FEBRUARY 2025 EDITION:
Commentary and Economic Outlook
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 | Top Headlines from Commentary and Economic Outlook: |
We believe there will be 5-10% tariffs put on most imports to the US. We forecast that this is very bullish for the stock market as the revenue from tariffs will be used to fund a substantial corporate income tax which will power the stock market over our $7,000 target. The tariff’s price impact will be muted by a very strong dollar that has rallied 8% since Trump’s election became obvious.
The economy is slowing with construction and overall investment turning negative in Q4 and growth decelerating in response to higher 10-year rates, which is the only financial condition that matters. Continuing claims are rising and PMIs were weak on Friday. We forecast growth to continue to decelerate into the 1-2% area.
We launched a new high yield bond ETF (BNDS), and we expect high yield bonds and preferreds to outperform other fixed income as a strong stock market drives spreads lower.
Pundits are ignoring the impact of rapidly rising minimum wages on the demand for low skilled labor as an offset to potential deportation of low skilled workers.\
We expect the new administration to be focused on cost containment, cuts in corporate taxes and lower deficits as the Treasury secretary has said. The market fears a massive increase in the deficit. Tariffs reduce the deficit and make a larger corporate tax cut possible.
Education is the key to leveling the economic playing field and eliminate poverty. Most low income students are disadvantaged relative to high income students due to unequal access to formal and informal tutoring.
| Stock Market: |
We are bullish on stocks with a $7,000 target on the S&P 500 Index assuming an 18% effective corporate tax rate is enacted. Our target represents 22x consensus 2026 S&P Estimate of $318after adjusting for a reduction in the corporate tax rate from 21% to 18%. The 22x multiple is justified by the lower corporate tax rate which drives higher returns on invested capital resulting in higher earnings growth. If there is no corporate tax cut our S&P target falls to 6,600 and if there is a full cut to 15% our target rises to 7,500.
Corporate tax cuts are the key driver of economic growth and stock prices. The IMF estimated that a 10% increase in country savings drives economic growth by 1.5%.
Earnings growth comes from investment of retained earnings and depreciation not margin expansion.
Most government policies, including immigration and tariffs, have an immaterial effect on inflation or growth. Corporate tax policy and major changes in anti-trust enforcement do have an enormous impact on economic growth and stock prices. Most market forecasters, including the Fed, are ignoring the inflation and growth impacts of the dollar appreciating by 8% over the last 3 months.
| Bond Market: |
We remain bullish on bonds despite the recent sharp selloff of 10-year treasuries in response to a hawkish Fed and expect the 10-year to move into the 3.5%-4.0% range by the end of the first quarter of 2025.
The best cure for higher rates is higher rates. There has been almost 120bp of tightening in financial conditions and associated increase in the dollar that has not yet been reflected in economic growth or 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:
If rates remain in the current 4.75% range with the 30-year mortgage over 7%, we will have a significant decline in housing leading to slack in the labor market and slow economic growth. The current 7.3% rate is only 70bp below the high for the Century and over 200bp above the 25-year average. Tight Fed policy has already triggered a housing recession with residential investment declining by an average of 3.5% over the last two quarters. We believe the only financial condition that matters is the 30-year mortgage rate as housing declines have caused 11/12 post WWII recessions.
The “Hatfield Rule” is a recession indicator which states that if housing starts drop below 1.1MM there will be a recession. It is superior to the “Sahm” rule as housing is a leading indicator and employment is a lagging indicator.
We believe Trump administration policies are actually deflationary as pro-growth policies reduce inflation (quantity theory of money) and strengthen the dollar which has already appreciated by 10%. Dollar appreciation is highly deflationary and would almost fully offset any potential tariff increases.
| Economics & Fed: |
We forecast CPI next week will print slightly cool at .26% but more importantly it will imply a PCE of .2%, which will cause Y/Y core PCE to decline to 2.5%, which will allow for future Fed rate cuts.
We continue to believe the Fed and the market are completely wrong (as usual in the case of the Fed) about the inflation impacts of Trump administration policies.
Anticipation of Trump policies have caused the dollar to strengthen by 10% which is highly deflationary. We believe the fact that almost no one has acknowledged this fact indicates that fears of inflation are more driven by politics instead of sound economic analysis.
Recent economic data show that inflation continues to steadily moderate with the last PCE core coming in at .1% and PPI coming in at .2%, and CPI coming in at only .2%. We forecast that Core PCE will come in at a cool .2% at month end.
Inflation is caused by excessive monetary growth, but the money supply is has shrunk by 3% over the last year.
The Fed is deeply flawed and needs to be reformed.
The Fed has been a disaster since they adopted the explicit 2% ceiling for inflation in 2006 when Bernanke took over as Chair, which precipitated the Great Financial Crisis.
The inflation target should be a range of 2-3% and should not have a single index to determine inflation as the Core PCE calculation is deeply flawed and caused the Fed to miss the inflation spike and now is causing the Fed to fail to recognize that inflation is below its target.
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”.
The Pandemic was nearly a perfect test of monetarism vs. Keynesianism and monetarism won. 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 monetary base shrank 3.5% Y/Y indicating we are headed for deflation if the Fed does not cut rates significantly.
We forecast that PCE-Core will roll down to below 2.5% by the end of the first quarter and to 2.1% by year-end of 25 allowing the Fed to cut 3-4 times next year. The key driver of that decline is the shelter component of CPI which has finally decelerated to the .2% level from the .5% monthly run rate. The BLS shelter inflation measure lags market rates by 18 months.
Our CPI-R real time inflation index which uses market rental rates to estimate shelter inflation is at 1.5% Y/Y for core and PCE-R Y/Y is at 1.8%, with auto services driving over .7% of the CPI-R headline increase.
| Commodities |
We believe oil to trade in the range of $70-80 / barrel for 2025.
We expect President Trump to pressure the Saudis to increase oil supply and keep oil under $80/barrel
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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