DECEMBER 2024 EDITION:
Commentary and Economic Outlook
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Top Headlines from Market & Economic Outlook Report:
We believe Inflation is contained, with our revised core CPI-R and PCE-R tracking at .86 and .56%, Y/Y respectively. Inflation is caused by excessive monetary growth, but year-to-date U.S. and global monetary base shrank by 3.4% and 3.7%, respectively, indicating we are headed towards deflation if the Fed does not cut rates. If Trump re-imposes the embargo on Iranian oil that would be inflationary if effective at reducing exports.
We are bullish on bonds and expect the 10-year to move into the 3.5%-4% by the first quarter of 2025. There are $56 Trillion of global pension assets that will rebalance by year-end.
We are bullish on stocks with a 7,000 target on the S&P 500 Index assuming an 18% corporate tax rate is enacted. Corporate tax cuts are the key driver of economic growth and stock prices.
Most government policies, including immigration and tariffs, have an immaterial effect on inflation or growth. Corporate tax policy and anti-trust enforcement do have an enormous impact on economic growth and stock prices.
We continue to be bullish on investment banks, financials, REITs, and preferred stocks.
The Fed is fatally flawed and needs to be reformed.
The Fed & Inflation:
We believe that fears of accelerating inflation are completely irrational. Inflation is caused by excessive monetary growth and energy shocks and is not significantly impacted by other government policies. As Milton Friedman said:
“Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Since the beginning of the Pandemic, the monetary base (“M 0”) is up over 60% and nominal GDP is up 38% with CPI up over 22%. Consequently, all of the inflation related to the Pandemic was caused by excessive monetary growth. The Pandemic was nearly a perfect test of monetarism vs. Keynesianism and monetarism won.
Voters were very unhappy about the 22% inflation over 5 years as many don’t own their own homes and wages did not keep pace with inflation.
The U.S. monetary base shrank 3.4% YTD, indicating we are headed for deflation if the Fed does not cut rates significantly.
Our core CPI-R and PCE-R index are up .86% Y/Y and .56%, respectively. Auto services are driving over .7% of the CPI-R headline increase.
We modified our CPI-R calculation to use market rents vs. housing prices as the record 950,000 apartment completions over the last two years has caused rents to decline despite a tight market for single family homes.
CPI-R uses market rents for shelter (down .71% vs. CPI at positive 5.1%) and excludes the absurd financial services measurement that uses stock prices to estimate inflation. The shelter component of CPI is deeply flawed as the BLS inexplicably purposely delays the calculation by 6 months and is further lagged by using lease renewals instead of market rents from new leases. Auto services inflation is a lagged impact of Pandemic production short falls and is likely to decline rapidly over the next year.
Trump’s pro-growth corporate tax cuts and attempts to cut Federal spending are dis-inflationary. Corporate tax cuts raise productivity as well, which is deflationary.
Tariffs have no material impact on long-term inflation and the proceeds from tariffs can be used to stimulate domestic investment which is dis-inflationary and the one time increase in prices has no long-term effect.
Deportations of asylum seekers and/or criminals is dis-inflationary as they are not working and are consuming public assistance/resources. More widespread deportations may or may not occur. The rise in the minimum wage makes the supply of low wage workers less important to companies’ cost function. In addition, automation including AI is reducing the demand for labor. Wages increases have never been a key driver of inflation with real wages declining by 6% during the 70’s.
The one Trump policy that would be inflationary is the potential re-imposition of trade sanctions on Iranian oil that could cause oil prices to rise $15-20 per barrel.
Fed Reform: The Fed has been a disaster since the implementation of the 2% target and deserves to lose its independence. The Fed’s policy framework is overly rigid and should be reformed. The Treasury secretary should also serve as the Fed Chair.
Stock Market Outlook
We are raising our 2025 year-end S&P target from 6,600 to 7,000 after the Republican sweep based on 22x 2026 S&P EPS estimate of 317 with risk skewed to the upside due to AI impacts. Our target assumes that the average effective corporate tax rate drops to 18% and the multiple reflects improved long term growth prospects due to lower corporate tax rates and deregulation. Our upside target is 7,500 if there is an effective corporate tax rate of 15%.
Despite our bullish 25 target, the market may stall around the 6.000 level during the seasonally weak late November period, but could grind above out target in December as investors continue to anticipate a pro-business policies out of the Trump administration.
The stock market surged over 20% in 2017 in anticipation of the corporate tax reduction.
The IMF estimates that capital formation is 70% correlated to GDP growth with every 10% increase in gross investment rate contributing to a 1.5% increase in the GDP growth rate.
We estimate the US government’s irresponsible fiscal policy costs the US economy .75% of economic growth per year.
The average corporate tax rates of socialist (more than 50% of economy controlled by the government) countries in Europe is only 20%, despite very high personal tax rates, due to the fact that corporate tax rates are 60% inversely correlated with economic growth
Interest Rate Outlook
Our 7,000 2025 YE target assumes a 10-year treasury rate of 3.5%. Every 25 basis points of rate drives our theoretical S&P multiple by 1 full point. We believe the recent rise in the 10-year is irrational and that the 10-year bond is finding a bottom at the 4.5% area.
The best cure for high rates is high rates. We forecast that a 10-year rate in the 4.5% range will slow the housing market significantly as it implies 30-year mortgage rates above 7%.
There is $56 Trillion of global pension assets that will rebalance at year-end and provide a deep bid for treasuries.
The rest of the world has stalled growth and will continue aggressive rate cuts in 2025 which will drive global rates lower including US rates. We forecast a $2 trillion increase in the global monetary base in 2025 as global central banks continue to cut.
There is also a yield premium built in due to Trump presidency. We disagree that a Trump administration is worse for the deficit as corporate tax cuts are likely to result in higher economic growth that spur increased personal taxes, offsetting lower corporate tax revenue. In addition, the higher economic growth will reduce the deficit as a percent of GDP.
After Trump’s 2016 election treasuries sold off dramatically but then rallied back as the market stabilized and actual policy emerged vs. political campaign promises.
Economic Outlook
We project that the economy will grow 2-3% this year (No Landing).
We believe the “Sahm” rule is not useful for predicting recessions as it follows a lagging indicator (unemployment). We follow the “Hatfield Rule” which states that a recession is indicated by housing starts (leading indicator) dropping below 1.1MM units. Home starts declined to 1.3MM as rates have risen over 70bp over the last two months.
If the 30-year mortgage stays above 7% we are at risk of a significant growth slowdown or recession.
11 out of 12 post WWII recessions were precipitated by a decline in housing investment.
Investors massively underestimate the importance of corporate tax rates. The 2017 corporate tax cut not only raised earnings but increased the sustainable multiple by 3x as the higher after-tax return on capital allows companies to grow earnings faster. Consequently, the 25-year average S&P multiple of 16.4x is no longer relevant because of changes in corporate taxes.
Most investors/pundits are way too focused on immaterial issues such as tariffs and immigration vs. the upside from a substantial corporate tax cut.
We estimate the long-term sustainable PE ratio at a 21% corporate tax rate is 21x based on 10-year interest rates in the 3.5% range.
If the corporate tax rate drops to 15% the estimated sustainable PE would rise to 23x and at 18% it would be approximately 22x.
Commodity Outlook & Environmental Issues
Pollution taxes are by far the most economic method to rapidly reduce carbon and improve the environment. Limiting natural gas production is highly destructive to the global environment and has led to regime change in Europe.
Recent oil price weakness is due to seasonal factors not economic weakness in China or growth fears.
A Trump Presidency would potentially create upside for oil, as Trump is likely to re-impose sanctions on Iranian oil exports.
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ABOUT US
Infrastructure Capital Advisors, LLC (ICA) is an SEC-registered investment advisor that manages exchange-traded funds (ETFs) and a series of hedge funds. The firm was formed in 2012 and is based in New York City. ICA seeks current income opportunities as a primary objective in most, but not all, of ICA's investing activities.
DISCLOSURE
Not for distribution to the public. Opinions represented above are subject to change and should not be considered investment advice. Past performance is not indicative of future results. The links to the fund fact sheets will provide standardized performance and risk disclosures.
FUND RISKS Investors should consider each Fund's investment objectives, risks, charges, and expenses carefully before investing. For a prospectus with this and other information about the Fund, please visit the Fund's webpage. Please read the prospectus carefully before investing.
ICAP Exchange Traded Funds (ETF): Investing involves risk, including possible loss of principal. An investment in the Fund may be subject to risks which include, among others, investing in equities securities, dividend-paying securities, utilities, small-, mid- and large-capitalization companies, real estate investment trusts, master limited partnerships, foreign investments and emerging, debt securities, depositary receipts, market events, operational, high portfolio turnover, trading issues, active management, fund shares trading, premium/discount risk and liquidity of fund shares, which may make these investments volatile in price. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Fund's returns. Small and Medium-capitalization companies, foreign investments, and high-yielding equity and debt securities may be subject to elevated risks. The Fund is a recently organized investment company with no operating history. Please see the prospectus for a discussion of risks. Distributor, Quasar Distributors, LLC
PFFA Exchange Traded Funds (ETF): The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities. Preferred Stock: Preferred stocks may decline in price, fail to pay dividends, or be illiquid. Non-Diversified: The Fund is non-diversified and may be more susceptible to factors negatively impacting its holdings to the extent that each security represents a larger portion of the Fund’s assets. Short Sales: The Fund may engage in short sales, and may experience a loss if the price of a borrowed security increases before the date on which the Fund replaces the security. Leverage: When a Fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded. Derivatives: Investments in derivatives such as futures, options, forwards, and swaps may increase volatility or cause a loss greater than the principal investment. No Guarantee: There is no guarantee that the portfolio will meet its objective. Prospectus: For additional information on risks, please see the Fund’s prospectus.
PFFR Exchange-Traded Funds (ETF): The value of an ETF may be more volatile than the underlying portfolio of securities it is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities. Preferred Stocks: Preferred stocks may decline in price, fail to pay dividends, or be illiquid. Real Estate Investments: The Fund may be negatively affected by factors specific to the real estate market, including interest rates, leverage, property, and management. Industry/Sector Concentration: A Fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated Fund. Passive Strategy/Index Risk: A passive investment strategy seeking to track the performance of the underlying index may result in the Fund holding securities regardless of market conditions or their current or projected performance. This could cause the Fund’s returns to be lower than if the Fund employed an active strategy. Correlation to Index: The performance of the Fund and its index may vary somewhat due to factors such as Fund flows, transaction costs, and timing differences associated with additions to and deletions from its index. Market Volatility: Securities in the Fund may go up or down in response to the prospects of individual companies and general economic conditions. Price changes may be short or long-term. Prospectus: For additional information on risks, please see the Fund’s prospectus.
AMZA Exchange Traded Funds (ETF): The value of an ETF may be more volatile than the underlying portfolio of securities the ETF is designed to track. The costs of owning the ETF may exceed the cost of investing directly in the underlying securities. MLP Interest Rates: As yield-based investments, MLPs carry interest rate risk and may underperform in rising interest rate environments. Additionally, when investors have heightened fears about the economy, the risk spread between MLPs and competing investment options can widen, which may have an adverse effect on the stock price of MLPs. Rising interest rates may increase the potential cost of MLPs financing projects or cost of operations, and may affect the demand for MLP investments, either of which may result in lower performance by or distributions from the Fund’s MLP investments. Industry/Sector Concentration: A fund that focuses its investments in a particular industry or sector will be more sensitive to conditions that affect that industry or sector than a non-concentrated fund. Short Sales: The Fund may engage in short sales, and may experience a loss if the price of a borrowed security increases before the date on which the Fund replaces the security. Leverage: When a Fund leverages its portfolio, the value of its shares may be more volatile and all other risks may be compounded. Derivatives: Investments in derivatives such as futures, options, forwards, and swaps may increase volatility or cause a loss greater than the principal investment. MLPs: Investments in Master Limited Partnerships may be adversely impacted by tax law changes, regulations, or factors affecting underlying assets. No Guarantee: There is no guarantee that the portfolio will meet its objective. Performance Data: Performance data quoted backtested results. Backtested Performance was derived from the retroactive application of a model developed with the benefit of hindsight. Backtested performance is no guarantee of future results and current performance may be higher or lower than the performance shown. Investment return and principal value will fluctuate so your shares, when redeemed, may be worth more or less than their original cost. Please visit https://www.virtus.com/products/virtus-infracap-us-preferred-stock-etf#shareclass.742/period.quarterly for performance data current to the most recent month-end and the Fund’s standard performance information. You should consider the Fund’s investment objectives, risks, charges, and expenses carefully before investing. For PFFA, PFFR, and AMZA funds, contact VP Distributors LLC at 1-888-383-4184 or visit www.virtusetfs.com to obtain a prospectus that contains this and other information about the Fund. The prospectus should be read carefully before investing.
Virtus ETF Advisers, LLC serves as the investment advisor, and Infrastructure Capital Advisors, LLC serves as the sub-adviser to PFFA, PFFR, and AMZA. These three funds are distributed by VP Distributors, LLC, member FINRA, and a subsidiary of Virtus Investment Partners, Inc.
Past performance is not indicative of future results.
The links to the fund fact sheets will provide standardized performance and risk disclosures.
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