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.
What do these two unrelated stocks have in common? They are high-quality companies whose stocks were selling at what we deemed to be an attractive price. It did not matter that one was purchased when its stock price was going down, while the other was purchased when its stock price was going up; The price movement of the past has no bearing on whether the current price is a good value.
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!
Warm regards,
Chuck Osborne, CFA
~Happy New Year!
“It was the best of times, it was the worst of times…” ~ Charles Dickens, “A Tale of Two Cities”
I know that isn’t the Dickens novel we should be quoting this time of year, but it wasn’t Christmas when our story began. There I was in a client’s office in Norfolk, VA, in early March of 2022. The regional bank Silicon Valley Bank (SVB) had just gone under, and panic was ensuing in the regional bank market. As I entered my client’s office I was greeted by the recently retired manager of that location. “Hey Chuck, are you buying banks today?” To which I responded, “Why yes I am. Good to see you, by the way.”
Let me digress briefly: Whenever I give examples of specific investments, it is important to understand that this is for educational purposes only and not a suggestion to go out there and buy it yourself. I am going to be specific, but the important part is not the companies whose stocks I mention, but the thought process that goes into the decisions.
Back to the story: That very day while I was in Norfolk, our traders had been given instructions to buy shares of Western Alliance Bank. Like SVB, Western Alliance is a regional bank in the West; Unlike SVB, Western Alliance is well run. Its stock had been thrown out like a baby with the bath water, but this was guilt by association. We knew Western Alliance well as we had owned it before and felt confident in its future. We suspected that once the dust had settled it would actually be a beneficiary of SVB’s demise, while the Wall Street pundit machine assumed that all the deposits at SVB would find homes in one of the big national banks.
As usual, Wall Street did not understand main street. People who choose to bank at a smaller regional bank do so specifically because they do not want to bank at a large national bank. Some deposits might go to the big banks simply out of fear, but most would search out another small regional bank. Western Alliance was one of the best positioned to take advantage of that. We purchased Western Alliance (WAL) when the stock price was down and most thought it would continue to drop; we pulled the trigger on March 22, 2023, at a price of $34.17. We still own it in accounts where we believe it is appropriate, including my own portfolio.
Fast forward to this past summer when Michael Smith, our director of research, brought a new idea to my attention. He really liked a company named AppLovin, a company that helps app developers monetize their apps. We really liked what we saw: it is a good company, well run, and in an industry with lots of potential. The problem? The stock had already risen 118 percent year-to-date to that point. Who in their right minds would buy a stock that had already gone up 118 percent? The answer turned out to be Michael and me. We purchased AppLovin (APP) on September 10, 2024, at a price of $87.15. We still own it in client accounts where we believe it is appropriate.
What do these two completely unrelated stocks have in common? They are high quality companies and their stocks were selling at what we deemed to be an attractive price. It did not matter that one was purchased when its stock price was going down, while the other was purchased when its stock price was going up; The price movement of the past has no bearing on whether the current price is a good value. This is one of the hardest psychological traps for investors to avoid. We are hard-wired to believe that prices that have gone up are expensive while prices that have gone down are a value. In most of our daily lives this is true, but when it comes to investing, price has to be compared to value. In other words, we compare the price of the stock to the value of the company. The stock price can go down and still be more than the company is worth, and it can also go up and still be a bargain.
This dynamic is important to understand because the stock market has gone up significantly in 2024 and there is a lot of talk about it being expensive. In fairness, as a whole it is expensive, but the price of the market is heavily skewed towards a small number of really big companies. Prudent investors make decisions from the bottom-up, judging each individual investment. There are still attractively valued opportunities out there and there is no sign that this bull market is over. The economy is still going strong: The Atlanta Fed’s GDPNow says we are growing at 3.1 percent. That bodes well for company earnings, which is what drives long-term stock prices.
That doesn’t mean we might not be heading for a correction. We have come up quite a bit and it is natural and healthy for the market to take two steps forward and then a step back. We are not traders, so we don’t get worked up about corrections; if anything, corrections provide opportunities. Regardless, to paraphrase Dickens, we are closer to the spring of hope than to the winter of despair.
