John Gorlow
| Jun 14, 2024
As November elections draw near, the threat of election interference from Russia and China looms large. Both countries aim to undermine the stability of American democracy by creating confusion among U.S. voters and pushing them toward extreme viewpoints. Such interference could unsettle markets and have far-reaching consequences for high-stakes issues including U.S. fiscal policy, immigration, and foreign policy.
Consider the polarizing issue of immigration. Investors typically see this as a political issue, but it also has important economic implications. Just this month, the Kansas City Fed reported that immigration expands the economy by increasing consumption and alleviating staffing shortages. And according to some studies, immigration may have kept the lid on wage demands and reduced core inflation by up to half a percentage point during post-pandemic recovery.
Tension is heightened by the dramatically different decisions Biden or Trump could make on everything from taxes and spending, to who will lead the Federal Reserve, and even how the Central Bank is run. The next president will also steer the U.S. through a time of heightened global tensions, with escalating conflicts involving autocrats and authoritarian governments in the Middle East, Russia, and China.
Meanwhile, many believe that one issue isn’t receiving the urgent attention it deserves. Near Times Square, a massive electronic billboard displays continuous updates on America's mounting debt, which has exceeded $35 trillion, or about 100% of GDP. It’s a doom-scroll in real time, a reflection of growing unease on Wall Street and elsewhere. We’re seeing an uptick in warnings from the financial sector, that if left unchecked, America’s debt poses a grave risk to the stability of the U.S. bond market, the foundation of the global financial system.
So when does debt become a problem? Professor John Cochrane, senior fellow at the Hoover Institute at Stanford, has been warning about the national debt for a long time. He allows that “People like me … have carrying on that the world is ending for about 20 years now. It hasn't happened yet. But, you know, I live in California, and earthquakes don't happen that often. That means you shouldn't worry about money? We have a big debt. It's about 100% of GDP. That's five years of government revenue. So if your debt were five years of your income, and you were operating at a deficit, you would be pretty worried, wouldn't you?
Speaking at a recent roundtable, Ben Harris, vice president and director of economic studies at the Brookings Institution, said “There's a decent chance that in my lifetime this [debt] will not become a huge issue. There's also a decent chance that the next 2 or 3 years, it will blow up our whole economy.”
Both commentators point to something once unthinkable. What if worldwide purchasers of American debt (US bonds) were to declare “enough is enough,” resulting in a buyer’s revolt? Harris points to signs that we’re already seeing: credit rating downgrades, escalating interest rates, and other indicators that buyers of the debt are already starting to show some resistance. He points out how the spiral could continue. “At some point investors will say, look we're worried about this. This is a problem. And then that becomes a problem for everyone else. Because interest rates rise, and it becomes more expensive to buy a house. It becomes more expensive to make the payments on your credit card. It becomes more expensive to borrow if you want to start a small business. And then you can see all these other challenges with financial stability. And anyone who was alive in 2008 knows how problematic that is.”
This is why Gita Gopinath, the IMF’s second in command, is urging Washington and other advanced economies to address how they plan to rein in spending, raise taxes, and reduce their debt back down to pre-pandemic levels. Gopinath warned that even though adoption of generative AI could raise productivity and boost growth, it also “could amplify the next economic downturn.” IMF research has found that the technology could endanger 30% of jobs in advanced economies in the next recession.
Another angle on the debt problem is the one we're living through right now, says Douglas Holtz- Eakin, President American Action Forum, Former Director Congressional Budget Office. “In the 20th century, from 1960 to 2000 the U.S. economy grew fast enough that the standard of living doubled roughly every 29 years. Since then, in the 21st century, the standard of living doubles at a pace of roughly every 56 years. And so access to the American Dream has gone from one working career to falling over the horizon. And people feel that there's a palpable sense of not having the same opportunities that we had before. I believe a lot of that is the headwinds provided by debt. To grow, you have to save and invest as a nation, and the debt subtracts from that saving and investment.”
“And so we do have to find a way to address this. I don't know anyone who thinks the solution is just raising taxes. I don't know anyone who thinks the solution is just cutting spending. I think that both are going to have to play a role in getting us back to something that's a more sustainable fiscal future. And the more important question then is, how much we will raise them [while] maintaining incentives for people to take risks? How effectively can we raise them without interfering with the economy? And how can we have a social safety net that meets the needs of our seniors and our less affluent Americans, and still is manageable and sustainable? And I think that's the challenge.”
How to Fortify Your Own Financial Future
John Cochrane, speaking with DFA, offer common-sense thinking about market timing that reflects our own advice to investors at Cardiff Park Advisors: don’t try to time the markets. “Even though we know that there is a strong correlation between recessions and stock returns, long-term investors shouldn’t really be worrying about market timing. Do I get out before the recession? Do I get in after recession?” Cochrane asks. “Recessions are extremely hard to predict. For the same reason, stocks are very hard to predict. And part of risk is, is a situation that nobody really knows what the heck's going on. So we are in the longest period of a widely forecast recession that never happened. And of course, stock markets fall into a recession and rise out of them, but timing them and knowing when to sell or having the courage to buy when everyone else is selling is the challenge. You must jump back in just when everybody is completely scared and thinks the world is about to end and hope that they're not right about that. And this is why I don't believe in market timing.”
At Cardiff Park, we believe that planning for short-term expenditures while embracing a long-term vision is the best way to navigate market volatility. Investors can manage risk astutely by investing in short-term, stable, low-risk vehicles that fortify their ability to withstand sudden market volatility by having the assets they need on hand.
At the same time, a long-term perspective should be like a beacon, or guide, to building wealth over the long-term. Cultivating a long-term vision takes work and requires trust in the unpredictable resilience of the markets. But armed with a solid strategy, built to one’s own timeline and needs, investors can benefit from reduced fear and anxiety in the present. By removing the temptation to play the market for better or worse (how much did I make/lose this month, this year, the past few years), a long-term vision prevents costly mistakes and knee-jerk reactions.
In this and every fraught election season, my advice is similar: hedge short-duration planned expenditures with stable investments, embrace a long-term perspective, and stick to passive and index investing.
Meanwhile, try to remain level-headed and thoughtful about America’s future, including the difficult issues of spending, taxation, rising debt and more. Your vote matters in November. Let it be influenced by thoughtful discourse rather than by outside actors. We’ll all be better for it.
May Market Report
Courtesy of Avantis Investors
U.S. and global stocks rallied back in May after slumping in April. Bond returns also rebounded, as April inflation data largely matched market expectations and Treasury yields retreated.
Amid technology-sector strength and easing Treasury yields, the S&P 500 Index gained nearly 5% in May. The May rally lifted the index’s year-to-date return to 11.3%.
All S&P 500 sectors advanced in May except energy, which declined fractionally. The information technology and utilities sectors were top performers, gaining 10% and 8%, respectively.
Non-U.S. developed markets stocks also bounced back but not as strongly as U.S. stocks. Emerging markets stocks returned less than 1% and lagged developed markets stocks.
Annual U.S. headline CPI slowed slightly to 3.4% in April, while core inflation eased to 3.6%. After nine consecutive months of declines, eurozone core inflation rose in May to 2.9%, while U.K. core inflation slowed in April.
With inflation easing, the futures market revisited its late-year rate-cut expectations. Meanwhile, the European Central Bank signaled it may cut rates at its June meeting.
All size and style indices posted monthly gains. Small-cap stocks outpaced their larger peers in U.S. and non-U.S. developed markets. Comparisons between growth and value were mixed.
U.S. Treasury yields declined in May, and the broad bond market advanced.
Equity Returns
U.S Markets
U.S. stocks rebounded in May, and most indices delivered solid year-to-date gains. U.S. stocks outperformed their non-U.S. peers.
Small-cap stocks returned 5% in May and modestly outperformed large-cap stocks. Year to date, large caps returned nearly 11%, outpacing small-cap stocks, which were up nearly 3%.
Growth stocks outperformed value stocks among large- and small-cap indices for the month and year to date. Large-cap growth stocks were top performers for both periods.
Non-U.S. Developed Markets
International developed market stocks advanced but underperformed U.S. stocks in May and for the year-to-date period.
Small-cap stocks outperformed large caps in May. Year to date, large caps gained more than 7%, compared with 4% for the small-cap index.
In May, value stocks outperformed growth stocks among large caps and lagged among small caps. Year to date, value outperformed in both size categories.
Emerging Markets
The broad emerging markets stock index advanced slightly for the month and gained 3.4% year-to-date.
Small-cap stocks modestly outperformed large caps in May, but they underperformed large-cap stocks for the year-to-date period.
Value stocks outperformed growth stocks in May. Year to date, growth stocks outperformed in the large-cap arena. Among small caps, value outperformed with a year-to-date gain of nearly 5%.
Fixed-Income Returns
U.S. Treasury yields declined in May, and U.S. bonds delivered a monthly gain. Inflation persisted but monthly data were in line with market expectations.
The Bloomberg U.S. Aggregate Bond Index returned 1.70% in May, as all index sectors advanced, led by MBS. Despite the month’s solid gain, the index declined 1.64% year to date.
Treasury yields retreated for the month, with the 10-year note dropping 19 bps to 4.50%. The two-year Treasury yield fell 17 bps to 4.88%, and the yield curve remained inverted.
Investment-grade credit spreads tightened slightly, and corporate bonds outperformed Treasuries. High-yield corporates advanced but lagged investment-grade corporates.
The annual headline inflation rate slowed to 3.4% in April, from 3.5% in March. Core CPI eased to 3.6%, compared with 3.8% in March. Core PCE, the Fed’s preferred inflation gauge, remained unchanged in April at 2.8%.
Amid easing inflation, the futures market recalibrated its Fed rate cut expectations. At the end of May, the futures market factored in up to two cuts by year-end.
Municipal bond yields rose in May and returns declined modestly for the month, underperforming Treasuries.
Inflation expectations increased in May, and TIPS outperformed nominal Treasuries.
Do you have questions about your portfolio? If so, please contact us. We are here to help.
Regards,
John Gorlow
President
Cardiff Park Advisors
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