2024 Q4 Market Commentary

President Trump's return to the White House will bring both familiar considerations and new challenges. His views on trade, regulation, and geopolitics are well-established, but the economic landscape has shifted significantly since his first administration.

The nature of inflation, interest rates, and the scale of debts and deficits have all undergone substantial changes. The economic conditions of January 2016 are a distant memory. At that time, there was weak demand and little infrastructure investment, inflation stood at 1.2%, 10-year Treasury yields around 2.25%, and the annual deficit was a manageable $440 billion, allowing room for pro-growth policies.

Today's economic environment presents a stark contrast, with new innovations driving high demand, expensive infrastructure investments, higher inflation, and larger deficits. This creates a more complex backdrop for implementing additional pro-growth strategies focused on deregulation, tax cuts, and America-first trade negotiations.

This shift presents both opportunities and challenges for the incoming administration's economic policies. All of which is well known and priced in by market participants. Investors across the globe have poured trillions of dollars into the US economy with more commitments coming every day. This has led to remarkable returns for the US stock market, led by the “Magnificent 7” juggernauts – Apple, Amazon, Alphabet, Meta, Nvidia, Tesla, and Microsoft – up 76% and 48% respectively for 2023 and 2024. Their combined total market cap is approaching the GDP of China, the world’s second largest economy! Apple alone is now larger than the GDP of France.

By most historic measures, valuations are stretched and priced for perfection. How this new era of innovation unfolds is still to be seen. Will 2025 see a peak on AI expectations or continue its recent run? Will quantum computing or other new innovations propel technology higher? What is clear is that several sectors of the economy will be impacted by tariffs, especially in the early days, and healthcare is worried about Kennedy’s influence over possible changes to the sector.

Reshaping Global Supply Chains

The trade wars initiated in 2018 have had a profound impact on global supply chains, with U.S. companies demonstrating remarkable agility in transforming their operations. Initially, there was skepticism about the ability and willingness of U.S. businesses to adapt. However, the geopolitical tensions that sparked the trade war, combined with the challenges posed by the COVID-19 pandemic, have accelerated the pace of supply chain transformation. The pandemic exposed vulnerabilities in global supply networks as companies struggled to meet surging consumer demand. China's extended lockdowns, which persisted longer than those in other developed nations, forced businesses to confront the limitations of their supply chain control. This realization, coupled with fiscal incentives, has prompted companies to diversify their supply chains, often favoring allied nations.

The ongoing reconfiguration of global production networks affects not only U.S. and Chinese businesses but also companies in other countries. This shift underscores the complex interplay between trade policies, geopolitical dynamics, and corporate strategies in shaping the future of global supply chains. At its peak, China was by far the largest trading partner, producing nearly 22% of the total goods imported into the country. Six years later, China has fallen behind Mexico and the Euro Zone.

The Tug of War Between Monetary and Fiscal Policy:

A significant dynamic currently unfolding in the economic landscape is the divergence between monetary and fiscal policy approaches. This tension creates a complex environment for economic management and growth.

On the monetary side, the Federal Reserve and other central banks are actively working to curb inflation through restrictive monetary policies like raising interest rates, reducing the money supply, and implementing quantitative tightening. The primary goal has been to bring interest rates back down to lower levels once inflation was back to target levels and before the economy slowed down too much.

Simultaneously, fiscal policymakers are pursuing expansionary measures. Key aspects of this approach include implementing subsidy programs and incentives for specific industries for clean energy, data centers, and microchip production. These initiatives aim to stimulate economic growth, promote specific policy objectives, and potentially outpace the mounting national debt through increased economic activity.

This divergence between monetary tightening and fiscal expansion creates a unique economic environment. It raises questions about:

• The overall effectiveness of each policy approach relative to cost.

• The long-term implications for economic stability and real growth.

Policymakers and economists are closely monitoring this situation, as it represents a departure from traditional economic management approaches and could have significant implications for future economic outcomes.

The Growing Debt Burden

The fiscal policy landscape in the United States presents significant challenges, with both major political parties inclined towards continued spending. This approach is contributing to a growing debt burden that may become the most pressing long-term issue for markets. The compounding nature of this debt has the potential to significantly impact the economy's growth trajectory. Ac-cording to recent Congressional Budget Office (CBO) projections, the national debt is expected to reach $50.7 trillion by 2034, rep-resenting 122% of GDP.

Addressing this fiscal challenge presents difficult policy choices. Attempting to raise revenues through increased taxation could potentially burden the middle class, while significant spending cuts might risk economic growth. The unique circumstances that allowed the U.S. to recover from high debt levels after World War II, such as pegged interest rates and a growth-inducing baby boom, are unlikely to recur in the current economic and demographic context. This fiscal situation underscores the need for careful consideration of long-term economic sustainability in policy decisions, balancing the need for investment in critical areas with the imperative of managing the national debt.

It’s a precarious task, but there is hope…

A country's debt burden is primarily assessed by its size relative to GDP and the strength of its institutions, which assure investors of repayment credibility. Therefore, strengthening the foundation of our institutions and growing the denominator in the Debt/GDP ratio may be the government's most effective strategy to avoid a potentially unsustainable debt spiral left for future generations. To illustrate this point, if nominal GDP and the cost of debt both run at 4% for the coming decade, the Debt/GDP ratio would increase from 1.0x to 1.3x. However, if nominal GDP grows at 5% and the cost of debt averages 3%, the Debt/GDP ratio would reach a more manageable 1.1x, signaling credibility to investors of our ability to manage our nation’s debt levels.

Summary

The U.S. economy has demonstrated remarkable resilience and leadership on the global stage. Key areas of strength include innovation, urban development, productivity growth, and capital investment.

These factors contribute to significant structural tailwinds that are expected to persist in the coming years. However, this positive outlook is not without risks.

Market Considerations

• Current valuations: With the hype of AI, public equity valuations are extended compared to historical norms with S&P 500 forward price-to-earnings ratios at 129% of their 30-year historical average. Will AI follow Gartner’s Hype Cycle, or will earnings meet expectations?

• Risk factors: High prices combined with upcoming tariff and sanction uncertainties create a wide range of potential outcomes, likely leading to periods of volatility in 2025.

Investment Considerations

Given the current economic landscape, investors should consider the following approaches:

• Asset Allocation Rebalancing: After years of equity outperformance and fixed income underperformance, we are evaluating overall exposure to each category as a crucial discipline for managing risk over time.

• Maintain a long-term Mindset: Maintain a long-term perspective amid potential market fluctuations and uncertainty around changing governmental policies. Focus on the next 3-5 years of life more than the next 3-5 months.

• Time Horizon: Investors can construct positive real yield bond ladders to meet cash flow needs and avoid seeking aggressive total return strategies when valuations are extended. Forward-looking real bond rates are more attractive than they have been in the past three years to secure short-term cash needs.

Comments on Wealth Management

As always, these comments are not meant to encourage market timing, which is a waste of time and costly to long-term performance. Instead, it’s about being aware of your unique needs and circumstances to achieve your long-term goals. As we often com-ment, money is not a goal; it is a resource. Successful wealth management is a lifelong endeavor of accumulation, use, and trans-fer. Investing (resources) should always occur in the context of the lives of owners and heirs.

Sound financial advice is about prudence, sound decision-making, identification of biases or emotional triggers, designing of goals, and the creation of a framework to achieve both quantitative and qualitative objectives. It is not about avoiding market losses but reducing and avoiding cognitive mistakes. The last two years again prove that the long-term application of a well-defined strategy will win out over trying to time the markets or avoid losses in a single year. All the best to you in 2025. We look forward to working together this year.

*The foregoing content reflects the opinions of Van Hulzen Asset Management DBA "Van Hulzen Financial Advisors" and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.