story, or will they play catch up in the near future? I think it may be a little of both. They may be telling a different story of the pain of high rates and a slowing consumer but many of these lagging areas have a history of outperforming after the first rate cut. So, we may likely see a broadening of the market and a greater participation in the gains after the first rate cut only to have things settle back down if those economic cracks lead to more. 

Speaking of rate cuts, we can’t dismiss the Federal Reserve and their interest rate policies. I’ve been comfortable with the Fed holding tight up until about a month ago. The Fed has a history of always waiting too late to take their foot off the brake. I understand they’ve been extremely fearful of a resurgence of inflation, but the economic cracks are very concerning. I think the Fed needs to start cutting now. It may already be too late, but I think if the Fed refuses to cut by September in response to the weakening economic data, a recession in 2025 becomes much more probable. Even still, a recession is better than hyper-inflation. If inflation stays stubborn and the Fed errs toward inflationary concerns, I wouldn’t fault them. We can easily get through a recession.  

Finally, there’s the valuation of the market. The market is expensive, PERIOD. The only way for it to become less expensive is for earnings to expand substantially and soon or for the market to fall. Companies may be able to pull off increasing earnings by focusing on their margins as they did in the most recent quarter. The concern we have is that the top line growth has been weak in a lot of areas. Companies have had higher earnings with less revenue. That type of margin expansion to meet numbers can only last for so long. Eventually, all the financial engineering and expense cutting has been done and you simply need more sales and revenue to grow profits. Profits MUST grow to support the current valuation of the stock market. It’s expensive and earnings need to rapidly expand, or the market needs to take a step back. 

I know we didn’t discuss the National Debt whose interest expense is about to overtake defense spending to become our third largest expense. If rates don’t fall soon, it’s on track to become our largest expense in the very near future. Although a problem, we don’t believe we’re at the cliff’s edge yet and will talk more about this in future newsletters. 

The charts of presidential election years suggest a robust August, weak September, dismal October followed by a strong post election rebound regardless of outcome. We expect similar market movements to the past with some extra volatility given the uncertain nature of this particular election. 

Near-term concerns aside, I believe the market can give us another 10% to 15% gain between now and the first quarter of 2025. We may have a 5% to 10% drop between now and then but we do think the market will reach higher levels.

Even with that expectation, we want to be somewhat cautious. Unlike most of our peers, we have not dismissed the possibility of a recession in 2025 or 2026. As such, we will continue to take a very disciplined and measured approach moving forward by utilizing higher levels of bonds in our models. Bonds are paying great rates of interest that we haven’t seen in 16 years and with the Fed’s next moves likely being cuts than hikes, bonds can do even better if rates are falling. When the stock market gets choppy and it surely will at some point, bonds will be the old workboat that we can follow through one of the most dangerous inlets in the world…