Pure’s Executive Vice President & Chief Investment Officer, Brian Perry, CFP®, CFA® charter, AIF®, provides insight into the financial markets for the upcoming 2025 year.
Outline
- 00:00 Intro
- 00:14 Major stories in 2024
- 3:10 US economic growth
- 5:37 Inflation
- 8:30 Yield a strong predictor of future returns
- 11:55 Crypto
- 13:11 Gold
- 14:03 Q&A
- Since the markets are up significantly, but there are signs of recession, would it be prudent to move money out of stocks and into more secure investments?
- Related to the bonds slides, can you explain the details of this slide?
- 19:00 Stocks
- 20:40 Top 10 stocks in S&P500
- 24:34 International stocks
- 26:19 The Road Ahead
- 27:00 Trading with China
- 28:30 Q&A
- In the return of what asset class is the determined by the bond chart?
- China trade has been declining already, how about the other areas, like Taiwan?
- How will the immigration policy impact inflation?
- Sounds like the S&P500 is overpriced, should the investors in the S&P 500 reduce exposure?
- 34:07 Higher Taxes Needed to Balance Budget
- 37:10 Small caps
- 45:06 Q&A
- What makes a company a value vs growth company?
- How does someone get diversified in all of those categories? Is there a mutual fund group or ETF we should be looking at?
- Does someone have to have a financial advisor to do all this or can I just go to my bank and help me there?
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Transcription:
Kathryn: Welcome to this webinar we have for 2025 Market Outlook webinar with Brian Perry, our Executive Vice President and Chief Investment Officer at Pure Financial Advisors.
Brian: Let’s dive on in and talk a little bit both about what’s happened in the past year, but also what’s to come. Federal Reserve, right? This year, one of the major stories that we saw in 2024 was, after several years of very high interest rates, the Federal Reserve began lowering interest rates. And that was really key. Really added fuel to the market and for a lot of the year, the performance of risk markets, whether that’s stocks, bonds, real estate, etc., almost moved in lockstep for expectations of what the Federal Reserve was going to do. Were they going to ease? Were they going to not ease? Were they going to ease more than expected or less than expected? And that will continue to be a dominant theme in the year ahead for sure.
Another thing, stock markets. Stock markets have had a phenomenal year. And we’ll talk more about that, but stock markets have gone more or less straight up this year, really good year for almost all markets. Continued unrest in the Middle East and Ukraine. So all of this is happening against a backdrop of volatility in the geopolitical world, and serves as a useful reminder that the lights are never all green. So if any of you out there are waiting until everything looks peaceful, calm, and smooth seas ahead to invest, you’re probably going to be waiting a long time. You’re probably going to miss out on some gains in the interim. We’ll talk more about the Middle East and Russia, Ukraine as well a bit later on.
We got a conclusive election, and so that was a big topic coming into the year was what’s going to happen with the election. Obviously everybody had opinions, yay or nay for this candidate or that candidate. A lot of people also worried that maybe at the end of things, we wouldn’t know who the President was or who controlled Congress for an extended period of time, or perhaps there’d be some sort of unrest, following the election. And the result, the actuality is that we had a relatively smooth election, somewhat surprising, a Republican sweep of all, of both branches of Congress, as well as the White House. So we will have a unified government for the next couple of years, but a relatively smooth election process.
And then a Goldilocks economy. And so let’s talk a little bit more about that. And as you know, Goldilocks, right? There’s the porridge. It’s either too hot, too cold, or just right. And this is a term that, from my recollection, goes back to the 90s. I remember talking about the Goldilocks economy, where you want the economy to grow, economic growth, to post strong numbers, lots of jobs available, lots of GDP growth, lots of earnings expansion, but you don’t want it to be too hot because if it gets too hot, you see what we saw a couple of years ago of very high levels of inflation. Then the Federal Reserve has to come and tighten monetary policy. So the Goldilocks economy, of course, refers to strong economic growth, but not so strong that it prompts inflation. So what about that economic growth? And what we’ve seen this year is some solid economic growth. On the left-hand side here, the blue dotted line is potential or trend growth of 2.1%. That’s the average that we’ve seen going back to the start of the millennium. And then you see the gray, the actual growth. And you can see a couple of different segments there. In the early 2000s, we were ahead of trend where the economy was growing faster than it than the trend and then the impact of the great financial crisis and the ensuing recession you can see we dropped below trend growth and stayed below for the better part of a decade. And what that reflects really is that for the entire decade of the 2000s was really- or excuse me the 2010s- was really playing catch up in order to get back to where the economy would have been if we hadn’t gone through that financial crisis and ensuing recession. And then of course COVID comes along and you see the super sharp drop, sharpest we’ve seen in history. But a very, very temporary drop followed quickly by an economic recovery as the world opened back up. And we’re now more or less right on trend to perhaps just slightly above trend on economic growth. But again, getting back to the idea that the economy has been chugging along and a lot of folks, including, and I hate to admit this myself, back in 2023, I thought as the Fed moved towards tightening interest rates, stamp out inflation, we would see a recession. We’ve not seen it yet. Consensus economic forecast for the coming year is for a soft landing. So in other words, maybe somewhat moderating economic, expansion, but without tipping into a recession. That’s the base case for a lot of people. Of course, the reality is, you seldom get the base case. You either get something better than that or worse than that. So we’ll see what happens. One other item I want to highlight here is the composition of GDP, or what makes up the economy, with the key number here, or the key color being this light blue. 68% of the economy is driven by the consumer, and that’s why there’s always such a focus on things like how is the job market? What is consumer sentiment like? And frankly, what is inflation? Because inflation hinders people’s ability to go out and spend money. So for all of you, right, we just went through Black Friday. We had Cyber Monday or Cyber Saturday or whatever that is, Small Business Wednesday, all these different days. I’m probably butchering them. But the idea is it’s the holidays. So people, if you’re out there, go spend your money. Go to the store. Your shopping is the key to the economy. It’s the corporate profit. So spend, spend, spend. But don’t spend beyond what your financial advisor says you can spend, because that’s the road to disaster. CPI, inflation, consumer price index. This has been the dominant theme here since COVID was the rapid increase in inflation. Federal Reserve got behind the curve eventually tightened monetary policy quite a bit, raised interest rates from effectively 0% to 5.25% in order to stamp out inflation, and they’ve been successful. And not only have they been successful, as you can see here on the right-hand side with inflation coming down, they did it again without causing an economic recession. So inflation is very close to the Fed’s target slightly below the long term trend of roughly 33.5%. The Fed targets 2% inflation, so we’re still marginally ahead of that, but not so much that it’s a concern. Our anticipation is that the Fed will continue to tighten, or excuse me, to loosen monetary policy a little bit, ease those interest rates, which is bad news for savers, where you might see your CD or money market rates come down a little bit, but should continue to support the economy. The pace of those changes, the pace of those declines will be very important in 2025, though. How much does the Fed cut interest rates? As an aside, while a lot of people get excited, hey, I hope the Fed cuts interest rates a lot. If you look at the correlation between stock market returns and Fed interest rate cuts, modest interest rate cuts historically have coincided with better stock market performance than aggressive interest rate cuts. And that makes sense because usually if the Fed is cutting interest rates aggressively, it’s either because something bad is happening or because they were too slow to act, neither of which is good for stocks. Whereas modest or moderate economic or interest rate cuts tend to lead to strong economic performance. So we’ll see what we get on that front. Let’s talk about FIC, Fixed Income Currencies and Commodities, and take a look at what’s been going on there. You know, the bond market hasn’t done great over the last several years, but I think that tune could be changing. We saw pretty significant performance, or good performance, the first half of this year, and then as we got into the second half of Summer, we did see another increase in interest rates, not back to highs, but higher than they were back in the first half of the year, around, excitement about how quickly the economy was growing, maybe a little bit of a hesitancy to declare victory over inflation. And then as it became clear that Donald Trump might win the election and as he eventually won it, people said, hey, he’s going to be expansionary, his administration is going to tend to print money, stimulate the economy, etc., and all else being equal, that might lead to somewhat higher interest rates. We have seen interest rates back up from some of the levels they hit earlier in the year, but bonds remain relatively attractive. And these bars here are different kinds of bonds and they look at the range over the last 10 years is the gray bar. The 10-year median or average is the purple horizontal. And then you can see the blue dot of where we are right now. And you can see that in many, many instances, rates are above their 10-year average. And indeed, in some cases closer to their highs than their lows. And why this is important is that starting yield or how much income you can get from your bonds is a very important component of how your bonds are going to do over time, which I think is clearly evidenced by this slide. So this slide looks at yield to start, and then what are subsequent 5-year returns from the bond market. And then groups them, and you can see the 2010s, those orange blobs, when interest rates started very low, subsequent returns on bonds were not very good. Come all the way up to the far right side, which was the 1980s, when interest rates were the highest, you can see that subsequent returns were the best, and you can see just statistically, this is a really tight correlation with the 1970s really being one of the few outliers.
Other than that, for the last 40 or 50 years, the starting return, or the starting yield on bonds, has really been a great predictor of how bonds are going to do. So we see right now the current yield of 4.25% or so in the bond market speaks to the fact that you may expect something in the 4% to 4.5% rate as a return from your high quality investment grade bonds over the next 5 years. So, when people ask me, am I afraid of interest rates going up, I say no. What worries me is interest rates going down. Interest rates going up will work itself out. If you need the money in the short term, then you shouldn’t be taking on interest rate or duration risk, and you should be in very short-term instruments. But assuming you don’t need the money in the next 6, 12, 18 months, higher interest rates lead to higher returns over time. So what worries me is interest rates going very low. And this isn’t a prediction. I don’t think interest rates are going back to 0% or 1%. But if they did, that makes it somewhat harder, all else being equal, to meet your financial goals. If you have some mix of assets and you can get some sort of yield from your fixed income, your cash, etc., well, that just makes it easier to meet the goals laid out in your financial plan. So, higher interest rates are net positive for investors. This is oil, and so this shows a couple things. One is oil has been very volatile. You can see it’s been as high as $145 back in 2008. It’s been as low as $11 back during the height of the COVID lockdown, so you couldn’t drive, so there was no demand for oil. But what I think is really interesting is the far right-hand side, particularly over the last, let’s say, 12 months. And this begs a question of how easy is it to predict the future? You know, Mark Twain said something to the effect that predicting the future is really difficult. You know, and the idea is that how do you know what’s going to happen? And more importantly, even if you do know what’s going to happen, what are the knock on effects? So if we flash back a year, a year and a half, and I told you that Israel was going to be attacked, there was going to be war in the Middle East, potentially Iran was going to become involved. There were going to be risks of this blowing up into something much more significant. Oh, and at the same time, Russia would be occupying Ukraine, or fighting with Ukraine, and there would be restrictions or shutdowns of some of the flow of oil and natural gas in and out of Far East, or Eastern Europe. If I told you all that, I said, those are the next year’s headlines. Do you want to buy oil? Do you want to be long? Do you think the price is going up or do you think it’s going to stay the same or go down? I think most people would agree. Hey, thanks for the insight. I think it’s going to go up. And the reality is oil has not gone up. And if anything has gone down, despite that backdrop, just speaking to the difficulty of predicting the future, right? There’s a famous movie, Back To The Future, where the enemy guy, the bad guy has a book. He goes back in time and he’s got this book with all these sporting outcomes for the next 30 years. And he bets on it and it becomes really rich. Knowing the future in financial markets isn’t that simple. Because even if you know what’s going to happen, you don’t necessarily know how other market participants are going to involve- are going to react.
Want to talk a little bit about crypto. Crypto has been on fire in the last 12 months. In the last 5 years, it’s done pretty well also. But really from its lows back in 2023 of around 18,000, Bitcoin pushing 100,000, 95,000 at this point, really has stabilized as an asset class, we don’t necessarily include crypto or Bitcoin in client portfolios for the simple reason that there’s no cash flows. And so it’s hard to predict what the future value is. There is probably some sort of underlying utility of Bitcoin, Ethereum, and a few of these other cryptos, both for settling transactions on the blockchain, as well as for countries with unstable currencies, as a sort of store of value, or a place to transition money. It was interesting to me back in the 2023 time frame that despite a really severe bear market in Bitcoin, where it went from 60,000 to getting cut by 2/3, people didn’t necessarily talk about it going away, they talked about it more as a bear market, the price stabilized and has done quite well lately. Again, not something that we put in client portfolios. If you do own it, it should be a very small percentage, right? It’s a little bit like hot sauce on your food, a little bit goes a long way. Because along with this upside, you get the downside, too. And there have been multiple really severe bear markets in Bitcoin over time.
Bitcoin’s other cousin, or its long standing cousin of gold, right, been around for thousands of years as a store of value, has also done well in the last couple years. Long term returns of gold have not been good, but in the last 10, 15, 20 years, the returns have been much better. And you can see that in the last 12 months, returns have been strong as well. A problem with gold is always one similar to Bitcoin of how much do you own and how do you value it, right? How do you value gold? Because again, there’s no cash flows. What you’re really speculating on is what somebody else will pay for it in the future. The other idea is how much of it do you own? Because in a lot of environments, gold might be a drag on a portfolio. And so you don’t want to have too much, but if you don’t have enough, then even when it’s going up or when other things are doing poorly, the gold won’t make a difference. And so gold, difficult to size in portfolios, has some competition as insurance, if you will, now from cryptocurrency, but it’s had a good year. Let me pause there, see if there’s any questions, then we’ll turn to stocks.
Kathryn: “Since the markets are up significantly, but there are lots of signs of recession, would it be prudent to move some monies out of stocks and into more secure investments?”
Brian: From signs of recession, I mean, I guess the one thing I would point out is that there’s plenty of signs of recession out there or of an economic slowdown. But for every statistic, that would come up for that, I could also point to a statistic that says, hey, the economy is actually doing just fine. And so, I think we’re in a very uncertain time economically. And all else being equal, I think the evidence tilts towards the economy continuing to do okay rather than go into recession. It doesn’t mean we won’t. But, you know, if you just looked at all the economic indicators, I think they would say that the economy in the next several months is not going to go into recession. But as far as shifting into more conservative investments, I think that really gets back to your goals. And a lot of times the reason to make a change to a portfolio isn’t because of what’s going on in the external world, but rather what’s going on in your personal situation. And this is where your financial plan comes into play is what rate of return do you need to meet your financial goals? What’s your time horizon? What kind of cash flow needs you need from your portfolio? What’s your personal risk tolerance? How much risk can you take? How much can you see your portfolio fall before you say, no mas and you sell everything, right? And so depending on that, you’re going to have your strategic asset allocation. And then around there, if you want to make changes, I think the key is not what kind of change, it’s to make it small and incremental. So, what institutions do is if, let’s say their mix is 50/50, if they’re bullish or bearish on something, they might go up to 52% or 54% or 55%, but what they’re not doing is going to 80%. Or if they were 50/50 and now they think stocks are overvalued or there’s a recession coming, they don’t go to zero stocks, they make small incremental changes. So if you’re going to make changes to your portfolio, make sure that you do it incrementally. More importantly, make sure that they’re designed primarily to meet your circumstances. And if those circumstances are changing, not necessarily what’s going on in the rest of the world.
Kathryn: All right. “Would you go back to the slides that- for the bonds and explain that when you’re looking at your, the one that says yield a strong predictor?”
Brian: So if you look across the bottom here, this is your starting yield on your bonds. Right, so if you’re over here, you can see the orange clumps. That means that when you bought the bonds, the yield on those bonds was 2% or 3%. So, you can see that over here, these blue dots, you were buying them at a time where your starting yield was 9%, 10%, 11%, 12% or whatever. And then on the left-hand column is your subsequent return over the next 5 years. So, if you bought a bond on a given day, how did it do in the next 5 years? And what you see is that when you bought these bonds down here where your starting yield was 2%, your return for the next 5 years was 2%, 3%, 4%. The green ones, you bought them at a time where starting yields were 4% or 5%, 6%, and your subsequent returns were 4% or 5% or 6%. You come out to the blue right again where you’re buying them at 11%, 10%, 12% and see your subsequent returns in the next 5 years were 10% or 12%. And so what that tells you, and you can see that’s a pretty tight grouping of the dots around the line, what that tells you is that when you’re buying bonds, if you look at what the yield is on those bonds, all else being equal, it gives you a pretty good indicator of what kind of return you’re going to get. And that makes sense because a big component of a bond is you’re getting income from it every 6 months or whatever, and then you get your money back at the end of it. So if you’re buying bonds in an environment where you can get 2%, you’re probably not going to earn 10% from those bonds. If you’re buying bonds today where you could get 4% or 5%, your odds of getting some sort of reasonable return, whether that’s 3.5% or 5% or something like that, is probably pretty good. And so the idea being that today it’s a much better time to buy bonds today. If you’re looking out at what kind of returns you’re likely to get, then it would have been a couple of years ago when rates were much lower.
Kathryn: “With Republicans running the show for at least the next two years, is there a concern with too much regulation cutting, particularly in financial markets?”
Brian: Yeah, I think that the idea, I mean, markets are happy that there’s theoretically going to be less regulation in the next 4 years. I mean, who knows what reality is, right? But I think that’s the expectation. You know, a little bit less oversight of, markets, a little more of a free hand for M&A and stuff like that. And all else being equal, I think markets are cheering that. But obviously, just like with anything, too much is not a good thing, and we’ve seen, you know, the, period, the, questioner was referencing in the mid 2000s, where you saw really light regulation was great for a while, you know, and then eventually, it got to be too much, and we had the financial crisis. So, yeah, I think it’s a concern. I think it’s certainly too early to say whether or not that will happen. Time will tell. And I think it’ll be important to be sensitive to signs of that. But I think it’s very much too soon to tell whether we’ll have a nice amount of reduced regulation where it’s a positive or whether that positive tips over to becoming too much.
Kathryn: And, I know we have a lot more to talk about.
Brian: Yeah. Let’s dive into stocks. And this is one thing I wanted to point out, like everybody probably knows who Warren Buffett is. There’s been some headlines lately about Buffett selling stocks. And so some of them, right. He’s, Wall Street has hit a fever pitch and the financial world can’t ignore it. Buffett sells more stock. Why you might want to copy Warren Buffett and stash the cash. And we’ve gotten the question some of, you know, hey, if Warren Buffett is selling, should I? And, you know, I think that there’s a couple important things to consider. One is that you’re not Warren Buffett. If you are, you, I doubt if, Warren, if you’re out there, give me a call. But you’re probably not on this webinar, right? His situation is completely different and he still owns hundreds of billions of dollars worth of stock. So I think that’s important. It’s not like he sold everything. There was a story 5 years ago of Buffett selling treasuries and it was a headline. He had sold whatever amount of treasuries and he still owned hundreds of billions of treasuries. So this is all relative. But I think the more important thing is Warren Buffett runs a company that’s worth a trillion dollars right now, and he himself has come out and said many times that he doesn’t expect to outperform the market the way that he used to because he’s simply too big. And what that means is that his opportunity set is completely different than everybody else out there. So Warren Buffett cannot go and buy any stock he wants. Or more to the point, he can, but it’s not going to make a difference. If he goes and buys some $10,000,000,000 company, he could buy the whole thing and it’s not going to move the needle. So his opportunity set is constrained to a small handful or, you know, however many big, huge companies. And maybe those are fairly priced, maybe they’re not. Right, so here’s the weighting of the top 10 stocks in the S&P, and you can see that we’re at virtually all-time highs. So the 10 biggest stocks in the S&P are 35% of the index.
So if you just buy the S&P 500, a third of your money’s going into 10 companies, those 10 companies are somewhat expensive, right? The top 10, the PE ratio, the price earnings ratio, or valuation on them is 30.5%. Which is 150% of the long-term average. But if you look at the rest of the S&P 500, the other 490 stocks, their PE is 18.4%. So only about 60% of what the top 10 is, and it’s only 117% of the long-term average. So, you know, obviously the rest of them, the 490 stocks are not cheap historically, they’re still a little bit more expensive than average. But there’s a big difference between being 17% more expensive than normal and 50%. And so I think as you, whether you consider Warren Buffett or if you talk about quote/unquote, the market, the key is to define what the market means. And the S&P 500 is 500 large cap U. S. companies tilted towards growth. And the reality is that there’s about 13,000 or 14,000 publicly traded companies in the world, U. S., international, big companies, small companies, growth, value. Not to mention tens or hundreds of thousands of private companies that you can invest in through various alternative investments. Some of those are expensive and some are not. Just like some big companies are expensive and some are not. But I think it’s important to take the lens back a little bit and move past just the S&P 500 or big cap U. S. companies, which very well might be expensive, but, you know, frankly, they’re minting money. And if you look at earnings expectations, the forward PE, if these companies grow as they’re expected to, is more like 17% or 18%, not 30%, which is closer to being in line with the long-term average. One thing you get, as well, if you just concentrate on these big companies, is a bumpier ride. And so you can see, there’s a lot of lines on this chart. The green is the Magnificent 7, the big tech companies. The gray is the S&P 500. You can see that you’ve done better, mostly just because of the last 12 months. In the Magnificent 7, but it’s been much bumpier. And you can see that, you know, as of mid-2023, you are in about the same spot. More recently, the rest of the market has caught up to the Magnificent 7 in the last 6 months, but they had a period from the end of 2023 through about the middle of this year where they just soared. But it’s been a much bumpier ride, both to the downside and to the upside. And, you know, again, these are great companies, Amazon and Google and NVIDIA and whatnot. And we own them as part of our portfolios, but we don’t think a third of your money should be in a handful of stocks. We think something in the 5% to 10% range should be in a handful of stocks. So let’s talk about the broader universe and some of the valuations, right? And what stocks are you looking at? This looks at big companies across the top and small companies across the bottom. And then at growth companies down the right-hand side. And value companies down the left-hand side. And then what is the valuation today as a percentage of the 20-year average. And you can see that again that these big growth companies 150% as expensive as the long term average, you tilt down towards value in the big side, 120% so expensive, but not as expensive. You get to some of these smaller and more value oriented companies, much closer to historical valuations. And guys, keep in mind, there are roughly 500 large growth and large blend companies. There’s roughly 2000 or 3000 of these smaller, more value oriented companies, which again, the valuations are much closer to historical norms, which we think speaks to the idea of spreading your positions around certainly owning these companies, but also owning these companies and these companies and making sure that you’ve got exposure to all parts of the economy.
International stocks also may be more reasonably priced than international. Again, this is just refuting some of the fear and I’m not arguing that some companies aren’t overpriced or that the market’s not going to go down, right? I’m just saying that not all stocks are expensive right now. International stocks, and there’s just way too much lines and stuff on this slide. So I apologize. But the important point is that right now, international valuations compared to domestic U. S. valuations, two standard deviations below the average. So you can see the cheapest they’ve been since 2004, so in the last 20 years, international stocks have not been less, less expensive compared to U. S. stocks than they are today. Now that doesn’t guarantee international stocks are going to do great. They have headwinds. Right? France’s government is collapsing as we speak. South Korea had martial law yesterday. Not that we don’t have problems in the U. S., right? But there’s a lot of dynamic companies in the U. S. The NVIDIAs, the Teslas, the Apples, the big tech companies are mostly clustered in the United States. But there’s also a lot of great companies abroad, right? And I think that as you look at international markets, and I say this often, it’s not just about investing in Japan or Switzerland or this or that. It’s companies, right? And so in the U. S., you could buy car companies. You could buy Ford, you could buy GM, you could buy Tesla. But you could also go to Japan and buy Nissan and Toyota and Honda. Anybody out there drive one of those? Or Germany, BMW, Mercedes, Volkswagen, I’m sure some of you folks drive those cars, right? Italy’s got Chrysler, Ferrari, Maserati, so there’s great car companies all around the world and if you just invest in the U. S., you’re constraining yourself to a small subset of the opportunity, which is why we think investing internationally in conjunction with the relatively attractive valuations makes sense. Obviously there could be some headwinds.
I don’t know what will happen in the next 12 months and we’ll talk about tariffs. But tariffs aren’t going to surprise anybody. We know they’re coming. So let’s pivot to the road ahead. And then I’ll pause here in a moment. I want to talk about tariffs in the context of the stock market. First of all, there’s a lot of talk that, Hey, Trump came in and there’s going to be tariffs. And that’s true. But the reality is if you look at the percentage of people have an unfavorable opinion of China, for instance, and sorry to single out China here, it doesn’t matter what party people are in, almost everybody has an unfavorable opinion of China at this point. Right? And you can see, in general, people are favorable towards Taiwan and unfavorable towards China. Tariffs remained in place under Biden. He hasn’t been as vocal about it. It’s not as much in front and center as it was under Trump. It’s frankly not as new as it was under Trump, but they’ve been there. So there continue to be tariffs. The economy has done just fine. The stock market has done just fine. The other part of it is I think the devil is in the details.
And so there’s two ways the tariffs could go. One is that they’re very targeted. Maybe they’re on China. I think that’s likely to be increased, right? But you even saw China came out recently and took a wait and see approach with some of their policy where they continue to keep trade mechanisms in place through February to wait and see what Trump did rather than escalate. So we’ll see what happens vis a vis China. Is it directed towards the auto industry? Is it more broad? I think really broad tariffs across the world and across asset classes would probably have negative impacts. It would be inflationary. So tariffs help producers domestically. So they’ll help some people. But they also cause the price of things to go up. So they lead to slightly higher inflation, but it’s not like tariffs are going to surprise anybody. And with China specifically since 2016 trade with China has been declining. And so when you look at the gray line here of trade with China, it’s dropped off quite a bit in the last 7 or 8 years. So, we’re not nearly as sensitive to trading with China as we were when the tariffs were first put into place. They’re not as unexpected as they were in the first place, and they’re starting from a higher level. Tariffs could certainly have a significant negative impact, but I think the devil is in the details, and it’s not a guarantee that they’re going to be uniformly bad or even cause much of an impact on either the economy or markets. With that, let me pause for a moment and then we’ll take more questions, and we’ll take more questions.
Kathryn: Back to the bond chart. “In what- in the return of what asset class is determined by the bond return chart?”
Brian: It would be things like treasury bonds, investment grade corporate bonds, municipal bonds, basically any kind of high quality fixed income. If you look, and that was just one chart, but there’s tons of statistics that show when you look at high quality investment grade bonds, your starting yield is a pretty good predictor of what kind of return you’re going to get over the life of that bond, right? So if you buy a 5-year bond and, or a mutual fund with a 5-year average maturity of the bonds, and your starting yield is 4%, you’re likely to get something close to 4% over those 5 years.
Kathryn: And then going back to the tariff chart that you showed. “China trade has been declining already. What about the other areas like Taiwan?”
Brian: So obviously other areas, right, there’s still trade happening, and you can see like Taiwan, Korea, and Vietnam has increased as China has fallen. And I think that there’s a couple things there. One is that trade needs to come from somewhere, right? And so, if it’s dropping off with, let’s say, China, it’s going to be made up to a degree from other places. The other is that some of this is a consequence of tariffs. Some of this is a consequence of just changing dynamics geopolitically. Some of it is companies wanting diversification in the supply chains, and it’s all exacerbated by COVID and nearshoring, right, where you saw what happened if you couldn’t get supplies from this place or that. And so a lot of companies are choosing to nearshore things and maybe move, manufacturing to whatever, Canada or Mexico or something like that, rather than someplace halfway around the globe, or they’re moving it to countries that are perceived as being friendlier to U.S. interests than some other countries, right? And so, you know, when you look at it India, trade still very low, but been increasing because they’re viewed as a little bit more of a friend of the United States at this point than China. It could be that there are tariffs on all of these countries. But my guess is that it’ll be a little bit more targeted and one thing I think is important is that and you saw the market reaction when he was announced that Scott Bassett was going to be the Treasury Secretary. He’s a longtime hedge fund manager, very well known in the industry. Has been a supporter of Trump and was seen as one of the front runners for Treasury Secretary. But it’s also seen as somebody with a keen understanding of financial markets and potentially a moderating voice against too aggressive tariffs. And so, while I do think there will be tariffs, at the very least, the person in charge of the Treasury and, really the lead financial person in the United States has a pretty good understanding of the potential impact of tariffs. And, tariffs are usually seen as a negative. So I tend to think that we’re not going to see blanket tariffs on all of these countries. But again, time will tell and I can’t guarantee that. I would also say that Donald Trump is pretty focused on the stock market as sort of a voting mechanism for how he’s doing and wants the stock market to do well while he’s in office. And again, Scott Bassett also has a very tight interrelationship with the financial markets. So if you see tariffs coming out to the degree where it’s really harming markets, I think that there’d be some moderation on that front.
Kathryn: “How will the immigration policy impact inflation?”
Brian: And again, I don’t know exactly what the immigration policy will be, but if you have less labor, right, let’s say you restrict immigration in some way, shape or form, you have less labor. It’s simple supply and demand. If there’s less supply of labor, if the demand stays the same, well, you have to pay more. If there’s more money going to fewer people, they’re going to more likely to spend it. You’d see higher inflation. I think almost uniformly and who knows what will happen, but I think almost uniformly it’s viewed that the policies that are likely to be proposed, whether or not they come into fruition, who knows, but the, whether it’s tariffs, whether it’s, deficit spending, whether it’s pressure on the Fed to keep interest rates lower than they would all else being equal, whether it’s immigration, are almost uniformly seen as moderately more inflationary than their opposites, right? So. All else being equal – and this is the key – all else being equal, you would see in the next 4 years, inflation somewhat higher than it would have been without these policies, and interest rates somewhat higher than you would have seen without these policies. But, and I want to stress this, the key is all else being equal, right? It could be that there’s so many inputs into all of this, it could be that, you know, inflation would have been 2% otherwise, and now it’s going to be 2.25% or 2.5%, so still at a very low level, right? I’m not saying that these, you know, inflation is going to go to 10% again, and interest rates are going to go to 8%. I’m just saying that all else being equal, if it would have been 1.5%, it’ll be 2%, or if it was going to be 2%, it’ll be 2.25%. So, the absolute level is unknown, but these are inflationary policies. But inflation could be a good thing. I mean, Japan’s been trying to get inflation for 40 years. Somewhat levels of inflation are a good thing. That’s why the Fed targets 2% inflation, not 0%.
Kathryn: Sounds like you’re saying the S&P 500 is overpriced. Should investors in the S&P 500 reduce exposure?”
Brian: Whether the S&P is overpriced or not, I mean, time will tell. I think it’s fully valued, but that doesn’t mean that it needs to go down. I mean, the S&P was fully valued in the mid-90s, and it continued to absolutely soar for a period of time. And so when you think about the underlying companies in the S&P, a lot of them are world class leaders in their industries and are generating phenomenal amounts of profits. So they could essentially grow into their valuations. And I think that there’s a distinct possibility that happens, but I guess what I am saying is I want to own only the S&P 500. I’d have some of these compliments, these core satellites, right? Where the core might be the S&P, but I’d satellite around at these other types of stocks that both get you different exposures and also might be somewhat more fairly valued in order to complement your S&P exposure. Let’s talk about taxes, right? And so, this is, I did this in an election webinar too. I went through this slide, but I think that this is key is, for all the talk about balancing the budget, the reality is the budget’s not getting balanced. And the reason being is because you cannot cut spending enough to balance the budget. If we assume for a moment that you’re not going to drastically cut defense spending or veterans benefits, at the bottom here, and that Social Security and Medicare are the third rail and nobody’s going to touch them, and I haven’t heard anybody propose getting rid of them, right? If you don’t touch those, you would need to cut every other spending in the budget by 85%. There’s no way we’re cutting 85% of the post office, and KPBS, and national parks, and roads, and this and that, it’s just not happening. So it’s almost statistically impossible to balance the budget, except that title, right?
Higher taxes needed to balance the budget. So the only way that you’re actually going to balance the budget is with higher taxes. Now, with Trump coming into office, I think higher taxes in the next couple years are less likely, but who knows? I mean, one of the things that we focus on constantly here is, it’s not what you make. It’s what you keep. I used to manage money for institutions. Taxes didn’t matter. They didn’t pay taxes. Individuals pay taxes. And so you need to focus constantly on taxes. How much are you paying today? How can you save money today, but also how can you structure yourself to save money in the future as you distribute income back to yourself to live on in retirement? Whereas you pass money on to causes you care about or the next generation. Taxes have to be a constant consideration. Whether they go up in the next 4 years or not, I don’t know. There’s, I think, a reasonable chance some of the tax cuts that we saw in 2017 with the Tax Cut and Jobs Act will be extended, but I think it’s a near certainty that it’s some point in your lifetimes, taxes will go higher. And for many of you, I mean, you could be whatever age, even if you’re approaching retirement, you’re probably gonna live 20, 30, 40, 50, more years. You’re going to see high taxes, low taxes, but I think over time the trend is going to be higher and it’s important to prepare for that.
Talk about the dollar, right? There’s a lot of talk. I hear this all the time. The dollar is going to go to zero. Nobody’s gonna buy the dollar. This other currency is going to supplant it. Bitcoin is going to take it away. The reality is the dollar has done really well the last, I don’t know, 10, 15 years. The other thing is that the administration, a lot of those policies were talking about tariffs and this and that, are viewed as dollar positive and you can see the sharp increase in the value of the dollar immediately following as it was seen that okay, Trump’s increasingly likely to win. You know, September, October we bottomed out a little bit for the year and then we skyrocketed up about 7% on the dollar index and for currencies. That’s a really big move. So the Trump administration is seen as being bullish for the dollar. And again, I don’t think the dollar is going away under any circumstances. And I don’t think the value of the dollar in a vacuum is a good thing or a bad thing. I don’t think the dollar softening would be bad. I don’t see that. I don’t see any scenario where the dollar completely collapses.
Let’s talk about one segment of the stock market that I actually think could be attractive, and that’s small companies. So, small companies are historically cheap. You can see here a couple periods where small caps were expensive here in the 1980s. You can see times that they were cheap back in the 1990s. This was the dot com boom here. And then you can see here. So, right now, small companies are almost as cheap compared to large companies as they’ve ever been, you know, going back to 1980, with the only comparable period being the mid-1990s and the tech boom. And what happened after that is that small companies significantly outperformed large companies in the ensuing decade to catch up. So, valuation doesn’t prove what’s going to happen in the short term, but it’s a good starting point. Looks like small companies are cheap. And the reason that’s interesting is the market’s looking at the election as a positive for small companies, so you can see the light blue line being small companies. That’s the Russell 2000. And then the purple is the S&P, and the orange is the NASDAQ. And this is the month or so following, leading into and following the election. You can see that small companies were up like 11%. When you think about some of the policies being proposed, they should be good for smaller companies. If there’s going to be tariffs, well, all else being equal, that helps domestic companies and domestic producers. Small companies tend to both produce less and sell less abroad than huge multinationals, right? So all else being equal, I don’t know, the local taco stand sells less stuff internationally than McDonald’s, right? So all else being equal, if there’s tariffs, if there’s things that are unfriendly for foreign trade that should benefit smaller companies, in a vacuum.
The other thing is that Trump is seen as pro-economy, right? That interest rates are going to be a little bit low, eased that the fiscal stimulus will happen a little bit more, stronger economy, generally small companies do well. So we could be setting up a backdrop for small companies to do well, or at the very least the markets for running that. However, I think it’s important to realize that not all small companies are created equal. And so this chart just looks at two things. The purple is the Russell 2000, so that’s the main small company index. The orange, I just picked a mutual fund. This is a targeted value ETF. And you can see that this goes back for the last, two and a half years or so, two years. And you can see the big difference in performance where the targeted value is up 31%, whereas the index is only up 9%. The reason for that difference is that targeted value ETF excludes certain small companies. And so when you look at small companies, they’re not all created equal. Unprofitable small companies, and you might have seen news headlines about how many Russell 2000 companies are unprofitable. Unprofitable small companies tend to be among the worst performers out there. And so it’s important as you look at investing in the small company universe, that you’re very selective, that you screen or scan for companies that are profitable versus unprofitable, that are a little bit less expensive versus a wing and a prayer. That wing in a prayer area is always very popular because you get the next, you know, Google in there or something like that and everybody wants the stock that they’re going to buy at ten and it’s going to go to a thousand. but that tends to get buried in a lot of companies that are just overpriced and their dreams never come to fruition. So, it’s really important to be selective in the small company universe.
Value and growth are the other two main breakdowns in addition to small and large in the types of stocks. For a long time, I mean, there’s been ebbs and flows. The first half of this year, growth significantly outperformed value. But you can see here that in the last 6 months or so, value’s caught up. And in fact, in that time period, value is actually incrementally even with, if not even a little bit ahead of growth now. And so, the beginning of the year, and I had shown this earlier, really dominated by those large tech companies. That’s really normalized since the Summer. And we’ve seen the market leadership expand out quite a bit. I want to point out one more thing about how hard it is to time markets. And again, I go back to that slide of, hey, if I told you all the news, you would have said oil prices are going up, but then all that news happened and oil prices didn’t go up, right? And this is just another way of looking at trying to time the market with perfect foresight. And this is each quarter from March of 2021 going across to September of 2024 and then different asset classes. And what I would question for all of you, the question I would pose is what pattern do you see here? And I’ll pause and let everybody think about that for a moment. Look closely and you’ll see the pattern. Alright, if you’re not seeing it yet, focus heavily on the middle. Alright, if you still don’t see it, focus over here on this side. Alright, I’m messing with you all and this is a lot more fun to do with a live audience than talking to the camera’s eye. If you’re staring really hard for a pattern and not finding it, it’s because there is no pattern. There’s literally no correlation between what does best in a given quarter and what does best the next quarter or what does worst and what does best. I mean, of course, over any time horizon, different asset classes are going to come in and out of favor. But you can see that things go from top to bottom or they’re in the middle and this and that. And you can run this chart over any time horizon you want. And the story is always the same is that the past doesn’t guarantee the future. And so I think that it’s really important to look at this and see that, hey, it’s really, hard to time perfectly in and out of asset classes.
The one other thing I want to pull up here, and then I’ll invite some more questions, is that we’ve had a really good run in the stock market, and this looks at year by year the performance of the market going back to 1980. How did the market do that year is a gray bar, but then you see the red dots and the red dots is what it’s a low point or the drawdown during the year. And what I think is important is that even in 75% of the years, 33 out of 44, the market was up. In every one of those years, basically, you had some time during the year where the market fell, right? And so at some point, we’re going to see a return of volatility. We saw some volatility in like late Summer, early Fall in this year. Next year, I suspect that we’ll see some more volatility. Okay. The key is not to panic and to accept that it’s normal, right? Markets are like Winter, right? It’s a season. And you know at some point it’s going to snow and you’re going to have to shovel out. And if you’re well prepared for that, it’s not a big deal. But if you’re caught by surprise, if you have too much risk in your portfolio, too much concentration among a few names, if you don’t have enough money on the sidelines to fund your short-term cash flow needs, you might panic and sell. But if you’re prepared, if you know that at some point it’s going to snow, you have your shovel, you know the market’s going to fall, it shouldn’t catch you by surprise.
And that gets back to the financial plan, making sure that your overall asset mix is appropriate for what you’re trying to accomplish and your risk tolerance. I’ll invite some more questions. Many of you out there are already Pure clients. So, you know, if you have any questions on anything that we’ve covered that you don’t get a chance to ask today, certainly talk to your financial advisor. If you’re not already working with a Pure Financial advisor and you want to meet with somebody, we do offer free complimentary assessments. Usually we charge several hundred dollars an hour to meet with somebody. But for people that attend these webinars, we do waive that fee. We do invite you and you can set an appointment, meet with one of our CERTIFIED FINANCIAL PLANNER™s, no cost, no obligation. They can talk to you a little more about the market. They can analyze your portfolio to see what kind of risk you’re taking, what kind of expected return you might have. And equally, if not more important, they can take a look at your cashflow down the road, give you thoughts on Social Security, pensions, etc. Do you have enough money to retire either in the next couple of years or well in the future? And also your taxes, right? As we come to the end of the tax year, are you positioned now to minimize your taxes today and in the future, or are there tax steps you should be taking in order to cut your future tax bill? So again, we have in-house CPAs, in-house investment professionals, etc. The CFP® can coordinate with all that, give you a free set of eyes, no cost, no obligation. If that’s something you’re interested in, Kathryn will drop it somewhere up there. I’m sure you can sign up for it and come in. If not, make sure you do something with this information. If you already have a financial advisor, talk to them, do more research, etc. But make sure that you do something with the information we’re talking with today in order to advance you towards your financial goals.
Kathryn: “What makes a company a value versus a growth company?”
Brian: Yeah, that’s a really good question. There’s several ways to analyze it, but it all comes down to how cheap or expensive is the company to be honest. And so generally speaking, growth companies are expanding rapidly, whether it’s sales or earnings. But the price you pay for that is higher. And then value companies are ones that aren’t expanding as quickly. Maybe they’re in a more boring industry. But you don’t pay as much. And so think, you know, Tesla would be the classic growth stock, right? Where it’s a high flyer expanding rapidly, but very expensive. You see the price bounce all around. A lot of times the value stocks tend to be, you know, maybe it’s a concrete maker or something like that. And then some industries tend to be concentrated where financials or industrials or natural commodity producers tend to be more value. Whereas something like a technology company might be more of a growth. And neither is good nor bad. You want to own both. They come in and out of favor, and you definitely want to own both. As far as how you actually break it down, a lot of times it’s either price to book ratio, price to earnings ratio. There, there’s a lot of different ways to decide exactly what falls where.
Kathryn: “How does someone get diversified in all those different categories? Is there a basic mutual fund group or ETF that they should be looking at?”
Brian: We definitely think the S&P 500 makes sense, you know, and so owning that, but then it’s important to go out and find other parts of the market to satellite around that or to complement that. And so it’s really doing research and looking at it- And again, if you want to chat with one of our folks, they could give you some guidance more specific, but it’s looking at, what small company ETFs are there, what value company ETFs, what international ETFs, and then what weightings are appropriate, right? Because at the end of the day, it’s like going to the food store, you buy sugar, you buy salt, etc. But then how much of each do you use? But for the most part, I think that you want to be really thoughtful about the investment vehicle you use and make sure it’s a good expression of what you’re trying to accomplish. And what I mean by that is you don’t want to go buy a value ETF or mutual fund and then you buy it and it acts like a growth stock, right? Because that’s counterproductive. So you want to make sure that it’s actually accomplishing the role consistently that you’re putting in the portfolio for.
Kathryn: Now this one sounds like a plant, that I planted it myself. But it says, “Does someone have to have a financial advisor to do all this or can I just go to my bank and have someone help me there?”
Brian: You know, I mean, if you go to your bank and get somebody to help you there, what they’re going to do is they’re going to go in the back and get one of their financial advisors that are in-house and have them help you. And that might be okay, you know, a lot of the times they’re not, fiduciaries, which we’re legally obligated to act in your best interest. Some of those folks are not. So my recommendation is always whether you work with us or somebody else is to go work with a fiduciary. But yeah, if you go in a bank, depending on where you go, if you go in, you know, the Chase or this or that, they have people that could help you, but they’re financial advisors too, or brokers, maybe more, maybe a more apt term. You could do some of this on your own. I mean, it depends on whether you have the time and the resources and really the desire to do it, you know, so it definitely takes time. I mean, when you think about it. We have, I don’t know, 150, 160 employees that spend, you know, all day, every day focusing on this stuff.
So, it’s just a matter of resources. If you want to spend a lot of time doing research on investments, learning the tax code, and then going in and figuring out your future tax projections, what sort of assumptions should you use building out a financial plan for yourself? You may have the capacity to do that. I don’t know who’s asking the question, but then do you have the time and the willingness and then to update it and stuff? And, for some people, the answer to that is yes. For a lot of them, it’s no. And so then either you do it yourself anyway, but maybe you accept, you know, somewhat subpar results and that could be okay, or you go find somebody to help you with just like, you know, you would, with a doctor or a personal trainer or something in a different aspect of life. My prediction for next year, to the degree that I want to make one is that I do think we’ll see continued volatility as there’s uncertainty around exactly how much the Fed lowers or raises interest rates as far as the new administration comes in and some of their policies. As well as an economy that has really been in a very good place. And does it get stronger? Does it get weaker? What does that look like? And then some of the international affairs, I do think we’ll see a little bit more volatility next year, which is where I think diversification and making sure that your portfolio matches what you’re trying to accomplish becomes important. But I don’t think that volatility should scare you. I think it’s just part of the course. And then, you know, go ahead. Make sure your plan is updated. Talk to your financial advisor here with us, or if you have an outside one, if you want to come in and talk to one of our CFP®s for a free assessment, but make sure you pay attention. Take a look at how you’re allocated today, both from an investment and a tax perspective to make sure that you are well positioned for volatility and whatever life throws at you both next year and the year after. So With that, you know, we’re coming into the end of the year. Everybody have happy holidays, happy new year and, you know, look forward to connecting in the new year.
Kathryn: Great. And thank you to everyone who joined us. We hope that this was informative.
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