Here’s one that we’re guessing was not on your 2024 bingo card. The president of a populous and economically important Asian country decides to declare martial law, attempts to take over the media and use the military to shut down parliamentary proceedings, only to then say “just kidding” and find himself the target of impeachment by that very same parliament. All within a span of twenty-four hours. The country, of course, is South Korea and this really did happen this week, for reasons that remain shrouded in the fog of dissembling attempts at explanations by various South Korean parliamentarians and others on the scene.

Meanwhile, over in Europe, Michel Barnier became France’s shortest-lived prime minister since the beginning of the Fifth Republic in 1958, following a no-confidence vote that effectively brought an end to the very unstable parliamentary coalition that has been trying to run the country for the past ninety days. The Eurozone’s second-largest economy is now essentially without a functioning government, just weeks before it needs to pass a budget in order to avoid a complete shutdown of services and payments. Oh, and don’t forget that Europe’s largest economy, Germany, is also heading for snap elections in February after its governing coalition pulled the plug on itself last month in the wake of various scandals and interparty feuds.

With all this going on, one could easily have missed this headline in today’s Financial Times about yet another European polity: “Romania annuls election after alleged Russian meddling.” Well, at least the rule of law still seems to be working there, maybe.

And in the always-volatile Middle East, Syrian rebel forces captured the country’s second-largest city, Aleppo, and are gaining ground elsewhere in the country as the government of authoritarian strongman Bashar al-Assad struggles to remain in power. The Syrian conflict has broader geopolitical implications given Russia’s longstanding support for the Assad regime. Russian citizens in Syria are being advised by their embassy in Damascus to leave the country via any airports not yet under the control of the rebels.

Financial markets have a storied history of ignoring geopolitical events, and this week proved to be no exception to the rule. South Korea’s equity indexes registered declines in the neighborhood of one percent in the wake of whatever this week’s political developments could be called – not much more than a bump in the road. Ten-year government bonds in France – which, again, could be in a very large pickle should the non-functional government fail to pass a budget – are yielding around 2.9 percent, 0.3 percent or so lower than they were in early November. “Keep calm and carry on” seems to be the order of the day.

Back here in the good old US, equity markets mostly rose without making much noise this week, while the financial news media to a man and woman remained singularly fixated on the apparently mind-blowing phenomenon of bitcoin breaching $100,000 (the fact that bitcoin still does not actually, you know, do anything went largely unmentioned during the breathless commentaries by the punditocracy). Meanwhile, this week’s macroeconomic news largely set a benign backdrop: decent jobs reports including a better-than-expected 227,000 additions to nonfarm payrolls in the BLS report today; signs that the recent contraction in manufacturing activity may be turning around; and improved consumer vibes reflected in this morning’s Michigan sentiment report. A batch of generally positive earnings reports from tech companies also helped.

We’ll take good macro news any day of the week, and for the time being there’s enough of that to go around. But things seem decidedly off as we look around the world. We can’t price things like the chaos in South Korea into rational valuation models – there are no meaningful quantitative inputs for either-or outcomes like that. But we need to pay attention, even when the markets are quiet. Too quiet, one might say.

On Tuesday morning this week, investors awakened to animated chatter in the financial media about tariffs, lots and lots of tariffs, aimed directly at our country’s three largest trading partners – China, Mexico and Canada. Twenty-five percent on all goods imported from the latter two, and an additional ten percent on top of the tariffs already existing with respect to China.

Now, to be perfectly clear, if this proposal were to make its way from effervescent bloviating on social media to become actual policy, it would have decidedly negative consequences in the form of slower growth and higher inflation. Stagflation, as they used to say back in the disco days of the late 1970s, and those of us who were around back then remember a lost decade for both equities and fixed income. Someone investing in the S&P 500 on November 29, 1968 and holding that investment until August 12, 1982 would have earned a cumulative return over that almost-fourteen year period of minus 5.5 percent. Not great. To paraphrase a saying popular back in the Seventies, stagflation is not healthy for children and other living things.

So what did markets do on Tuesday, following the news about these supposed tariffs? Well, not much of anything, actually. After watching most of Asia and Europe lose ground, US stocks opened higher and wafted gently upwards as the day went on. The bond market – where one might expect rates to pop on expectations of higher inflation, likewise found its moment of Zen. The yield on the benchmark 10-year Treasury note is around 0.15 percent lower than where it was a week ago. What gives? Does the market know something we don’t, or is this serene mien a case of badly misplaced confidence?

Our best guess is that markets are going to remain in a wait-and-see mode until something comes along to make a definitive case otherwise. In other words, we are (probably) not going to see major gyrations every time some new pondering of possible policy burps itself into the conduits of social media. Investors have already given their collective-wisdom thumbs up to the new administration’s primary economic policy team, a collection of Wall Street-adjacent types who mostly care about the traditional Republican playbook of tax cuts and deregulation.

Sure, there will be lots of kabuki-like drama around tariffs, goes this line of reasoning. But behind the bluster, away from the spotlight, the sober types will keep things from going off the rails. What markets seem to be expecting, given their beatific calm heading into the Thanksgiving holiday, is that rather than a bunch of punitive tariffs coming into force on Day One, as yesterday’s announcement intimated, there will be some vague future date specified, likely of intermediate term, and the countries in question will have until then to make some grand gesture about cutting off illegal immigration or drug smuggling operations or whatever. A lot of show, but no economic gut punch when all is said and done.

We are neither convinced that the market has it right here, nor are we convinced that a wildly irresponsible tariff regime is going to come into effect on January 20, 2025. In other words, we are neither blissfully serene nor stewing in a wild panic. We will be watching many things very closely in the weeks ahead as we put our 2025 portfolio models in place.

In the meantime, though, it is Thanksgiving week, and we will use this time to be thankful for the many blessings in our lives. We hope that each and every one of you will do the same. A happy, healthy and restful Thanksgiving to all.

There will, probably, be a time again when it will make sense to have a significant allocation of non-US equity indexes in one’s investment portfolio. But that time, in our considered opinion, is not today.

As the end of the year approaches, our primary focus as always turns to our asset allocation choices for the year ahead. Some years can elapse quietly with minimal tweaks to portfolio weights, while others require extensive rethinks on a more frequent basis. We imagine that 2025 will fall into the latter category. Fair warning: our model portfolios in June may look quite different from their appearance in January. Maybe that rethink will include a fresh take on non-US equities. But nothing today is telling us to expect a shift away from what has been perhaps the single most enduring advantage in equity allocation for several decades now, and that is US large cap equities. Consider the evidence, as shown below over multiple long, intermediate and short time periods.

The upper-left quadrant in the above chart sums it up neatly: if you had invested $100 in the S&P 500 index of large-cap US stocks in 1990, that $100 would be worth $1,683 today. Had you opted instead to invest it in emerging markets (via the MSCI Emerging Markets index, shown in green) your investment would be worth $505 today. Moving on down, a decision to go with developed economies outside the US, here represented by the MSCI EAFE (Europe, Australasia and Far East) index, would leave you with just $216 today, thirty-four years later.

And that’s without taking risk considerations into account. Both non-US indexes (particularly emerging markets) exhibited a higher level of volatility over this period than the US, turning on its head the traditional mantra of “higher risk for higher return” that the finance textbooks teach us. The US advantage has held up consistently in shorter time periods as well, right down to the last twelve months. As the chart in the bottom-right quadrant shows, the S&P 500 in 2024 maintained its advantage throughout a year which many in the financial chattering class thought would finally mean-revert to favor non-US opportunities.

The root causes of this enduring advantage are several. We think two of them offer the most convincing explanations: first, the dominance of information technology in domestic US indexes; and, second, the flatlining of the China supercycle from the mid-2010s as the world’s second-largest economy failed to rebalance towards a more equitable distribution between industrial production and consumer spending. Let’s take each of these in turn.

US large cap equity indexes are dominated by a small number of technology companies that own a vast amount of the intellectual property that powers our economy. This intellectual property is pervasive across the entire spectrum of industry sectors from finance to retail to manufacturing. There simply is no comparable pool of high-tech IP present in the equity indexes of our peer developed economies. Information technology makes up less than nine percent of the EAFE index by sector weight, compared to 31 percent of the S&P 500. And that’s not even counting the contribution of four companies – Alphabet (Google), Meta (Facebook), Amazon and Tesla that are technically not part of the “information technology” sector (Alphabet and Meta being constituents of the communications services sector while Amazon and Tesla reside in the consumer discretionary sector). Those four companies alone make up twelve percent of the S&P 500’s market cap, in addition to the 31 percent in the IT sector.

Over in the world of emerging markets, it has largely been a story of China and everybody else, at least until recently (we have our eyes on India as a potential challenger). In the 1990-present chart above (upper-left quadrant) you can see the effect the China supercycle in its heyday had on the emerging markets index, from roughly 2002 to 2012. China came out of the 2008 global financial crisis in a stronger position than most of the developed world and seemed well-positioned to make a serious challenge for global leadership. But that all stalled out in the middle years of the 2010s as Beijing’s economic policymakers made several half-hearted attempts to rebalance the economy and bring its consumer spending component more closely in line with that of other countries. It never managed to pull it off, always reverting back to the tried-and-true formula of increased spend on manufacturing and, especially, property development. The Chinese property market today is in a slow-burning collapse, with its largest enterprises bankrupt or in serious financial trouble, and its discontented homeowners shutting down their monthly household expenditures. The economy is dangerously close to tipping into a deflationary cycle reminiscent of Japan in the late  1990s and early 2000s.

These structural challenges to both developed and emerging non-US markets would have been present regardless of how the recent US election went, with the attendant implications of trade hostilities, tariffs and sanctions replacing the seemingly bygone world of free trade and open borders. Those only add to our conviction that now is not the time to be making a meaningful move into non-US equities. This all may change, and probably will, sooner or later. But not yet.

So what do we know now that we didn’t know one week ago, regarding possible trajectories for the US economy? To be perfectly honest, not much. But if it is still too early to talk about the economy of the future, we can at least take stock of where we are starting from. We call it the 4-3-2 economy, which we think is a reasonable way to quantify what a soft landing looks like:

Four (4) percent unemployment (the current unemployment rate is 4.1 percent).

Three (3) percent real GDP growth (3.0 percent in Q2 and 2.8 percent in G3).

Two (2) percent inflation (still higher by most measures, but headline PCE is currently 2.1 percent).

Here’s the 4-3-2 economy in one simple chart.

This is the economy the current administration will be handing over to the next administration. But let’s remember a couple important facts. First, if any institution in Washington can legitimately take credit for this economy, it is neither in the White House nor in the halls of Congress, but in the Eccles Building where the Federal Open Market Committee, since March 2022, has guided interest rates higher to break the back of inflation (getting that number back down to two percent) while not wreaking misfortune on the labor market (a four percent rate of unemployment is cooler than  the blistering, historically low levels of 3.4 percent in early 2023 but well below the plus-five territory that typically accompanies a recession. Those two numbers – inflation and the unemployment rate – represent the Fed’s dual mandate of maintaining stable prices and full employment. If the central bank can pull off that tricky feat (which most don’t, hence the “soft landing” normally being the stuff of economists’ dreams rather than reality), then a decent pace of economic growth should ensue. Three percent real GDP growth is healthy; in fact, it is probably pushing the boundaries of what the US economy is capable of achieving steadily over the long run. The Fed may have been late to the party when it made the first increase to the Fed funds target rate in March 2022, but it appears to have pulled off the soft landing.

The other important fact to remember is that the economic cycle ultimately depends on the decentralized decisions made by households and businesses around the world as to how much they intend to spend (households) and invest in productive capacity (businesses), and these economic agents only pay sporadic attention to what the legislative and executive branches of the government are doing (e.g., when tax rates change or business regulations come into or out of existence). Throughout the cycle when interest rates were going up, we heard a similar refrain on many of the quarterly corporate earnings calls we dialed into: “macro uncertainty is high, and we have less conviction around our sales targets in the coming twelve months.” Yet consumers kept on spending.

Then, in 2023, businesses started investing again at levels not seen since the end of the 2008 global financial crisis. The catalyst for this new wave of spending, as we all know very well, was newfound enthusiasm about artificial intelligence as the apparent wonders of generative AI made themselves known. Now, there is still much debate about how useful all this capital investment will prove to be. Maybe it will be a productivity game-changer, maybe not (we are ever so cautiously on the side of thinking that it will). But it has certainly contributed to that 4-3-2 soft landing.

Nor should it come as a big surprise that the US stock market has continued to set record highs throughout the year, as the probability of the soft landing rose and with it the permission slip for the Fed to start cutting rates. The consensus forecast of analysts who cover S&P 500 companies is for mid-single digit growth in top line sales, with bottom-line earnings per share growing by around ten percent – with this trend likely to continue into the first quarter of next year.

That’s where things stand today in the US economy. As we noted last week and will continue to observe in the weeks and months ahead, what works today might not work tomorrow. But it is a good starting point, and we would have to imagine that the rational course of action for any policymaker being handed a 4-3-2 economy would be to do as few things as possible to make it worse. That’s not a guarantee by any means, but we think it’s about as good a starting point as one could hope for.

Our weekly market commentary has never been the space for hashing out politics, and that will not change going forward. But every now and then, politics and the economy intersect in a meaningful enough way to merit top consideration among all the topics we might cover. So it is, in the days following what is likely to be recorded in the history books of the future as one of the most consequential elections in modern American history. What does the election mean for the economy, and what opportunities and risks might be ahead in the coming year?

Let’s start by putting our own politico-economic cards on the table. We are, by and large, globalists, believing that our own domestic economy benefits greatly from the advantages of free trade and the intricate, globally-linked supply chains that optimize the factors of production, logistics, research & development, marketing and sales to deliver goods and services at the right time, at the right price, to the right customer in the right location. The Global Age – our expression for the economic era that ran more or less from the early 1980s to the mid-2010s – was by no means perfect. But it established the foundation for what remains today the strongest economy in the world, despite the major setbacks of the 2008 global financial crisis and the 2020 Covid-19 pandemic. An economy growing at steady clip of around three percent, with unemployment barely over four percent and inflation heading back down to two percent, home to the lion’s share of the globe’s most innovative enterprises, is an economy that deservedly remains the envy of the world.

This could change, radically, if some of the most extreme economic ideas heard on the campaign trail, about sky-high tariffs and an ultra-protectionist turn away from a multilateral trade system towards narrow, selective and restrictive bilateral arrangements, become actual policy. We have reason to believe that they won’t, and that is where the “guardrails” of this article’s title come into play. Markets – organic, decentralized and efficient in rendering an apolitical verdict in the form of a price – will let us know if the incoming administration’s economic policies are working or not, mostly likely before they even happen. We have already seen a taste of this. Not in the unchained animal spirits of the stock market in the immediate aftermath of the election, but in the spike in bond yields, with the 10-year Treasury yield opening Wednesday morning nearly one percent higher than its level back in mid-September.

Structurally high tariffs and other protectionist measures, combined with a potentially draconian crackdown on immigration, in the absence of countervailing productivity-enhancing measures, would be a recipe for the return of that one thing on the minds of so many of the Americans casting ballots for Republicans this week – inflation. The bond market will warn us first, but eventually the stock market will follow suit. The good news? This incoming administration is going to take any warnings from the market seriously, because the market – financial markets in general and the stock market specifically – is how the former and future president himself measures his own performance more than by any other yardstick. If the market renders a negative judgment on a set of policies, those policies are likely to be withdrawn and replaced by ones more market-friendly.

Friedrich A. Hayek, an Austrian economist of the mid-twentieth century and one of the original founders of what became known as neoliberalism, said that price was the ultimate arbiter of democracy in a free society. An individual “votes,” in a sense, by deciding to accept the price of one thing while rejecting that of another. When the micro behavior of individuals aggregates to the macro expression of markets, the result is a guardrail against potentially destructive policies.

Does this mean we can all sit back and coast along with a traditional allocation of equities and fixed income in 2025? Of course not – there are always plenty of ways things could go pear-shaped, and we need to be highly attentive to developments as they unfold when the new team takes over in January. For now, we believe the best approach is a “wait and see” position. That implies, among other things, that we will be even more deliberative as we assess our duration and credit risk positioning in the bond market. We hope that we are correct in our assessment of markets as the most effective guardrails in place as policymakers consider their economic agenda. If not, though, we will be ready to take action accordingly.

Here is what has happened, is happening and will happen between this past Tuesday, October 29, and next Thursday, November 7: the third quarter US Gross Domestic Product (GDP) report; the September Personal Consumption Expenditure (PCE) inflation report – the one the Fed pays the most attention to – the September jobs report from the Bureau of Labor Statistics; the highly consequential US election; and the Federal Open Market Committee (FOMC) meeting that is expected to end with another cut to the Fed funds target rate. Not to mention a bevy of quarterly earnings reports from companies including tech behemoths Google, Apple, Microsoft, Amazon and Meta. All this furor, in a span of just ten days.

Not Much To Change the Script

So far, at least, there hasn’t been much to alter the longstanding market narrative of a soft landing with the continuation of the growth cycle at a more moderate pace. In the realm of corporate earnings reports, much was made of a “disappointing” report from Microsoft on Wednesday. Disappointing in the sense that the forward guidance for sales in the company’s Azure segment (cloud services) was “only” 31-32 percent, at the lower end of analysts’ expectations. Meta took a hit in the market over concerns about AI-related capital expenditures, while Google and Amazon got a tailwind from upbeat AI commentary. All told, the main takeaway from the AI debate seems to be that nothing much changed. If you are in the camp that sees this as just the latest iteration of tech bubble mania, you can make your case. If you think it is a productivity-enhancing game changer, you can likewise make your case. The debate goes on.

Likewise with the macro data. PCE came in right about where expected, and the headline number (which the Fed doesn’t care as much about but which is more important for actual households) is now at 2.1 percent. Jobs data was noisy, with a survey from ADP showing better than expected job gains, while today’s BLS report showed a much lower number of nonfarm payroll gains, due in no small part to the twin effects of the Boeing strike (adding to an overall decrease of 46,000 jobs in manufacturing) and the late September / early October damage caused by hurricanes Helene and Milton. The unemployment rate remains unchanged at 4.1 percent. Real GDP in the third quarter grew at a healthy pace of 2.8 percent, slightly more than expected and in line with recent quarters. Net-net, the soft landing narrative remains intact.

Votes and Rates

Much of America has already voted; turnout at early voting sites across the country has reached record numbers. By Tuesday evening all the votes will be in, though in many places including some of the most consequential battleground states (ahem, Pennsylvania) the counting is likely to go on for several more days at least. Whether or not we know anything definitive by Wednesday morning about who will be occupying the White House and the two chambers of Congress, we should at least have a sense as to the likelihood or not of a sweeping mandate in one direction or the other. Wall Street, in time-honored fashion, would likely be in its sunniest frame of mind if it looks like a split decision, with both parties claiming at least one of the three prizes on hand. That could put a restraint on the recent upward trend of intermediate-term interest rates.

More voting happens on Thursday, when the FOMC is likely to decide that another cut of 0.25 percent is warranted for the Fed funds target rate. That was the base case coming out of the FOMC’s Summary Economic Projections in September, and there really hasn’t been much since then that would seem to argue for a change of mind. We could always get a surprise, of course, but this Fed has managed to stay pretty surprise-free while engineering the two years of monetary tightening and then easing back into deliberative rate cuts. We don’t expect that to change.

There is plenty at stake for us as a country, and a lot that we will have to navigate through regardless of how the election turns out. The good news is that we have a strong economy that appears well positioned to continue delivering healthy results as we head into 2025. The Economist magazine – as sober-minded a journal as there is – was not wrong when its cover last week featured a wad of dollar bills blasting into space alongside the heading “The Envy of the World.” We have our problems, but a weak economy is not one of them.

Over a very long history as a mainstay of the economic landscape, gold has been many things to many people. During the Second Industrial Revolution, from around the 1870s to the outbreak of the First World War, the precious metal was the sole arbiter of international monetary policy. Any nation aspiring to a place in the energetic world of global trade in those days had its currency indelibly fixed to the value of an ounce of 11/12 fine gold (that precise measurement translated into three British pounds sterling, seventeen shillings and nine pence, a unit of exchange to which everything else that mattered from US dollars to French francs and Russian rubles was anchored).

A Hedge Against What?

Many decades have passed since gold was last a major factor in global monetary policy (that ended when then-President Nixon closed the exchange window on gold for a fixed amount of $35 dollars per ounce in 1971). Its principal role since then, arguably, has been to serve as a hedge of sorts against movements in other kinds of assets, or against general economic inflation. During the notorious “stagflation” years of the late 1970s, with double-digit consumer inflation and anemic real economic growth, the price of gold soared while investors in equities and fixed income during that period largely got burned.

It’s interesting, then, that gold has more recently been behaving in a rather atypical fashion. The post-pandemic inflation we have all been living with for four years peaked in 2022, with the Consumer Price Index topping out at nine percent in June of that year. The price of gold was essentially flat that year, with an ounce of spot market gold trading around $1,810 at the beginning of January and the end of December. No need for an inflation hedge, apparently.

But maybe that was because interest rates were also going up in 2022, right? Gold doesn’t pay interest, so when rates go up for the safest of assets, that should take some of the shine off the metal. Sounds reasonable – but then again, the price of gold increased by around 25 percent from November 2022 to May 2023, a period during which the Fed raised the Fed funds target rate by 1.75 percent. There doesn’t seem to be a consistent inverse correlation with fixed income, either.

Against Everything, Maybe

That brings us to today. We’re not writing about gold in 2024 because of what it did in 1979 or even 2022, but because it has gone up in value by 39 percent from the same time one year ago. Was gold just part of a broad-based rally that has included most equity asset classes? Not according to the time-tested view of gold as a risk-off asset, which one would expect to be underperforming during a period of risk-on growth for equities. The S&P 500 is up 22 percent or so for the year as we write this – a nice return, but trailing gold’s 31 percent gains since January. Most recently, since the Fed’s decision to cut the Fed funds target by 0.5 percent in September, the yield on the 10-year Treasury has actually gone up by a whopping 0.6 percent to its highest level since July – and gold has rallied right alongside the spike in the bond yield.

In fact, there most likely is not one specific thing to which one can point and say – aha, gold is hedging against that. Perhaps it is not one thing but, rather, everything – everything that one could be nervous about today but cannot pinpoint exactly. Geopolitical unrest, historically high peacetime deficits, the stability of the dollar-based global trade system – heck, the political stability of some of the world’s leading economies. Things you can’t quantify in terms of magnitude or timing in your scenario planning exercises, things that may or may not be actualizable risks today or tomorrow or ever, but things that keep you up at night anyway.

We have a process by which we look to traditional equity and fixed income asset classes and ask ourselves: are these exposures providing all the solutions we believe we need to accomplish the three goals of growth, safety and income for each of the portfolios under our management? If yes, then no need to venture farther afield – Ockham’s razor applies (simplest solution that achieves the target outcome). But we always need to be aware of what else is out there, to understand the properties of alternative asset exposures, and to decide when and how they may be necessary additions. We do not take these decisions lightly, and we do not act rashly in jumping onto short-term market trends. But we always have to ask “why?” and decide if there is something there worth pursuing.

Yesterday we were participating in a panel discussion at a wealth management conference near Philadelphia, and the moderator posed an interesting question. Looking beyond the short-term environment of the next twelve months or so, he asked, what are the biggest structural concerns that keep you up at night? That’s a question that rarely gets asked at these types of events, or really anywhere in the public financial discourse, where the conversation tends to focus on the immediate, the here and now of the Fed and monthly jobs reports and quarterly earnings calls. In a world where multiple news cycles can happen in a single calendar day, sometimes it is important to stand back, clear one’s head and think about the bigger picture. Here is a brief digest of our answer to that question.

The Greatest Bull Market Ever

Let’s set the table for this discussion with a focus on a multi-decade bull market. No, not the stock market of the late 1990s, or anything that happened in equity markets since then. We’re talking about the bull market in bonds, which began in the early 1980s and persisted, more or less, through the zero-interest rate policy (ZIRP) world of the 2010s and again in response to the Covid-19 pandemic. The yield on the 10-year Treasury note, shown in the chart below, fell from mid-teens levels in 1981 to less than one percent at the height of ZIRP. Through multiple economic cycles and five recessions, rates for the most part kept going down, down, down.

Three Tailwinds, Working Together

That benevolent structural bond market environment was largely due to three enabling tailwinds. The first was the large-scale entry of women in the US labor force, a dynamic that began in the mid-1970s and more or less topped out in the 1990s. The labor force participation rate rose from 59 percent in the early 1970s to 68 percent by the end of the 1990s. This had the effect of raising average household incomes – the dual-income household as the new normal – while at the same time keeping wage growth in check due to the added supply of job seekers.

The second tailwind took place in China, where the reform policies of Deng Xiaoping in the early 1980s brought about a massive migration of Chinese workers from their rural homes to big cities, where they became part of the fastest and most successful industrialization in history. This had the effect of sharply lowering the cost of labor. But it was the third tailwind – the globalization policies of economically developed nations in North America, Europe and the Asia Pacific Region – that opened up China’s supply of cheap labor to all corners of the globe. Eventually, globalization moved beyond simply access to cheap labor, and produced the complex industrial supply configurations optimizing all parts of the value chain from production to research & development, marketing and logistics.

Needed: A New Tailwind

Those three tailwinds have largely played out, meaning that there is not much more in the way of new productivity to squeeze out of any of them. And the tailwinds are dying down at the same time as global population demographics are starting to emerge as a real headwind. In the developed world, populations are either growing at a rate below the natural replacement level (the US and much of Europe) or in outright decline (Japan). In China, some observers estimate the population could be as low as half its size today by 2050. The population mix is ageing, so whereas the dynamic in the 1980s and 1990s was more workers, the new environment is more (older) non-workers dependent on fewer workers to provide for them. The most likely structural outcome of this demographic shift will be persistently upward pressure on wages and prices; i.e., higher inflation. Not today or tomorrow or next year, necessarily, but likely within the time horizons of many of our clients and their portfolios. We will have to think and act accordingly.

Unless, of course, a new tailwind comes along, and here is where we had something of a spirited debate at yesterday’s panel discussion. Could that tailwind come in the form of the advances we are seeing in artificial intelligence? That is an open question with many opinions, but without a definitive answer as yet. However, we are starting to see some evidence of the productive effect AI can have even in some of the traditionally least productive areas of the enormous services economy. There are even stories (believe it or not) of AI interfaces that can resolve customer service problems with human-like reasoning skills, so that the customer would think that she is actually being helped by a live human. That may sound far-fetched to anyone for whom “customer service” evokes Dante’s eighth circle of hell, but imagine the large-scale benefits of it actually coming to pass.

We are in a transitional period now, with more hard questions and fewer definitive answers. That can indeed keep us up at night. But we also have been in this business for many, many years now. With the experience of time and observation, we continue to have confidence in our economy’s ability to adapt and figure out solutions to even the most serious problems. A new structural tailwind or two would certainly be a big help in that regard.

A lot of things have been happening in the bond market as of late. What to make of the fact that, subsequent to the Federal Open Market Committee reducing the Fed funds target rate by a larger than usual 0.5 percent on September 18, Treasury yields across maturities from six months to 30 years have gone up? The benchmark 10-year yield is more than half a percent higher than where it was one month ago. The two-year yield, which sits in closer proximity to the Fed funds rate (the overnight bank lending rate) is up a quarter percent from where it was last week. And while the spread between the two-year and ten-year yields is no longer inverted, it has waxed and waned like a harvest moon in the three weeks since the FOMC’s rate cut move.

More Time, More Variables

When we meet in our weekly investment committee to discuss our fixed income strategy, we start with what we know with a high degree of certainty, and move from there into the fog of the unknown. What do we know at present? We know that the Fed is moving from a pause on monetary tightening into an easing cycle, which we expect will continue for the foreseeable future. Interest rates clustered around the Fed funds rate, which the Fed influences directly through its open market operations, should come down over the course of this cycle. We can posit with fairly high confidence that interest rates on Treasury bills (maturities up to and including one year) will be lower than they are today.

Moving farther out the yield curve, though, things get trickier. Consider the above chart, with the post-FOMC spike in intermediate Treasury yields. Yields out here rise and fall as the market ingests multiple data points about anything that can have an impact on the global economy. Notably, the last couple weeks have served up several important insights into the strength of the economy. Last week’s blockbuster jobs report erased all those concerns about a tanking labor market that impacted risk assets back in August. This week’s Consumer Price Index report showed that, while inflation appears to still be on its downward trajectory, price growth in September was a bit higher than economists expected. Ongoing strength in the economy suggests the absence of an environment that would prompt the Fed to accelerate its monetary easing, hence the pronounced rise in rates. But buyer (or seller) beware – that could change on a dime as yields lurch from one data point to the next. Volatility in the Treasury market, according to the Ice BoA Move index (a measure of expected bond market volatility) is at its highest level since the beginning of the year. Every macro report, every quarterly corporate earnings call, every unexpected flare-up somewhere in the world, adds to this cocktail of volatility.

De-inversion Tea Leaves

Then there is that persistent question about what the de-inversion of the yield curve means. After more than two years of inversion, the 2-10 Treasury spread normalized in early September. According to the textbook theories about inverted yield curves, it is when the curve returns to a normal shape that we should all start to worry about a recession. But – as we noted above – the economy is currently showing no convincing signs of any approaching recession. Is this the event that puts paid to the predictive powers of the inverted yield curve?

Here’s the thing: since 1982 – the year in which for many reasons we argue that the modern age of securities markets began – we have had a total of four recessions. One of those – the 2020 Covid recession, was manufactured by human hands. The other three – the 1990 cyclical downturn, the 2001 event adjacent to the tech stock crash and the 2008 Great Recession – have very little in common with each other.

Simply put, there just is not a lot of statistical significance behind the argument that “recessions follow inverted yield curves.” Maybe we’ll have one at some point next year, maybe we won’t. In the meantime, we will continue to position our fixed income portfolios according to the things we know with more confidence, and tread more carefully in the more uncertain terrain of intermediate and long durations.

It is supposed to be the month of March that comes in like a lion, out like a lamb, according to the custodians of timeless wisdom. This year, though, that appellation could just as well apply to September. After a volatile beginning, financial markets settled down and more or less calmly navigated the twists and turns of the daily news cycles. At the end of it all, the S&P 500 posted a gain of just over two percent from the beginning to the end of the year’s ninth month – not a shabby chunk of change.

So how is the final stretch of the year shaping up? Well, we’re barely a week into the fourth quarter, but there are a few reasons why it might make sense to move the arrow a bit more in the direction of the bull and away from the bear.

Jobs Mojo

Remember the market’s big freakout back in August, as a handful of jobs numbers raised fears among some observers that a recession was just around the corner? Well, those fears seem to have largely dissipated into the ether. We had more jobs data this week – from a job openings report on Tuesday to a survey by ADP on Wednesday and then the monthly employment report from the Bureau of Labor Statistics this morning – all coming in ahead of economists’ forecasts with a particularly strong showing in nonfarm payroll additions in today’s BLS report.

Oh, and in addition to the 254,000 increase in nonfarm payrolls this month, the BLS also revised up by 55,000 the July NFP number. So that 89,000 payroll gains figure that everyone was so distraught about is now a haler 144,000 (the August nonfarm payroll number also was revised up by 17,000). Moreover, the unemployment rate for September ticked down a bit to 4.1 percent. As the above chart shows, the labor market picture looks remarkably stable over the past two years, with a slight cooling from last year’s torrid pace, but nothing that resembles a downward spiral into recession territory. As always, we apply a note of caution when looking at data from a single point in time. The trend, though, does not make a compelling argument for approaching turbulence.

A Strike Averted

A second potential near-term concern fizzled out in this morning’s news dump when we learned that the strike begun by the International Longshoremen’s Association earlier this week, threatening a protracted shutdown of US ports just in time for the holiday season, was called off thanks to a partial agreement reached between the unions and the port operators. The strike, about to enter its fourth day, could have caused billions of dollars of damage to the US economy – a JPMorgan report suggested the economy could lose around $4.5 billion for each day of the strike. Not to mention the political implications, as the non-arrival of Amazon packages could have people in a less than festive mood as they mail in their ballots or head to the polls on November 5. The current agreement extends union members’ contracts until January 15 (with an eye-popping 62 percent increase in wages already agreed to), so at least that will get us through the holidays.

Election a Non-event for Markets?

There has been a lot of talk throughout the year (and more than our fair share of chats with nervous clients) about the potential impact of the upcoming election on markets. We’re about a month away from the event itself, but we really are not seeing much in the way of market jitters with any identifiable connection to the election. If you are inclined to believe the polls, the presidential race is nearly entirely within the margin of error, and thus essentially a coin toss come Election Day if momentum has not moved significantly one way or the other by then. Of course, the polls are not perfect oracles, and this year in particular it may be difficult to accurately model what the electorate of actual voters is going to look like.

Beyond the race for the top job, of course, there are also the consequential outcomes of the House and Senate that will figure directly into whatever prognostications one might make about the formation of economic policy next year. So rather than worry about something with too many variables at play, the market’s attitude would seem to be indifference. Que sera, sera. Of course, October is only four days old, and there still may be some nasty tricks out there, somewhere. For now, though, we’ll take the treats of good jobs numbers and open East Coast ports.