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1/12/2025
It’s a new year and there is a lot on David’s mind – the Fed, Trump inauguration, Earnings season, House prices and the tragedy in California.
David Bianco
Chief Investment Officer, Americas
Happy New Year to everyone. As we return from the holidays, I have a lot on my mind. Hopefully, it helps us navigate the year.
The Fed
Let’s start with the Fed, and the macro picture in the U.S. It seems to me that the U.S. economy is in solid shape. The labor market is fine and inflation is slowing, albeit still too high, yet the deficit remains a serious concern. What mostly worries me is the potential for the long-term bond market to lose confidence in the Fed’s ability to return inflation to 2.0% in a timely manner (it’s already been too long), while simultaneously becoming alarmed about pro growth, albeit at the risk of higher inflation policies from the Trump administration. I fear the Fed’s credibility is on the line with long-term bond investors right now and especially that of Chairman Powell. Let me explain. I said at the time that I thought the 50 basis points (bps) cut in September before the election was risky, and the two subsequent 25bps cuts seemed especially unwise upon the election results. Now, with longer term yields rising, it seems as if the bond market is saying no to more cuts, at least absent a shock. So, I think the cutting is likely done for now. I’d go even further and say that, if the Fed were to cut again, ahead of the clarity that expedited fiscal legislation should bring in perhaps March or April, then that would smack of policy negligence. I understand that it’s very hard to predict the future, but I think the Fed must hold steady until we have clarity on the fiscal front.
As we went into the end of last year, I had been expecting the usual Santa rally, but the Fed’s somewhat clumsy pivot ended up putting some coal in our stockings. They changed their inflation forecast to 2.5% through 2026, and their highly uncertain outlook for future Fed Funds rates fueled a rise in the ten-year yield to above 4.5%, and those two combined to put the lower end of my S&P 500 forecast, to 5,700, back in the spotlight. And, now many investors are asking us what’s to stop a 5% handle on 10-year Treasury yields? Yields above that level would send a warning shot to Washington and perhaps that’s what’s needed at this crucial moment – if there is a veto on any fiscal package, it’s one the bond market wields!
Trump inauguration
The Fed aside, I think next week’s inauguration has the potential to move markets. I wonder if we’re going to see a big announcement, perhaps to firm up previously mentioned features of campaign proposed tax policy, like a lower corporate tax rate, or no tax on tips? Or perhaps a key announcement on space exploration or expanded defense or energy related initiatives, essentially some kind of “moonshot” commitment? After all, there’s a very big difference between campaign sound bites and an inauguration speech. Anything concrete we hear about moving forward on tax cuts, new tariffs or deportations has the potential to pose market risk, especially to the bond market.
Earnings season
Once we’re through Trump day one, I expect attention to turn to the earnings season and earnings better be good. I have been calling for around $245 of S&P 500 earnings per share for 2024, and I’ll need to see near $65 in the fourth quarter to get there. Manufacturing has been weak in the U.S. for 2-3 years, and there’s just a suggestion of softening consumer spending. I need to see double-digit earnings growth in the fourth quarter if I’m to remain confident about our S&P targets this year with these Treasury bond yields. Some big tech names are still very bullish in their outlook, and I think right to be, but recall the speed with which some multi trillion-dollar market caps have been reached and the subsequent concentration in the S&P 500. It’s all been so fast, so it does concern me.
Regional banks
What else is on my mind? Well, I get asked about regional banks and the potential for more problems there. I think most smaller regional banks are overextended in terms of valuation, and the spike in ten-year yields doesn’t help them, but I don’t think there’s much risk of another rash of bank runs. It was more the speed of the rates move that was problematic last time and not the absolute level. Now having said that, many smaller regional bank stocks seem to have fully priced in a Trump corporate tax cut. So if that doesn’t transpire, or if we see, say, just a modest decrease and targeted manufacturing tax credits instead, then there could be some small dislocations, but I don’t see a systemic threat. I prefer big banks where there’s more fee income.
House prices and the tragedy in California
Two final thoughts – house prices, and the tragedy in California.
On the former, I think there is a misalignment between high mortgage rates, and still buoyant home prices. Something has to give, I hope it does so slowly, but we don’t need higher mortgage rates, or we risk something breaking in that critical market. And don’t forget that the costs to homeowners remain sky high, with maintenance, property taxes and insurance continuing to rise much more than 2%. Shelter is a key component of inflation, along with healthcare costs, and I see these challenging the 2% inflation target. That’s a real challenge to a Fed trying to juggle still sticky inflation with a need to contain mortgage rates.
And of course, the insurance component brings me, finally, to California, which is a natural disaster, and praise the first responders, but I am afraid also a failure of political leadership. It’s a state where taxes are too high, it’s losing its attraction to the tech and entertainment sectors as their primary home, and we are seeing real impatience with the way the state and localities are run. I think business leaders are fed up. I wouldn’t be at all surprised to see a red swell in California mindsets and politics. Not to diminish the scale of the human tragedy, the state’s economy might actually benefit in the intermediate term from insurance payouts, rebuilding, and hotel occupancy, but there are going to be long-run ramifications for Californian politics and leadership or just more folks leaving California.
– David
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