like this when prudent investing is so important. We say it all the time, but prudent investing is done from the bottom-up, it is absolute return-oriented, and it is risk-averse.
We invest from the bottom-up so that we know what we own. Stock prices may react in irrational ways because of macro issues like tariffs, but ultimately, they reflect the value of the actual companies. This new world order may cause temporary stress, but quality companies will figure it out and continue to do business and grow earnings. We will get through this.
We are absolute return-oriented, which means we invest in what actually makes sense and not simply what is popular. Over the last several years, many have questioned allocations to international stocks as well as to bonds because the S&P 500, driven by U.S. large technology firms, has been the dominate driver of results. Yet, international stocks are doing much better than U.S., and bonds have rallied to help mitigate the damage being done.
We are risk-averse. We have our risk control process for a reason: It keeps us from making emotional decisions at stressful times. The recent action has been severe, but it must also be kept in context. We are still above our risk thresholds, and we will take action if we deem it necessary and prudent to do so.
Finally, tariffs will be bad for our overall economy, but there will be winners. This is actually one of the problems with tariffs: the government gets into the business of picking winners and losers. We will talk more about that, but in the meantime, understand that opportunities are being created. Many proverbial babies are being thrown out with all this bath water, and those who keep their heads while others panic will be able to take advantage.
As always, if any of you are feeling too nervous, please let us know. We are here to guide you through this, and we will make it to the other side.
Warm regards,
Chuck Osborne, CFA
~Keep Calm and Carry On
“Life is pain, and anyone who says differently is selling something.”
~ Dread Pirate Roberts, “The Princess Bride”
Will tariffs be the end of us? Lately I am reminded of my college microeconomics professor who liked to say that the economy was stronger than any government. I did not have a clue what he was talking about back then, but as most of my hair went goodbye and what was left of it has turned grey, I now believe that may have been the most valuable lesson I was taught in my four years of undergraduate studies. I would add that both the economy and the market are stronger.
Tariffs and the mere threat of tariffs have caused a lot of uncertainty, and contrary to the motto, they have actually put America last. Through March 21, international stocks as represented by the MSCI EAFE index are up 10.26 percent year-to-date, while the S&P 500 is down 3.34 percent. On the surface it would seem that my good professor and I are wrong.
However, one needs to look deeper. When we entered this year, U.S. large-cap stocks were extremely expensive. Based on our work, large cap stocks were between 2 and 3 standard deviations above their average valuation; in other words, they were more expensive than they are 95 percent of the time and approaching 99.7 percent of the time. There was not really any room for them to go up.
International stocks, on the other hand, were within their average band. They were not cheap in that sense, but compared to the U.S., they were an absolute bargain. It makes perfectly good sense that international stocks would outperform. Add currency on top of the relatively low valuation and the recent results make even more sense. The dollar strengthened considerably in the 4th quarter of 2024, which means that euros were losing relative value, so investments denominated in euros therefore lost value for American investors. That has reversed itself in 1st quarter and subsequently provided a tail wind to European stocks. The Japanese yen has done likewise. These represent the two largest international markets.
So, is this what we are doomed to see in 2025? Will U.S. stocks continue to drop? Not so fast. Stock valuations are based on the companies’ earnings. For stocks to get less expensive, the price could drop and/or the earnings could increase. With the mild correction we have had in prices and an earnings season that saw over 17 percent growth in reported earnings, suddenly the large-cap stocks have gone from almost 3 standard deviations back to just over one standard deviation. In addition, expectations have come way down because of all the tariff talk. There are few things as freeing as low expectations.
This is what always happens: Wall Street exaggerates. They exaggerate how good things are and they exaggerate how bad things are. This likely bodes well going forward for stocks. This does not mean that tariffs will not cause pain. They will, and it is frustrating because it is a self-inflicted voluntary pain, but it isn’t all doom and gloom. There is always some form of pain somewhere. People will still consume goods and services. There will be jobs to be had. Life will go on, pain and all.
We will continue to talk about tariffs. We will also discuss tax and regulatory reform, which are also on the administration’s agenda. We discuss these things because our clients are interested in them, we are interested in them, and they do provide a backdrop that could impact certain companies. Investment decisions, however, are made from the bottom-up. Apple will sell phones regardless of tariffs. AI will continue to grow demand for Nvidia chips regardless of Canadian lumber cost. We could go on.
The future is always uncertain, and uncertainty is painful. It is when they tell you that the future is certain and there will be no pain – that is when they are selling something. Pain is a barrier that can be overcome.
Warm regards,
Chuck Osborne, CFA
~Overcoming Barriers
Several years ago I read Matt Ridley’s “The Rational Optimist: How Prosperity Evolves.” In the book he makes a point that hit home for me: The “problem” with the economists in the Carter administration was that they were economists first and Democrats second. I remember it because one of my former bosses was in the Carter administration. I enjoyed his stories and that quote, while funny, accurately describes him and others I knew back then. As much as they may have wanted reality to be different, they were not about to promote policies they knew wouldn’t work. Even if they were popular with their political side. Where are those professionals today?
The Biden administration got in trouble by following an economic theory known as Modern Monetary Theory (MMT). MMT suggests that the government can print money to finance spending without limit. I’m not sure how otherwise intelligent economists could possibly believe such nonsense, but it had the benefit of being a progressive’s dream, so Biden followed it; and just as real economics suggests, the end result was the worst inflation we have seen since, well, Carter. As a result, we have a second term for Trump.
Now at least one of Trump’s economists is telling him that tariffs are a wonderful way of stimulating domestic growth and raising revenue for the government all at the same time. This is a protectionist’s dream. The problem with dreaming is that eventually one wakes up. Tariffs have never been a good idea and they still are not. The laws of economics are what they are; trying to fight them never works out well.
How serious is the administration about implementing tariffs? That is the question we should all be asking. Much of the tariff talk is just that – talk. It is obvious that Trump wishes to use the threat of tariffs as leverage in negotiations, but it is less clear what will become reality. One thing is for certain: the economy moves very fast today. That speed means any tariffs that become a reality will have an almost immediate impact. In fact, we were told by one client that a vendor of theirs was raising prices by 10 percent in anticipation of yet-to-be-implemented tariffs.
This is just a guess, but I believe that if the negative effects of tariffs are seen, then the administration will reverse course pretty quickly. In the meantime, all this tariff talk has pundits once again claiming that recession is around the corner. I guess they figure that if they just keep saying it, that sooner or later it will actually happen. (Personally, I think I would be too embarrassed to speak publicly after being so wrong for such a long time.)
The actual economic data suggests that we are in the middle of the economic cycle and not near the end. As of this writing, the Atlanta Fed’s GDPNow indicator of real time GDP is at 2.3 percent, which was the reading for the 4th quarter of 2024. Unemployment remains very steady at around 4 percent. That is the latest reading, and it has only varied 0.2 percent either way since the 4th quarter of 2023. Unemployment being steady for more than a year and the economy still growing bodes well.
The market has retreated of late based on fear, but this too has to be kept in perspective. The market has been on a big run over the last two years. Stock prices are expensive still, and corrections are a normal part of a bull market. This is anecdotal, but Nvidia just reported earnings that grew 81 percent from last year, yet some still found excuses to be negative.
They call economics the dismal science. That has always struck me as odd, because economists as a whole are almost always more optimistic about the future than the average person. That was actually the point of Ridley’s book: some might wish they could spend without limit or tax foreign competitors out of existence, but the laws of economics force us to deal with reality.
All resources are scarce, even for the government, and competition + cooperation is the path to better economic outcomes. The Biden administration found this out the hard way. Let’s hope the Trump administration doesn’t actually take us down the tariff road. If they do, we will all be singing along with The Clash, “I fought the law and the law won.”
Warm regards,
Chuck Osborne, CFA
~Can’t Fight The Law
We limped to the finish but 2024 was still a good year. What does that mean for 2025? Our long-time readers know that I do not give a lot of credence to the calendar; January 2 is not some alternate universe from December 31. Nothing really changed over the one market-closed day that marks the New Year holiday. Still, psychologically, January is when we wake up from our holiday stupor and turn over a new leaf with resolutions we think could actually stick this time. It is a new year, after all.
There is lots of talk about the low odds of the market having three big years in a row, but that is all talk; no one who has actually looked at the data would come to that conclusion. In the 1980s the market, as defined by the S&P 500, had eight years in a row of positive returns. They were not all huge years, but from 1982 through 1989, we had positive years. In the 1990s we had nine years in a row of positive returns. The return in 1994 was only 1.32 percent, but still, that is up. Every year from 1995 through 1999 the market was up at least 20 percent.
The 2000s were a tough period for the S&P 500, but they also marked a good period for stocks outside of the S&P 500 – something we have been unable to sustain since. After the disaster of 2008, the S&P 500 once again went nine years in a row of positive returns. We are so focused on the here-and-now that sometimes we forget to look at the big picture. Yes, we are up considerably two years in a row, but this was after two bear markets within a three-year period.
I know what you are thinking, “But Chuck, the S&P 500 is so expensive.” That is true. Based on our proprietary work, the S&P 500 is two standard deviations above average from a price-to-earnings standpoint. However, this is mostly concentrated in technology stocks, which are almost three standard deviations above average. In plain English, this means the market is this expensive only five percent of the time, and technology stocks are this expensive only one percent of the time. That is not sustainable.
The rest of the market is not exactly cheap, but it is much closer to average. There are two take-aways from our perspective on this setup: First, valuation alone does not cause the market to go down. Valuations may predict how severe a downturn will be, but they don’t cause a downturn. Secondly, for the S&P 500 to continue to climb, we need stocks other than technology stocks to take the lead. Will this happen in 2025? Nothing is guaranteed in this world, but the probabilities are high.
In the third quarter of 2024, the rest of the market took the lead. Honestly, I would have wagered that it would have continued through the fourth quarter as well. It did not, but action in that third quarter certainly showed us that it is very possible for the market to broaden out. The fundamentals suggest this should happen.
I suggested that we would likely have a correction and that is how we ended 2024, but as we open the New Year, we do so still in a bull market. We have two good years in a row, and at this juncture, number three is looking like the most likely scenario. Of course, it is early and 2025 will certainly provide some surprises as most years do. We begin the year with optimism. Happy New Year!
