Historically stocks and bonds have been inversely correlated, meaning when stocks declined bonds gained or at least did not lose value—due to their negative correlation. Looking back to the 2000-2002 and 2008-2009 market corrections this was the case, yet recently the correlations between stocks and bonds have become more similar. This was the case in the 2022 correction and most recently when President Trump first announced his Liberation Day tariffs last April. Economists attribute the mutation in how stock and bond prices move to concerns about future inflation—typically the Fed raises interest rates to fight inflation. This pushes bond yields higher causing bond prices to decline (a bond you own becomes worth less when a new issue yields more) so correlations become similar. Tariffs are considered inflationary, explaining the rise in bond yields and the positive correlation of stocks and bonds.

The fact is when constructing portfolios, diversification is only a part of what’s necessary to build-in adequate risk management. Investment managers must also consider earnings, valuations, inflation, liquidity, monetary policy and pending legislation, particularly tax & trade policy changes, when structuring portfolios. Market corrections happen during periods of market stress. Volatility is the empirical evidence of market stress, but typically there is always a trigger event, some Black Swan incident that amplifies selling often initiated by algorithmic trading. When this happens correlations among asset classes change often causing them to converge so every financial asset’s price moves together. This is precisely why diversification does not protect against market risk. It further explains why so many investors lose too much.

Market corrections result in a lot of wealth is lost, and the causes of corrections differ. Investment managers combat adverse changes through their investment process that on the one hand must be biased to stay invested because stocks historically outperform most other asset classes, but on the other hand their processes must adjust to economic shifts by reallocating to the best, probable, expected return opportunities given new market circumstances. The investment process must weigh the risk of staying invested holding the same holdings and asset weights with the reality that suffering a loss requires a greater gain to get back even—lose 50% and 100% is required to get back even. Prudent investing is about employing proactive risk management that works to strike the optimum balance among the objectives of Growth, Income, Safety, Liquidity and Tax Advantages at the appropriate time.

At ProActive Advisors our investment process was formulated on research into Bull & Bear market environments to identify which indicators had the greatest, historical predictive power of forecasting a market correction, optimizing how to weight them, combining them into a composite index to score the Health of the Market and converting that score into a probability using a sigmoid function. Back testing this process over 50 years of market history has provided us with a mathematical tool to monitor the risk/return tradeoff and make opportune changes to portfolio asset allocations.

Our investment process has served us well in the past due to our continual focus is on risk management and not simply diversifying using passive indexing. We are not making any statement or promises about future outcomes or principal protections here. We are only saying we have a well-defined process to monitor portfolios where we proactively ask “What Can Go Wrong” while striving to keep accounts within thresholds of suitable risk capacities we believe are warranted given client profiles and the Health of the Market.

Looking at the current market, we still favor gold, silver, copper and oil & gas while continuing to hold leading tech stocks and select market sectors. Recently we harvested significant profits in silver and have begun culling software holdings we expect to be adversely impacted by AI. Those proceeds are being invested in quality fixed income holdings where we can earn real returns above inflation. Given our expectation of 3.0% ongoing inflation, we know over 15 years the purchasing power of the dollar (and US debt) will erode by 56%, requiring a 4.8% minimum return after taxes (28% marginal income tax rate) to breakeven. Our short-term positioning in these fixed-income securities is to get paid while we wait for better opportunities the stock market will eventually provide.

In summary, we see geo-politics as unsettling to the financial markets and causing increased volatility but believe last year’s tax bill will create a torrent of animal spirits to propel GDP to 6.0% or greater in 2026. That growth plus greater productivity should lessen concerns about US debt levels and provide room for the Fed to modestly lower interest rates. And while there is justifiable acrimony about US leadership that is disrupting supply chains, international trade, and accelerating de-dollarization, we expect a weak dollar to also boost US exports, offsetting the move to dethrone King Dollar. Our conclusion is that all these factors support higher stock prices, reinforcing the importance of following our process until probabilities warrant change.

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We arrive at this conclusion despite low Consumer Confidence by examining the facts, questioning consensus assumptions, and considering the possible outcomes and risks. We expect the growth initiatives put in place by the Trump Administration’s to stimulate as surge in business investment confidence. Reduced regulation, spending cuts, direct foreign investment, and the One Big Beautiful Bill Act (OBBBA) which takes effect next month are compelling business stimuli. The OBBBA provides $125 billion for businesses and $100 billion to low- and middle-class-income tax filers, including this year’s $6,000 for social security recipients whose modified adjusted gross income is less than $175,000 or $250,000 for married couples. These initiatives together with the administration’s shift to a China-like ‘State Craft” industrial policy, are expected to accelerate discovery in Artificial Intelligence and Quantum computing by unifying resources across labs, public science, and private industry. Barring some “Black Swan” event, we expect the financial markets to continue to rise at least into the mid-term elections.

While Affordability will take time to rectify, a growing economy with lower interest rates should unfreeze the housing market in the next few years. Meanwhile, cost of living issues are being addressed on multiple fronts. Regulations for utilities and energy production have been streamlined to improve the grid and lower energy costs which impact prices on all goods and services made or transported. The US has also reached agreements with countries to make direct investments here to increase US manufacturing and create jobs. Grocery prices should also decline with tariff exemptions for Brazil & Ecuador to export bananas, coffee, meat, sea food, and tropical fruits. Grain exports to China under the one-year tariff agreement aids US farm sales. These measures and tariffs on imports of steel and aluminum benefit US industry and should amplify growth making US debt levels less concerning. Additionally, a better economy should also lift consumer sentiment.

Government and consumer debt levels are unsustainable, yet the government needs to borrow as do businesses to win the AI race. A potential Black Swan event for investors could come in the form of an unwinding of the “Carry Trade.” For 25 years Japan has kept their interest rates near zero. This lured global investors to borrow cheap Yen to invest elsewhere to make easy profit spreads. All the money printing has crushed the Yen’s value and caused a huge loss of purchasing power for Japanese citizens. Now Japan faces a “Catch 22” dilemma. If it raises interest rates to help the people and strengthen the Yen, if would force billionaire hedge funds to sell their investments to unwind their trades to cut their losses. If it doesn’t raise rates to help people, their citizens will likely turn violent due to their suffering. Eventually the continued money printing would collapse their economy. Since the US and other Western investors have leveraged their carry trade investments, unwinding them could create a domino effect of selling around the world but certainly in the US. If the markets fall, the assets backing the monetary system fall with them. Governments have no choice but to step in with Swap Lines to prevent Japan’s financial failing. Such an ‘Black Swan’ event would affect China as well, so collaboration and competition is preferable to fuming and fighting over past bad deals the US has made—moving industry and jobs to make more profits with low labor costs. Still the crucial unanswered question is how the US with higher Costs of Goods Sold can make products here and sell them elsewhere without a weak Dollar policy which would only exacerbate de-dollarization. A partial answer may be to make a Gretzky move: “Skate where the puck is going, not where it’s been.” The US could create a digital Dollar for trade on mbridge and join the BRICs countries. The US I-Dollar would only be for international trade settlement and would be backed by our gold held in Fort Knox (?) valued at approximately $1 trillion. Such a monetary policy move would mirror what the BRIC nations (Brazil, Russia, India & China) are doing—building gold vault depositories in each nation to back their trade liabilities while using a digital currency on mbridge to speed settlement. Mbridge, developed with the direct collaboration of the Bank of International Settlements (BIS) and other countries, is fast, secure, auditable, and without excessive operational and currency conversion costs, making it ideal replacement for the BIS’s SWIFT system.

Joining mbridge would not negate the current US plan to offer stable coins as a safe haven for citizens living with unstable currencies (and an outlet for Treasuries), nor would it be the demise of Bitcoin. It would simply remove the risk of holding US currency in trade. Making products here again and selling them abroad without requirements to align with dictates of US foreign policy matches China’s policy although they use a Walmart-like trade policy focused on low prices. It is a mass market strategy mathematically equivalent to assuming that Low Price = Value. Yet Value ≠ Low Price. Developed nations making high end products need a branded strategy to build on the alure of owning the best quality with innovation worth a higher price— aka Apple like.

Transforming the world monetary system takes time to reach consensus. Historically, US think tanks like the Rand Corporation work to devise foreign policy & defense strategies. A recent Rand Corporation report entitled “Stabilizing the US-China Rivalry” reassesses planned preemptive economic and military measures to contain China concluding they may not work. The Rand Corporation’s analysis calls for stabilizing the US-China rivalry through principles like accepting the legitimacy of China’s Communist Party and reestablishing communication with China regarding Taiwan, the South China Sea, and science & technology. Key findings also rethink the maritime sea routes blockade viewing them as an ineffective means of enforcement given the advent of laser satellites and hypersonic missiles, not to forget nuclear weapons capabilities now triangulated among US adversaries. While the Rand report is certainly no guarantee of long-term peace, it does at least give some assurance of time as strategists rethink the consequences of war versus accommodating competition and diversity in political security.

In conclusion, it is clear this administration’s strategy is to prioritize US innovation and generate robust growth to calm concerns about US debt levels. Doing so strengthens the Dollar’s status while curtailing the chance of a Japan-like economic outcome for the US. However, our view is the Trump administration should remember what made America the beacon for the world. It was the values of Liberty, Justice, Freedom and Property Rights for all. We pray the Rand Corporation’s call for competition not containment becomes policy. As US embarks on our 5th Industrial Revolution with AI and Quantum computing there are many known unknowns. What is likely is the geo-political transformation will be to a multi-polar world rather than a US centric one, and that can be mutually inclusive. We are closely watching to assess what potential risks and opportunities arise. For the immediate present we see growth ahead in the markets punctuated with volatility, but do not expect any 2000 or 2008 type of market corrections. Mag-7 valuations so far are supported by earnings, and we see little evidence this will not continue as Agent AI boosts productivity. Yet we are realists and know market cycles are not linear. We expect this one to follow historical patterns where too high prices eventually correct. Meantime the US Treasury’s needs to refinance a great deal of US debt this month and next year. We see patterns in Treasury auctions where they correlate with negative news media likely to assist treasury security purchases and forsee more of the same. Our expectation is for a Santa Clause rally and then roller coaster market that is upward trending through the mid-term elections.

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Because the US Dollar is the world reserve currency, we have been able to borrow at favorable interest rates for eighty years and amassed a $37 Trillion debt which now seems to have reached the crossover point—the juncture where interest is compounding more rapidly than the growth of the economy. In economic terms, our debt is accumulating faster than the growth our GDP (Gross Domestic Product). This is a serious problem that threatens the long-term power & influence of the US.

The Trump Administration’s solution is to “Win” by incenting business growth with tax cuts and lax government regulations, while tariffing trading partners—friends and foes alike. While such targeted, anticompetitive policies undermine relationships and inclinations to work together to solve problems, the Administration’s bet is prioritizing US business growth while forcing interest rates lower will reverse Dollar degradation—a balancing act that must be expertly timed and managed because lower interest rates with rising debt levels are ordinarily inversely correlated. GDP growth must exceed Debt growth which has ranged between 4.4% to 6.9% since 2021 and most recently YTD debt growth is 4.5% according to both the US Treasury and Joint Economic Committee data. Current GDP is estimated at 3.0% (GDPNow.com). The challenge is that debt accrual is continuous while rate of economic growth is subject to business cycles.

Implicit in the Administration’s strategy is the promise of on-going consumer spending—after all that’s the “lure” to pay the tariffs or avoid them by building product here. ‘Build it Here’ creates jobs which supports this policy except the US has higher labor and raw materials costs in addition to regulatory, environmental, and legal (Tort) hurdles which increase Cost of Goods Sold. Though unstated but a likely part of the plan, may be Financial Repression, letting price inflation hover just above fixed income yields to deflate our debt over time.

Before year end, the US must refinance $6.4 trillion of its maturing debt. This issuance will create market turbulence, but absent some Black Swan event, and with interest rate cuts on the way, we expect improved earnings in the other non-Mega-Tech companies that have lagged in performance. Lower interest rates stimulate consumer spending and reduces debt service, which is beneficial. The unknown factors are enough buyers for our increasing debt and what happens to long-term interest rates. Treasury is already at work lowering bank reserve requirements and with the turmoil in Europe 3.0% – 3.5% yields on US 10-Year Treasuries will attract sufficient buyers. If not, we can be sure QE by some other name will get it done.

Looking back to 1971 when the US went off the Gold Standard, Nixon opened China to make US goods ushering in a long-term deflationary epoch. AI may be this same force for decades going forward. And although we seem to be a less civil society at present and partisan politics are exacerbating division, we all must remember money begets power & influence, and the Trump Administration certainly understands they must protect American wealth as it’s the collateral for our debt. Let’s be thankful for that peace of mind.

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The World Economy. Most countries need to borrow over the next few years to finance their governments. The US must refinance $7.8 trillion this year. The anticipated supply of debt is raising long-term bond yields despite the Federal Reserve’s 1.0% interest rate cuts. Yields are rising because a greater supply of bonds lowers prices and raises yields causing anxiousness about inflation.

Higher interest rates increase debt service burden and add to the difficulties in the Banking, Commercial Real Estate, and Housing sectors which the US relies upon for key drivers of growth. Higher interest rates can also trigger a shift in investor sentiment out of stocks and in to cash and bonds.

The US Dollar’s Reserve Currency status is tremendously advantageous for US, but since we have a record-high debt over $36 trillion, a robust economy is crucial to maintain the “full faith and credit” allegiance of bond buyers as Russia & China have undertaken steps using an alternative international trade payment system bypassing the US Dollar.

President Trump appears to be initiating “Beggar-thy-Neighbor” policies that will increase protectionism, shift demand away from imports, and move manufacturing back to the US in order to improve US finances. The risk is that his policies may instead create greater anti-US sentiment. The most consequential of which would be incenting retaliatory initiatives against the US, perhaps aligning countries to use a common CBDC instead of Dollars via the Mbridge alternative to the SWIFT system for international trade and payment.

Geopolitics. Looking at the evolving geopolitical landscape, it is clear the US has been positioning to defend its reserve currency status first by dropping the London Interbank Offering Rate (LIBOR) for loans in favor of its own Secured Overnight Financing Rate (SOFR)—finally completed at the end of June last year. The Bank For International Settlements (BIS), the central bank of central banks, then made Gold a Tier 1 Asset (Dollar substitute) for banking reserves and subsequently worked with China, UAE, and Thailand to test and implement interoperability among multiple CBDCs to facilitate direct cross-border payments between central banks and financial intermediaries across different jurisdictions with new software called mBridge—an alternative to the SWIFT system using CBDCs and blockchain technology. The US then discovered mBridge was the payment system Russia, China, Saudi Arabia, Iran, Brazil, India, and South Africa are using to bypass sanctions & trade amongst themselves.

Since the BIS together with the IMF favor deployment of a Central Bank Digital Currency (CBDC) to control money (see https://www.youtube.com/watch?v=rpNnTuK5JJU) and China, Russia, and Middle East dictator governments want to surveil and control their citizens, this mutual compact worked for all parties including Europe. Our best guess is the EU whose central banks are insolvent, view CBDCs as a next logical step, moving up one more level just as was done at the Bretton Woods Convention after WWII when the Dollar was made the Reserve Currency and the Central banks were created to guarantee each nation’s bank liabilities. With today’s proposed arrangement, the IMF would guarantee insolvent Central bank debts at the world level using the IMF’s CBDC.

Considered together, this series of circumstantial events warrant serious investigation of two important question sets: First: Are US allies and foes alike working together to replace the Dollar with a single Central Bank Digital Currency (CBDC)? Why did the BIS offer Gold as an alternative to the Dollar? Secondly: Did the US Treasury agree and contribute money to this enterprise development? Were US representatives left out of mBridge details that were underway? And were US representatives asleep at the wheel such that a colossal undertaking was discovered only after its implementation?

Regardless of the answers, the collective actions certainly appear contrary to US national interests and freedoms. They also shed new light on Trump’s targeted warnings that: “losing the Dollar’s reserve currency would make the US go to third world country status the way our country is run.”

Our Assessment. President Trump is taking the helm of our government with many serious problems long in the making by both parties. We assess his stated policy initiative as follows:

Energy is a key component necessary to make and transport goods. It is the most important driver of inflation. Lowering energy prices, ending Ukraine & Middle East war spends, reducing regulation, and reallocating wasteful spending will lessen the rate of debt accumulation putting downward pressure on inflation while fueling greater GDP growth. Lower inflation alongside improved economic growth unshackles the Fed to lower interest rates further. These improvements support higher commercial real estate values, alleviate FDIC insolvency, and ease concerns about US debt levels. A robust economy and strong dollar compared to the rest of the world should also slow the de-Dollarization move. Should chaos ensue, the Dollar’s safe-haven status should favor the US Dollar.

However, Trump 2.0 has potential problems as well. For example, putting tariffs on nations and their goods opens the door for lobbying to remove them and therefore increases political corruption. Unleashed corporate free-for-alls lead to needed regulations. Furthermore, if the Trump administration acts as a hegemon using Executive powers to dictate policy usurping other nation’s sovereignty, these actions will foster resentment. Unfortunately, indications already hint at a hegemony bent judging from his press conferences on Greenland, Panama, and Canada. We don’t
disagree in principle with mercantile benefits of Mr. Trump reasonings, but even a benevolent dictator is still a dictator and policies that don’t respect national sovereignty, ignores property rights, and dictates a rule of law they don’t follow themselves is doomed.

President Trump’s plan to use aggressive Tariffs as a bargaining tool against allies and foes is a mercantilist approach arguably justifiable given US debt levels that require corrective action to get our finances on sound footing and maintain our currency’s status. However, the “Greater Good” is
served not by solely employing an ‘US versus THEM’ political-economic approach, but by a strategy also recognizing there are interdependencies among nations. As economist Dr. Mohamed El-Erian of Pimco so candidly states: You cannot outpace the world without at some point having the
consequences of living in a bad neighborhood.” Best policies elevate other countries over time to a higher level rather than exploiting their weaknesses and saves yourself from living in an unhealthy neighborhood.

Investment Focus. We expect chaotic Presidential pronouncements (and tweets) that create shock and awe. This may lead to a roller coaster ride in both stocks and bonds but particularly in the technology sector which means in all major indices. We are not in the Bubble camp, nor do we see a
doomsday correction, stagflation, a hard landing, or hyper-inflation assuming Trump’s economic policies are implemented. We will closely monitor whether the administration dampens the US’s hegemon approach, as we deem it integral to Trump’s promise to end our forever wars and prevent
WW3. We will adhere to our proactive methodology and employ a barbell format should portfolio metrics move into a Contraction phase as indicated by our Market & Business Cycle algorithm. On one side of the barbell we’ll favor old school value providing liquidity, stable value income, and cash/treasuries (Defense) and on the other innovative growth, quality management, and optionality (Offense) while keeping a hyena-like focus on capital protection. Should portfolio risk breach our guardrail thresholds we will take corrective action. This also means we will favor liquidation over taxes. Remember money management is not an exact science, but a probability distribution guided by management tools and sound judgment. Investment success comes by keeping your headspace while not losing too much because the reward-for-risk opportunity is unfavorable.

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There are two wars underway, one in Ukraine and the other in the Middle East, which have the potential of expanding and involving the US to a greater degree. What’s more and not reported on network news is that central banks around the world are anxious about being the target of US sanctions if they do not subject their sovereignty to US demands. Confronted with what they view as a weaponized financial system, they are erring on the side of caution and have begun selling dollars and buying gold to hold as banking reserves. Most countries are also repatriating their gold to hold in domestic vaults just in case it could be confiscated as Russia, Iran, and Venezuela have experienced.

Meanwhile Russia and China long threatened by the US, have led the BRIC countries (Brazil, Russia, India, China, and South Africa) and others (“BRICS Plus”) including Saudi Arabia, (and with collaboration with the Bank of International Settlements), to create an alternative to the SWIFT system to facilitate money transfers in trade. Next week (10/22/24) they reportedly will announce their “UNIT” currency for international trade backed by 40% gold and other commodities. The UNIT blinds the US and Western countries, (the G7: US, UK, Canada, Germany, France, Italy & Japan) from seeing transactions in grains and raw materials transacted away from, or off, US and London futures exchanges. This obscurity creates a lack of price discovery in the world markets, the ramification of which is expected to adversely affect US and European farmers’ fall harvests. As winter is coming fast, this may affect what is available where at what prices.

Amidst these international tensions, we have an election in less than 3 weeks which may result in Administration policies employing expanded transfer payments that lead to a decline in productivity and recession on the one hand or to Administration policies that double-down on the US hegemony resulting in trade disruption while eventualizing a multi-polar world. While it is possible with experienced economic advisors and diplomacy that sound money polices are instead pursued that favor fair trade, peace, and a tax system that encourages people to work only in time will we see results which warrants caution when investing in this environment.

In summary, current monetary policy favors stocks over bonds. Yet there are geo-political events that may trigger a market correction with market valuations at highs. In managing accounts, we routinely assess the Health of the Market and employ a proprietary algorithm to evaluate whether we are in an expansionary, uncertain sideways, or contracting economy. We also consider ‘most likely’ scenarios along with these data and work to build-in flexibility to navigate outcomes. Part of our process employs hedges to offset risk which act somewhat like insurance while diversifying and holding some dry powder (cash or treasuries) on the sidelines to take advantage of opportunities. Utilizing this process and staying vigilant, we work to deliver good returns all the time while avoiding debilitating setbacks. It’s by no means a guaranteed process, but it is a carefully, time-tested discipline with both offense and defense built-in.

This Market Commentary discusses what is occurring in our world and should not be taken as political or persuasive rhetoric, but only as concerns we see on the horizon which warrant consideration when investing. We want to hear your thoughts and concerns and will be calling clients over the next few weeks to discuss and conform how we are managing your money to better sync with your objectives, preferences, and risk tolerance.

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In addition to these uncertainties the election polls now indicate both candidates have a 50/50 chance of winning with neither party getting a sweep of the Presidency and both houses in Congress. Prior to VP Harris becoming the Democratic nominee, Trump was favored to win, and billionaires clamored to fund his winning ticket. Harris by uniting Democrats and selecting Governor Waltz of Minnesota as her VP has now added a margin of additional uncertainty investors must wrestle with until we elect our next President.

The facts are the US economy has been remarkably robust but is now showing signs of slowing with unemployment claims beginning to rise. While Europe, Japan and China are already experiencing significant slowdowns, our Dollar being the Reserve Currency permits us to fund growth though we face challenges ahead. Paramount among these challenges are balancing wages and the cost of living, addressing deficit spending, and blunting the ensuing commercial real estate implosion that threatens the solvency of regional and community banks.

Our expectation is that we’ll see a combination of modest Deflation (lower prices) in housing, commercial real estate, and auto/truck prices with higher unemployment and above-average inflation in 3-4% annual range for a decade or more in healthcare, insurance, and leisure– travel & eating out at restaurants. Our basis for this expectation is that Fed Chairman Powell is on record saying, “the economy works for no one until price stability is reached.” Yet freezing prices at current levels means the economy still doesn’t work for the majority without wage increases as businesses passalong increased expenses in higher prices resulting in an inflationary spiral. Affordability comes with balancing incomes and the cost of living which in turn happens with abundant job opportunites. The strategic reshoring of manufacturing is part of the solution, but we have experienced a significant shortfall in birthrates for decades now necessitating immigration to meet future workforce needs according to Treasury officials. Bill Dudley, a former NY Federal Reserve Bank CEO and permanent FOMC member, recently explained in an interview that twenty years from now the US would not have enough workers to sustain our economy without today’s immigration. What will be crucial in anchoring affordability is well-compensated labor not cheap labor. Moreover, tariffs are protectionist levies paid by the consumer that permit higher prices to be charged by eliminating competition so innovation & invention should once again be our focus not protectionism.

Economies are multi-faceted behemoths with a lot of moving parts. Our view is that there is a global realignment that must see current importers exporting more and vice versa. While the US and China make this transition the markets will be sensitive to trade flows and if the elections results in a divided Congress again, it is likely by the end of 2025 that income taxes will rise an average of 3-4% while inheritance tax exclusions will fall by 50% ($12 million for couples instead of that amount individually). In other words, doing nothing should decrease the deficit, assuming no new additional spending, and both parties can claim they didn’t raise our taxes. Those living in high state & local tax jurisdictions will once again be able to itemize and deduct those expenses saving more.

Unfortunately, continued division in Congress leaves a void of global leadership and provides gestation time for a multi-polar world order to become established. Already plans are underway to strike a new balance of power limiting US hegemony. With new supply chain routes & international payment systems, the two blocs will have to adjust their foreign policies to avoid war. It is these uncertainties considered together that warrant investment caution, and not panic.
In managing accounts, we always evaluate the health of the market by looking at facts. We use an algorithm employing real time data to evaluate whether we are in an expansionary, uncertain sideways, or contracting economy. We also look at ‘most likely’ geopolitical scenarios and valuations along with these data. Then we work to build-in flexibility to navigate what we expect. Part of that formula is employing hedges and having some dry power to take advantage of opportunities when uncertainty falls. In addition to staying vigilant, we strive to deliver good returns all the time while avoiding big setbacks. It’s a careful process working to own the best companies where the reward-for-risk is favorable while also playing Defense to lessen potential drawdowns.

Once again, we thank you for your confidence & trust. Please feel ask more about our strategy and let us know if your personal or family situation warrants considering a change in how you’re investing particularly if you expect or want to take any sizeable withdrawals so we can make suitable adjustments to provide for them.

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But there are headwinds as well. Germany, UK, Japan, and China are now in recession and that may reduce trade. Although the US is not in recession, it’s because our GDP is growing due to energy exports and massive Government deficit spending. The Congressional Budget Office projects deficit spending to rise to $2.6 trillion annually in 10 years—that’s $54.4 trillion national debt should we continue as we are. And inflation is proving tough to tame while an inverted yield curve suggests we still have Recession risk.

According to Dr. Laura Veldkamp of Columbia University Graduate School of Business and a Research fellow at the National Bureau of Economic Research as well as a consultant to the Federal Reserve Bank of New York, the size of US’s debt is not a problem. She reasons that if the US economy is analyzed like a household’s balance sheet for a mortgage loan (on an Income to Debt Service basis) then current US debt is about 1.3 times US income (GDP). With interest on our debt averaging 4.0%, the government needs to pay only 5.2% of GDP to service its debt. US tax receipts are 18% of GDP, this is less than a third of US income. Dr. Veldkamp argues that what’s important is how we allocate our spending. If it’s allocated to investments that will provide a good future return, spending more isn’t a problem.

We don’t entirely agree with her logic but do agree the US can likely add more debt. The fact is the US is not just spending its tax receipts, it is creating money by spending trillions more than the income we produce, and higher interest rates are amplifying our debt service needs. We spend growing amounts on Entitlements and Defense that are not primarily future income investments? Both provide benefits and real security, yet people receiving government assistance and social security but who don’t become productive, and military expenditures to provide for national security are much like insurance premiums. The money spent is for peace of mind and “just in case,” they are not investments expected to increase US future income. (Of course, there is a valid argument that Entitlement spending supports families, education, and upward mobility while Defense spending preserves the US position as the policeman of the world, but that is not her argument. Should we worry then?

Our concern is for a “Black Swan” event like the UK experienced when Liz Truss, their 45-day prime minister, announced more UK stimulus with tax cuts. That resulted in a Bond rout the Bank of England had to intervene in by announcing it would by an unlimited quantities of government bonds to stop the meltdown. Congress now has a bipartisan bill for tax cuts for business permitting R&D expenses to be written-off immediately instead of being amortized over five years and it allows for retroactive tax return amendments going back to 2019. Could such a 2025 bill combined with $35-36 trillion in debt cause the ‘rebellion’ against the US Dollar Jamie Dimon, CEO of JP Morgan Chase is warning about?

We must ask: Does the Fed’s expectation to cut interest rates this year mean they expect a weaker economy? If so, will a rate cut in a slowing economy boost stock prices? And does the Fed believe they have overshot interest rate hikes so that Treasury can finance even more debt at under .0% interest rates?

Interest rate cuts are already priced into the market, but lower interest rates would ease pressure on commercial office loans helping banks while also providing needed help to consumers. Looking at the Fed’s Financial Conditions Index we think the Fed eyed it in December signaling a too tight policy prompting Chairman Powell to suggest a 75-basis point cut may be appropriate. Since then, the FCI-G index has dipped slightly on higher inflation, strong jobs, and higher mortgage rates. (Note the light and royal blue boxes representing Mortgages and the Dollar and the red boxes for BBB+ credit.) It’s not “politically correct” to question whether there are sufficient buyers of Treasuries, but the Treasury auctioning mostly short-term T-Bills, and not 10-30 Treasury Bonds, suggests lackluster demand for longer term bonds at current market rates. We believe it’s because investment managers look at inflation-adjusted, after-tax return yields. Current sub four percent yields aren’t attractive.

Unless the economy goes into Recession, we expect the Fed will make liquidity plentiful this year and ultimately let inflation run “Hot” for years to payback our debt in cheaper dollars. We also believe there is a small probability the US will have 10 more years to pile on debt. If we compare AI’s potential contribution to US growth, AI is at a very early adoption stage and this boom could extend several more years until prices become ridiculous. Indeed, Nvidia’s earnings justify a higher price.

To navigate potential risks, our process routinely evaluates the health of the market by looking at facts. We use an algorithm employing real-time data to evaluate whether we are in an expansionary, uncertain sideways, or contracting economy. We look at ‘most likely’ scenarios as well as euphoria in prices and sectors along with these readings. Then we work to build-in flexibility to navigate what we expect. Part of that equation is having some dry power to take advantage of opportunities when uncertainty rises. Our objective is always to be vigilant of events that may cause loss and to be proactive in navigating through them. Our goal is to deliver good returns all the time while avoiding big setbacks that wreck compounding. It’s a careful process striving to own the best growing companies where the reward-for-risk is compelling while also playing Defense with hedges to lessen volatility when prices rise and when the economy starts contracting. That said, there are of course no guarantees of return or profits.

In summary, today there are geo-political risks, Inflation, and Recession risks. The dollar is strong, jobs are plentiful, Q4 earnings indicate prices could rise 10%, and government debt levels are not excessive. With these positives outweighing the negatives, our take-away is that an outlier event in the Bond or Credit Market is the greatest short-term risk so we are closely monitoring Bonds and market liquidity.

We thank you for your trust and confidence. If you have questions or want to discuss reducing your account(s) risks please get in touch.

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The Fed’s Monetary policy and the Congress’ seemingly outlandish stimulus spending is confusing, perhaps maddening, but was/is likely required to get beyond the Great Financial Crisis & the COVID Dunkirk and to normalize the economy while maintaining US eminence. No doubt there have been excesses and their will yet be more fallout particularly for non-profitable companies and commercial real estate investors, but all in all positive initiatives underway provide optimism for robust employment, improved consumer sentiment, and plentiful jobs that are less administrative and more fulfilling. Though we remain cautiously optimistic by the many good tidings, we’ll still be prudent and dance near the exit door watchful of unfolding events while appreciating our Blessings as Americans. Reflecting upon those great Blessings, we genuinely thank you for your trust and confidence. Enjoy a wonderful Christmas and New Year filled with happiness!

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