As MAGA returns to Washington, should President Trump advocate for more tariff or smaller Government?

Summary

As President Donald Trump embarked on his second term, he immediately set forth expansive plans to revamp immigration, the economy, and the justice system, including lifting the TikTok ban, demonstrating his intent to make impactful decisions quickly. For those worried about Congress limiting the President’s deal-making authority—which could affect U.S.-China relations—referencing the 1937 United States v. Belmont case is instructive. It highlights the considerable powers a President has to negotiate agreements independently of Senate or House interference.

While many pundits predict another tariff war with China, it’s more plausible that Trump will negotiate aggressively to forge a beneficial US-China deal. Such an agreement could rejuvenate the fortunes of America’s rust-belt regions, neglected by previous administrations, and potentially ignite a rally in Chinese equities, commodities, and related markets.

Targeted tariffs will continue to be a crucial strategy for protecting U.S. economic and international interests. However, in today’s global economy, the impact of broad tariffs as a major revenue source is considerably diminished. The real answer to America’s fiscal challenges lies in reducing government size, cutting regulations, and lowering taxes, as incoming Treasury Secretary Scott Bessent emphasized, pointing out America’s “spending problem” rather than a revenue issue.

With the resurgence of the “drill baby drill” policy, we anticipate significant reductions in energy costs this year. Despite signs of weakening in the labour market, I expect the Federal Reserve to implement more than two rate cuts this year. Questions about the Fed’s independence persist, especially under pressure from President Trump, who is likely to criticize the Fed at any sign of labour market downturn, pushing for aggressive rate cuts—which the “independent” Fed is likely to enact.

For market sceptics who have dismissed the recent bull market trends as merely a bear market rally, attributing it to various factors from greed to FOMO, the first quarter may prove challenging as the S&P 500 is set to climb higher.

MAGA returns to Washington

President Donald Trump is back—and he’s not holding back. Four criminal cases and a near-miss assassination couldn’t stop him. Sworn in as the 47th President, he thundered: “The golden age of America begins right now,” and unleashed sweeping plans to overhaul immigration, the economy, and the justice system.

Before addressing tariffs, the President’s issued day-one executive orders, with market implications and potential consequences for the future.

On Monday, hundreds of crypto executives and political power players gathered in the nation’s capital to toast what they believed would be a golden age for digital assets under the Trump administration. What they didn’t expect was Trump’s own foray into the meme coin frenzy.

“It’s time to celebrate everything we stand for: WINNING! Join my very special Trump Community. GET YOUR $TRUMP NOW,” Trump announced on Truth Social at 9 p.m., catching everyone off guard. A day later, Melania Trump upped the ante, revealing her own token, $MELANIA.

But the shocks didn’t stop there.

On Tuesday, at 11:38 a.m. (ET)—just 22 minutes before his Presidency officially ended— President Joe Biden issued sweeping, unconditional pardons for his siblings and their spouses. Earlier, Biden granted similar clemency to several prominent Trump critics, including Gen. Mark Milley and Members of Congress who investigated the Capitol riot on Jan. 6, 2021.

These “pre-emptive” pardons unprecedented in history of America, can have a huge bearing in the future. Trump and those that follow him, can now greenlight illegal actions by members of their administration, friends, or family, allowing them to operate without fear of consequences, knowing they will be pardoned. This opens the door to the alarming prospect of a lawless administration, whether driven by self-enrichment or the goal of undermining opponents.

As history echoes back to 1787, when Benjamin Franklin famously remarked that the Constitutional Convention had given the nation “a republic, if you can keep it.” This question now looms larger than ever.

What will the next four years bring? Will the republic endure, or will the boundaries of power be tested beyond repair?

Trump Returns: A New Chapter in the Oval Office

Source: The White House @WhiteHouse

Moving on to markets and the threat of tariffs.

At a hedge fund (HF) macro dinner last week—and during a breakfast meeting four weeks earlier with portfolio managers from several key HFs—I was struck by the strong views on tariffs and the possibility that Congress could limit the President’s authority in foreign policy. Such restrictions could hinder efforts to “ease” relations with China, a prospect causing considerable unease among market participants.

To understand the breadth of presidential power in this arena, one must revisit the landmark 1937 United States v Belmont case. This case emerged from the aftermath of the Soviet Revolution, during which the Bolsheviks seized and nationalized various industries and assets, including some held in the US.

Justice George Sutherland, delivering the Supreme Court’s opinion, affirmed that the external powers of the United States are exercised independently of state laws or policies. Article II, Section 3 of the Constitution grants the President authority to conclude binding agreements with other nations, underscoring the executive branch’s pivotal role in shaping international relations.

A summary of the case and context:

• U.S. v. Belmont (1937) examined whether the president could make binding legal agreements with foreign states. The case arose after the Bolshevik Revolution, which left ownership of some US-held assets unclear.
• In 1933, President Franklin Roosevelt recognised the Soviet Union and negotiated the Litvinov Assignment, an executive agreement to settle mutual claims. It transferred American-held assets of Russian companies to the Soviet government and vice versa, aiming to normalise relations.
• August Belmont Co., a New York bank holding Russian assets, challenged the agreement, arguing the president lacked constitutional authority to make binding agreements without Senate approval. New York state courts sided with Belmont, dismissing the lawsuit, citing conflict with state public policy against confiscating private property.
• The Supreme Court unanimously reversed this decision, affirming the president’s authority to recognise foreign states and use executive agreements, which are part of the “supreme Law of the Land” and override conflicting state laws.
• This ruling, reaffirmed in U.S. v. Pink (1942), established executive agreements as a constitutional tool in foreign policy, bypassing Senate ratification and expanding presidential flexibility in diplomacy.

This precedent highlights the significant implications of any congressional moves to curb the President’s executive power in trade and foreign policy—particularly as markets brace for potential tariff shifts.

This doesn’t rule out the use of higher tariffs—or the threat of them—as a negotiation tool. However, it underscores the significant power the President wields to strike deals, bypassing Senate or House constraints.

Trump wasted no time in lifting the ban on TikTok, signalling his readiness to act decisively. While many anticipate another tariff war with China, I believe a more likely scenario, is Trump driving a tough bargain to secure a mutually beneficial US-China agreement. Such a deal could revitalize the fortunes of Americans in rust-belt states, long overlooked by successive administrations, and potentially spark a rally in Chinese equities, commodities, and related markets.

Staying on Tariffs: Should Trump Advocate for More Tariffs or Champion Small Government and Lower Taxes?

The answer is clear: The latter.

To understand why, let’s look back at history and examine the plausibility of tariffs as a significant revenue source—starting with a chart that highlights tariffs’ limitations.

Strategically targeted tariffs remain a valuable tool for safeguarding the economic and international interests of the United States. However, in today’s interconnected global economy, the effectiveness of broad tariffs as a significant revenue source is severely limited. Elevating federal reliance on tariff revenue would likely worsen long-standing income inequality by shifting more of the tax burden onto lower-income households, while also introducing severe negative distortions to the broader economy.

In the late 18th and early 19th centuries, higher tariffs were essential for protecting the nascent US economy and its fledgling industries.

In the early 19th century, US industrialisation focused on labour-intensive industries like textiles, relying on imported machinery and exporting raw materials, leading to trade deficits. Protective tariffs supported emerging industries, while access to imports boosted development. Post-Civil War, industrialisation shifted to capital-intensive mass production, driven by advanced techniques and railroad expansion.

From 1870 to 1914, the US achieved trade surpluses, reducing import dependence, and increasing exports of manufactured goods during rapid economic growth. By the early 20th century, the US had emerged as a global industrial leader, running sustained trade surpluses. As its manufacturing base matured and exports outpaced imports, tariffs became less necessary and began to decline.

Over the next 70 years, US manufacturing dominance and innovation drove sustained trade surpluses, reinforcing the country’s economic strength.

Today, tariffs are no longer a critical revenue source. Consider the fiscal year 2023:

• Revenue Comparison: Tariffs generated $80 billion—just a fraction of the nearly $2.2 trillion collected in individual income taxes.
• Limited Impact: With $3.1 trillion in goods imports last year, even a universal tariff of 70% (unrealistic in practice) would barely replace individual income tax revenue, as such tariffs would decimate import levels.

It’s worth noting that 1913 saw the introduction of income tax, which significantly fuelled the expansion of the federal government.

The US federal government’s size and revenue needs have expanded dramatically since Alexander Hamilton’s tenure as Treasury Secretary in 1789. Even then, tariffs alone were insufficient to cover spending. Today, tariffs play a minimal role in federal funding, reflecting the evolution of the US economy.

If you think tariffs had little impact on the trade deficit during Trump 1.0, just imagine the fallout from a proposed 10% general tariff across the board. It won’t be the “big”, “beautiful”, “massive” win that Trump desires.

The true solution to America’s challenges lies not in higher tariffs, but in shrinking the size of government, reducing regulation, and lowering taxes.

As incoming Treasury Secretary, Scott Bessent aptly stated, “We do not have a revenue problem in the United States of America; we have a spending problem… This spending is out of control.”

As Trump 2.0 begins, the presidential stock market scorecard resets.

During Biden’s presidency, the Dow Jones Industrial Average (Dow) gained +39.4%—18 percentage points below Trump 1.0’s performance but still marking the third consecutive term of strong gains. While Biden’s Dow performance was the weakest of the last three presidents, it’s far from insignificant and places him among the top ten performing presidents since 1900.

Source: Bespoke Invest

Politics and markets operate on completely different dynamics, as businesses adapt to the policies and politicians of the moment.

Take all the Tech leaders who are now lining up to “kiss the ring” of Trump, despite having largely “sided” with his opponents over the last eight years.

In 2008–09, many investors who feared Obama’s so-called “leftist” policies missed out on a +149.4% rally in the Dow.

The same pattern repeated with scepticism around Trump in 2016 and Biden in 2020—both of whom delivered strong market returns despite being labelled a “dictator” and a “socialist“ respectively.

Let’s see what next four years bring!

Markets and the Economy

This week, Scott Bessent, President Trump’s pick for Treasury Secretary, appeared before the Senate Finance Committee, for his confirmation hearing.

There were several nuggets but this response to Senator Ron Wyden (D-OR) stood out for me.

WYDEN: “We’re in a clean energy arms race with China. Which side are you on?”

BESSENT: “China will build a hundred new coal plants this year. There is not a clean energy race. There’s an energy race.”

Bessent sought to ease concerns about Trump’s tariff proposals—especially the pledge for universal tariffs on imports—by arguing that factors like currency fluctuations and the actions of foreign exporters would mitigate potential inflation.

According to Bessent, a 10% universal tariff would likely cause the dollar to appreciate by approximately 4%, preventing the full tariff cost from being passed on to consumers. Moreover, he suggested that foreign manufacturers, particularly those in China, might lower their prices to maintain market share, further reducing the tariffs’ impact on consumer prices.

Bessent said Trump has “a generational opportunity to unleash a new economic golden age that will create more jobs, wealth and prosperity for all Americans.”

Global Equity Index Performance (2025 YTD, 2022-2025 YTD and 2024 Performance)

On Monday, legendary investor Stan Druckenmiller appeared on CNBC and shared his perspective on the new administration:

• “I’ve been at this for 49 years, and it looks like we’re shifting from the most anti-business administration to the exact opposite”
• “From our conversations with CEOs and companies on the ground, I’d say they’re feeling somewhere between relieved and outright giddy.”

A record-low percentage of countries are expected to be in recession in 2025 and 2026. (see chart below)

Is this a case of everyone finally jumping on the same side of the boat after repeatedly getting the recession call wrong?

Thanks to social media, the battle between bulls and bears has become more dramatic than The Lord of the Rings.

Regardless of the data, there’s always someone predicting a recession. The mantra seems to be – good news can’t last forever.

Source: Apollo

While much focus is placed on the US 10-year yield, attention should instead centre on the 10-year breakeven yield—the difference between nominal and real yields—which is widely regarded as a market-implied gauge of inflation expectations.

Over the past 2.5 years, breakeven have remained range-bound, signalling that markets are not overly concerned about inflation. The recent rise in 10-year yields reflects the market pricing in fewer rate cuts rather than inflation fears. However, expectations around rate cuts could shift again.

Could the 10-year yield reach 5%?

Yes, this is possible.

Here’s a straightforward breakdown of the math behind the 10-year bond yield:

• 2% inflation target + 0.25% inflation risk premium
• 2% real GDP growth + 0.25% growth risk premium
• 0.5% term premium

Total: 5%

Alternatively:

If growth falls short and drops from +2% to +1%, the 10-year bond yield could decrease to 3.5% or lower.

I’d be happy to lock in 4.5% on the 10-Year, as I do expect yields to go lower by the end of year and the US Federal Reserve (the Fed), to cut rates more than twice this year.

I say that because energy costs are set to decrease significantly over the year.

In my view, energy prices are by far the most influential drivers of inflation, with the labour market coming in as a secondary factor (after all, a strong labour market is generally a positive, unlike these inflationary pressures).

The final point that’s often overlooked is Trump is in the (White) House.

Do we really believe the Fed will remain fully independent? And Fed Chairman Jerome Powell can ignore what Trump says?

As soon as there’s a hint of weakness in the labour market, Trump will likely blame the Fed for not acting sooner, and he will exert heavy pressure to push for rate cuts and I can assure you the “independent” Fed will follow suit.

Also, we should not underestimate the deflationary potential of AI, which could serve as a balancing force in the “animal spirit” economy.

5-year price chart: US 10-Year breakeven yield (USGGBE10) and US 10Y Treasury yield (USGG10YR)

Source: Bloomberg

The US Treasury faces a significant amount of debt issuance over the next 12 months (see chart below), and maintaining Fed funds rates at current levels seems counterproductive, especially as inflation appears to have bottomed out. The only factor keeping headline inflation from approaching the +2% target is the distortion caused by “rents.”

In the most recent data, the core Consumer Price Index (CPI)—which excludes volatile food and energy prices—increased by just +0.2%, the smallest gain since July and below economists’ expectations of a +0.3% rise.

Headline CPI remains anchored in the +3% range, driven largely by owners’ equivalent rent (OER), which constitutes about 37% of the CPI basket. OER has moderated, with a year-over-year increase of +4.8% in December, down from +6.3% the previous year.

New tariffs didn’t materialize on Day 1 of Trump’s second term, as many had feared. For now, it seems a full-blown trade war may also be off the table.

Instead, Trump has directed his administration to investigate why the US trade deficit in goods continues to widen and to provide a compelling case for why this poses a national security risk.

Agencies tasked with this review face an April 1 deadline to report back, potentially setting the stage for new tariff proposals or hikes. By then, the Senate is expected to confirm two key figures in shaping and implementing these policies: Howard Lutnick as Commerce Secretary and Jamieson Greer as U.S. Trade Representative.

For those who’ve spent the past two years fighting this bull market—dismissing it as a bear market rally or blaming the yen, the Fed, valuations, buybacks, greed, FOMO, memes, bubbles, and more—it looks like Q1 may bring more pain.

Sorry!

Benchmark US equity sector performance (2023-2025 YTD, 2025 YTD, Since Nov. 5 US election, and 2025 YTD relative to the S&P 500 Index

Materials (XLB), healthcare (XLV), and consumer staples (XLP), appear particularly appealing as interest rates decline and recession fears recede. These sectors have underperformed the S&P 500 (see table above) by more than 40% over the past three years, making them potential opportunities for investors.

Tech (XLK), Communication Services (XLC), and semiconductor stocks have further room to grow as Trump doubles down on his “Make America Great Again” agenda. His announcement yesterday on Artificial Intelligence (AI) is a prime example. Trump’s message to the AI community is clear: Build aggressively and keep the US ahead of China in AI development, contrasting with the Biden administration’s more cautious stance on AI and its societal implications.

Also, since Trump is back, expect market volatility and drawdowns to increase as the market wakes up to his posts on social media. However, these are not anomalies, but rather inherent features of investing and should be anticipated, embraced, and strategically addressed. Predicting short-term market movements can be extremely challenging.

Hence, I highlight the value of equity structured products, as a highly effective investment tool to manage and potentially capitalize on increased market volatility. These products offer a degree of capital protection, while helping to identify advantageous entry points. They also present opportunities to generate returns, even in flat or declining market conditions.

For specific stock recommendations and insights related to structured products, please do not hesitate to reach out to me or to your dedicated relationship manager.

 
Best wishes,

Manish Singh, CFA

Rigid tariff policies may not yield the desired economic invigoration or solidify the legacy Trump wants.

Summary

In a remarkable turn of events, the American electorate has afforded President Donald Trump a rare second chance. Unwavering in his commitment, Trump is poised to intensify his signature “Make America Great Again” (MAGA) agenda, focusing on reshaping trade and immigration policies. His strategy includes employing tariffs to redirect trade flows and deporting illegal migrants to enhance safety, improve wages, and fulfil the prosperity he promised during his campaign.

Despite Trump’s conviction that higher tariffs will bolster the U.S. economy, historical outcomes, particularly with China, suggest a complex reality. Businesses have repeatedly adapted to overcome trade barriers, suggesting that rigid tariff policies may not yield the desired economic invigoration or solidify the legacy Trump aims to establish. A more beneficial approach could involve negotiating a China-U.S. trade agreement—potentially a “Mar-a-Lago Accord”—that emphasizes mutual benefits rather than continuing a protracted tariff dispute. However, any agreement might be preceded by a temporary escalation in tariffs as the administration reassesses its strategy.

While President Trump relishes the rhetoric of protectionism, his preference for a buoyant stock market significantly overshadows it. With the potential shift of the House to Democratic control post-midterm elections, Trump has a narrow window of 18 months to advance his agenda. It is hoped that Treasury Secretary Scott Bessent will guide the administration towards strategies that avoid harmful tariffs, which could undermine economic momentum, reintroduce inflation, and interrupt the Federal Reserve’s cycle of rate cuts.

On the markets front, there is substantial cause for celebration. This year, the S&P 500 has achieved an impressive +25% return year-to-date, building on strong performance from the previous year. Even with a -20% dip in 2022, the three-year cumulative return stands at +27%, averaging an annual return of +8.3%. History shows that consecutive +20% gains in equities, such as those seen since 1950, do not necessarily predict a downturn; in fact, in six out of eight such instances, the following year continued to see gains, averaging +12% and a median of +13%.

Holiday Cheer Gives Way to Tariff Season

We’ve had Thanksgiving, Advent is underway, and Christmas is just around the corner.

Thanksgiving— centred around gratitude—is a holiday I believe that deserves more celebration and emphasis. Don’t get me wrong, spreading cheer is wonderful, but as Arthur Brooks, the Harvard professor, columnist, and podcast host, reminds us, it’s gratitude that truly brings lasting happiness.

Gratitude is a kind of psychological superpower. Unlike cheerfulness, which is fleeting, gratitude trains us to focus on what we already have rather than what we lack. The human brain is hardwired to process negative emotions, like resentment, much more efficiently than positive ones—a survival mechanism from when spotting danger meant staying alive. But in modern life, this negativity bias can make us miserable. Gratitude flips this script, grounding us in reality and encouraging us to appreciate what’s good in our lives.

Addiction, by contrast, feeds on emptiness, an endless chase to fill what we think is missing. Gratitude, on the other hand, fills us with contentment for what we already possess. It’s a simple shift in perspective, but one with profound effects—perhaps the best gift we can give ourselves this holiday season.

So, what are we thankful for this year?

There’s plenty to appreciate, but since this is a market commentary, let’s highlight the impressive +27% return on the S&P 500 (SPX) Year-to-Date—building on a similarly robust performance last year (see table below).

However, when factoring in the -20% decline from 2022, the cumulative three-year return comes to +26%, equating to an average annual return of +8.3%.

Global Equity Index Performance (2024 YTD, 2022-2024 YTD and 2022 Performance)

Significantly, a consecutive +20% gain in equities does not necessarily justify a bearish outlook. Since 1950, the SPX has posted +20% gains in two consecutive years on eight occasions. In six of those instances, the third year saw positive returns, with an average return of +12%, and a median return of +13% (see table below).

The US Federal Reserve (Fed) began cutting short-term interest rates in September, as inflation neared its +2% target. Minutes from the latest Fed meeting suggest that policymakers plan to continue gradually lowering rates.

The US economy remains on solid footing, and corporate profits are still rising. Bond yields are falling, like the conditions during the rally of the mid-1990s.

The final S&P Global manufacturing PMI for the US in November came in at 49.7, surpassing the preliminary estimate of 48.8.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence commented, “The mood among US manufacturers brightened in November. Optimism about the year ahead has improved to a level not beaten in two and a half years, buoyed by the lifting of uncertainty seen in the lead up to the election, as well as the prospect of stronger economic growth and greater protectionism against foreign competition under the new Trump administration in 2025.”

How rare it is to be given a second chance. That’s exactly what the American people have offered President Donald Trump. True to his style, Trump isn’t one to dwell on past missteps; instead, he’s likely to double down on his signature policy—Make America Great Again (MAGA). At the heart of this agenda lie trade and immigration—or more precisely, using tariffs to redirect trade and deporting illegal migrants to reduce crime, boost wages, and deliver the prosperity Trump promised on the campaign trail.

As the legendary baseball player, Yogi Berra might say if he were alive today: It’s tough to make predictions, especially about the future—and even more so when it comes to Trump and his tariffs. So, instead of predicting, let me lay out a few key points.

President Trump has unveiled plans to impose a 25% import tariff on goods from Canada and Mexico starting on day one, with an additional 10% levy on Chinese imports. To help implement this strategy, he has appointed Jamieson Greer as his trade representative. A protégé of Trump’s former trade chief, Robert Lighthizer, Greer is determined to bring manufacturing and industry back to the U.S. from China, regardless of the cost.

Trump has appointed Scott Bessent to be the new US Treasury Secretary. A former hedge fund manager at George Soros’s firm and later at his own, Bessent specialized in macro investing, using geopolitical analysis and economic data to make large-scale market predictions.

As an economic historian, Bessent understands the US’s unsustainable trajectory. Steering the nation towards sustainability amid conflicting priorities and entrenched interests will be challenging.

Bessent, a follower of late Japanese Prime Minister, Shinzo Abe, advocates a “3-3-3” policy for President Trump:

• Cut the budget deficit to 3% of GDP by 2028
• Raise GDP growth to 3% via deregulation
• Increase daily oil output by 3 million barrels

This approach, aimed at stimulating the economy and reducing energy costs by boosting oil production, is not about protectionism or free money. Instead, it focuses on free-market principles without excessive government spending, which can lead to debt and perverse incentives. While increasing oil production could help reduce both the current account and fiscal deficits and potentially strengthen the dollar, this may conflict with Trump’s preference for a weaker USD

In addition, cost-cutting measures from the newly established Department of Government Efficiency (DOGE), co-led by Elon Musk and Vivek Ramaswamy, could spur robust growth in the US by allocating capital more effectively, reducing debt and deficits, and boosting productivity.

Bessent has characterized Trump’s tariff threats as a tactical approach to secure concessions, stating, “My general view is that at the end of the day, he’s a free trader. It’s escalate to de-escalate”. Tariff war may gather headlines, but it will not benefit the US or achieve its goal to the extent Trump thinks.

Semiconductors: A Case in Point

US semiconductor equipment sales to China have remained robust, even under existing tariffs and the threat of further restrictions (see figure below from CSIS).

However, a notable shift has occurred: Since Trump’s election in 2016 and the onset of the tariff war, US firms have increasingly exported semiconductor equipment to China from non-US locations.

Between 2016 and 2020, the ratio of sales to exports rose by 34%, from 1.1 to 1.5. This trend accelerated significantly from 2021 to 2024, with the ratio nearly doubling from 1.6 to 3.1.

In practical terms, this means that while exports to China and sales within China, were almost equal in earlier years, post-2020 sales have far outpaced direct exports. This shift coincides with the imposition of stricter US export controls, underscoring how businesses adapted their strategies to maintain access to the Chinese market despite heightened restrictions.

Trump may believe that increasing tariffs will benefit the U.S., but evidence tells a different story when it comes to China. Businesses consistently find ways to navigate restrictions, adapt, and keep making sales.

Could DOGE cut $2 trillion from government spending?

While it’s an ambitious goal, it’s highly unlikely. In reality, a cut of around a quarter of that amount is more plausible.

“Mandatory” spending—encompassing Social Security, Medicare, and Medicaid—makes up two-thirds of the $6.75 trillion federal budget. Discretionary spending on defence and domestic programs each account for about one-sixth. Given these numbers, it will be a monumental challenge for Musk and the DOGE team to find $2 trillion in cuts from these areas.

Could Trump deport 11 million illegal migrants?

It’s a tall order. The economic impact of removing such a large labour force from the US workforce, potentially driving up wages and limiting the capacity of companies to supply goods and services, is overstated.

Trump would be wise to avoid expending political capital on policies that fail to drive economic growth, bolster markets, or contribute to the lasting legacy he seeks. With the House likely to swing back to Democratic control in the mid-term elections, his window for implementing such policies is limited to just 18 months.

Let’s hope Scott Bessent can talk sense into Trump and steer him away from punitive tariffs. Such measures could disrupt the current economic momentum, bring inflation back to the US, and force the Federal Reserve to pause its rate-cutting cycle.

If Bessent’s fiscal conservatism can temper the President-elect’s protectionist tendencies, we might see a strong equity market in 2025.

Another year of +20% growth for US equities? Don’t bet against it.

Markets and the Economy

Europe is in a pickle and the chart below sums up the extent of problem Germany and the European Union (EU) faces.

Mercedes-Benz hit zero sales for EQE (its all-electric alternative to the E-Class) in China.

The EQE’s inability to compete against Chinese rivals and Tesla’s Model S, even at a reduced cost, highlights the struggle of traditional luxury brands to remain relevant in one of the world’s largest and most competitive EV markets.

Chinese brands like BYD and Nio have set new standards in technology, design, and value, leaving foreign OEMs, particularly in the premium segment, scrambling to catch up.

The auto industry is vital to the European Union, employing 6% of its workforce. However, with the EU’s ban on new Internal Combustion Engine (ICE) vehicles from 2035 and stricter emissions standards, automakers are under pressure. The resulting decline in ICE sales will make the already low-margin auto business even less profitable, raising critical questions:

How will European automakers accelerate model development, find the right partners, and outsource in areas where they lack expertise?

Meanwhile, China’s car exports have surged nearly fivefold over the past 3–5 years, now exceeding 5.7 million vehicles annually. With the capacity to produce over 40 million vehicles a year but domestic sales of only about 22 million, Chinese automakers are leveraging the excess capacity to dominate global markets.

How did China achieve this?

China’s dominance in the new energy vehicle (NEV) sector is largely due to substantial government subsidies. From 2009 to 2022, China invested $173 billion in electric vehicles (EVs) and plug-in hybrids, a strategy that transformed it into a global EV leader despite industry challenges like overcapacity. This state-driven approach provides a complex but instructive model for European automakers facing the dual tasks of adopting EV technology and remaining competitive.

The global influence of China’s model is reshaping international relations, compelling even its critics to engage pragmatically. A notable shift is seen in Argentina’s President Javier Milei, who reversed his stance from rejecting to actively pursuing trade with China, recognizing the complementary nature of the two economies:

“Not only will I not do business with China, I won’t do business with any communists.” – Javier Milei, September 2023

“Relations with China are excellent…They are a fabulous partner…We have economies that are complementary, and the well-being of Argentines requires that I deepen my commercial ties with China.” – Javier Milei, November 2024

Milei’s turnaround underscores the potential benefits of non-ideological engagement with China, especially considering the historical impact of IMF programs in Latin America.

Furthermore, a recent Financial Times report reveals that global R&D spending is now concentrated in the software and computer services sector, led by US firms and surpassing traditional industries like pharmaceuticals and auto manufacturing. China is also making significant investments in tech R&D, with ambitious plans to become a leading AI innovation hub by 2030, supported by substantial venture capital investments, second only to the US.

Gross Domestic expenditure on R&D (2000-2022)

Mergers and acquisitions (M&A) in Europe’s banking sector are expected to experience significant growth in 2025, as banks aim to capitalize on strong profitability to expand and transform their businesses. In the past, large government stakes in banks had limited cross-border M&A activity within the eurozone. However, with European governments gradually reducing their stakes in banks that were rescued since 2008, many of these sales could be completed by the end of 2025, provided market conditions remain favourable, paving the way for more deals.

One of the latest notable developments in European banking M&A is UniCredit’s increase in its stake in Commerzbank. Following the sale of a 4.49% stake to the Italian lender in an accelerated bookbuild in September, the German government now holds a 12.11% stake in Commerzbank.

The rebound in profits, driven by higher interest rates, has bolstered banks’ financial positions. As the rate cycle shifts, many lenders will turn to M&A to counteract lower lending income, sustain earnings momentum, and enhance their global competitiveness.

EURO STOXX Banks Price Index (SX7E)

Source: Bloomberg

A China-US trade deal, call it a “Mar-a-Lago accord” driven by the mutual benefits it promises, is more likely than not.

However, it may first be preceded by a period of tariffs before the Trump White House fully realizes the value of such cooperation.

In my view, President Trump enjoys the rhetoric of protectionism, but he values the US stock market even more.

He is unlikely to pursue policies that risk triggering a major market correction and can be persuaded to abandon contentious positions if stock prices falter. Add to this a likely wave of tax cuts and a rollback of Biden-era antitrust policies—setting the stage for a boom in mergers and acquisitions—and the case for another 12–18 months of gains in US assets becomes strong.

Trump is a President in search of forging a legacy. While I haven’t visited Mar-a-Lago nor claim to be clairvoyant, it’s clear that Trump seeks higher stock prices, lower interest rates, and controlled inflation. To achieve these goals, he may reconsider his stance on tariffs. As we look forward to next year, here are several developments to monitor:

• RFK Jr.’s Senate Approval Unlikely: His confirmation as HHS Secretary appears doubtful, which might uplift healthcare stocks that have lagged recently. Nonetheless, health insurers still face significant unresolved issues.
• Trump’s Tariff Rhetoric May Soften: The possibility of a US-China trade deal is currently undervalued. Trump, with 18 months left to cement his legacy and a House likely to flip during the midterms, may pivot towards securing a significant agreement.
• U.S. Equities Set for Uptick: Predicting specific figures is challenging, but U.S. stocks are well-positioned to see a rise of approximately 10-15% over the next year.
• Renewed Interest in European Equities: Post-February 25 elections, a potential increase in German fiscal spending could spark greater investor interest in European stocks.
• Bearish on Oil Prices: Lower oil prices could serve as an economic stimulus, keeping inflation down and benefiting both the U.S. and emerging markets.
• China’s Equity Market to Rally: Expect a robust rally in Chinese equities later in Q1 or Q2 as China methodically boosts its economy by stimulating domestic demand and addressing its prolonged balance sheet recession.
• Strong Dollar Backed by Bessent’s Policy: Treasury Secretary Scott Bessent’s “3-3-3” fiscal conservative policy is likely to reinforce the strength of the U.S. dollar.
• U.S. Debt Refinancing Challenges: With over $6 trillion in debt refinancing due next year, there might be crowding out effects, potentially restricting credit availability for private and corporate borrowers.

Benchmark US equity sector performance (2022-2024 YTD, 2024 YTD, November 2024, and 2024 YTD relative to the S&P 500 Index)

Looking ahead to 2025, the potential for further rallies in U.S. equities could be driven by several key factors:

• Stable inflation coupled with declining interest rates
• The availability of affordable energy resources
• Expected tax reductions for both individuals and corporations, which should boost household incomes
• An increase in corporate earnings alongside sustained high consumer confidence
• The continuation of President Trump’s “America First” policies, aimed at bolstering the U.S. economy through strategic deals and initiatives.

As we approach the end of the year, I want to thank you for your continued engagement and trust. Wishing you and your loved ones a joyful holiday season and a prosperous New Year. For those celebrating Christmas, may it be a wonderful celebration full of warmth and joy.

 
Best wishes,

Manish Singh, CFA

“Whatever the outcome on November 5, the US remains the world’s most innovative economy, with a system capable of resetting and correcting its mistakes and excesses”

Summary

In the current US political landscape, Real Clear Politics’ (RCP) Battleground polling averages, place former President Donald Trump ahead in all seven key states, suggesting a potential Republican sweep of the Senate. Such an outcome could see the GOP controlling the White House, Senate, and House of Representatives, streamlining the advancement of their legislative agenda. Conversely, a win for VP Kamala Harris could face significant hurdles with a Republican Senate, possibly leading to policy gridlocks and challenges in appointments, further exacerbating political stalemate as the parties pursue divergent goals.

The US labour market showed signs of improvement in September’s jobs report. However, expectations for October, set to be released this Friday, are tempered by recent natural disasters—Hurricanes Helene and Milton—and an ongoing Boeing strike, complicating Harris’ campaign for the presidency. These disruptions are also likely to pose challenges for the Federal Reserve as it deliberates over interest rate cuts. I expect the Fed to cut rates by at least 25 bps when it meets on November 7.

Whatever the outcome on November 5, the US remains the world’s most innovative economy, with a system capable of resetting and correcting its mistakes and excesses. Europe, on the other hand…resembles a pensioner gradually spending savings, with a little less money each day. In China, things rarely progress as expected. The next major policy shift is likely in Q1, but in the meantime, the People’s Bank of China (PBoC) will keep supporting asset prices, helping to maintain a floor under Chinese equities.

In financial markets, high-yield spreads have tightened to their narrowest in over 15 years relative to U.S. Treasuries. This trend typically supports rising equity markets, yet such narrow spreads also signal increasing risks, potentially indicating a looming market correction— but may take months or years to impact equities meaningfully.

The Final Week: Trump Takes the Lead as Republicans Poised for Senate Victory

As the US elections enter their final week, tensions are running high.

Over the weekend, thousands of readers cancelled their subscriptions to The Washington Post after the paper chose not to endorse a candidate in the 2024 Presidential race, marking the first time it has withheld an endorsement since 1976. Similarly, The Los Angeles Times recently decided against endorsing a candidate, provoking a backlash from both readers and staff.

In my opinion, if this trend continues, it must be seen as a positive development. The primary role of newspapers is to report the news, and readers should then reach their own conclusion.

Traditional media gained power through advertising, but that foundation has been disrupted by platforms such as TikTok, YouTube, and META. Now, news consumption is increasingly shifting toward podcasts, long-form posts on X (formerly Twitter), and various other social media platforms.

Interestingly, the rise of social media has also led to a significant increase in content creators. This statistic recently blew my mind:

• There are now approximately 27 million paid content creators in the US, with around 44% (a staggering 12 million) treating social media as their full-time job

This raises a question: Could these figures be inflating the U.S. jobs report? While I hope not, it’s likely that some of these roles are reflected in the employment data.

This election cycle seems to illustrate how traditional media is being pushed to the sidelines.

Brian Armstrong, CEO of Coinbase, captured this sentiment well in a post on X earlier this week.

Shifting back to the US election, current betting markets give President Donald Trump an approximate 60% chance of winning, compared to 39% for Vice President Kamala Harris.

In contrast, at this point in 2020, President Joseph Biden was ahead of Trump by 64.7% to 35.2%.

According to the Real Clear Politics (RCP) Battleground polling averages, Trump currently leads in all seven key states, with Wisconsin and Michigan being the closest contests and Georgia showing the widest margin.

A quote from Bill May, a 71-year-old resident of Racine, Wisconsin, encapsulates Harris’s challenges:“Morally I think she’s better, but when it comes to the economy, you can’t keep buying votes.”

This sentiment highlights the uphill battle Harris faces, as voters weigh her policies against economic concerns.

The US jobs report for the month of October is set to be released on Friday, November 1, and it will likely add to Harris’ misery.

Hurricane Helene (Sept 24-29) marked the deadliest hurricane to strike the US mainland since Katrina, leaving many communities in recovery. Just two weeks later, Hurricane Milton followed, compounding the challenges for those affected. The October employment report is set reflect the impact of these storms. Both storms resulted in temporary job losses and closures of stores, factories, and construction sites.

The jobs report for September had painted a more optimistic picture of the labour market with an increase of 254,000 jobs that month. However, October’s figures are expected to reflect not only the disruptions caused by the hurricanes but also the ongoing Boeing strike. Economists predict that the report will indicate a gain of approximately 110,000 jobs for October. This could make the report especially vulnerable to political interpretation as candidates enter the final stages of their campaigns.

In the Senate race, Republicans are making significant inroads into the traditionally solid Democratic “blue wall” in Michigan, Wisconsin, and Pennsylvania. As the election season reaches its final stretch, the GOP is looking to destabilize a critical base of Democratic power.

The Republicans are favoured to take control of the Senate due to a favourable electoral map, with Democrats defending the majority of the approximately dozen competitive races.

The GOP anticipates a strong victory in West Virginia, where they are vying for the seat being vacated by centrist Senator Joe Manchin. Additionally, they are optimistic about their chances in Montana, where incumbent Democrat Senator Jon Tester faces tough competition amid the state’s Republican leanings. Just these two victories could potentially flip the current 51-49 Democratic advantage.

However, Republicans are also eyeing additional pickups that could further bolster their majority. Control of the Senate will be crucial for the next president in passing their legislative agenda and confirming key nominees, including potential Supreme Court appointments.

Sources:  WSJ, Cook Political Report, Inside Elections and University of Virginia Centre for Politics

A Trump victory could lead to Republicans controlling all three branches of government—the White House, the Senate, and the House of Representatives. This consolidation of power would allow the GOP to advance its legislative agenda with fewer obstacles.

Conversely, if Harris wins, a Republican-controlled Senate could act as a significant impediment, potentially resulting in policy deadlocks and appointment challenges. This scenario may lead to increased political gridlock, as the two parties would have contrasting priorities and agendas, complicating efforts to pass legislation and confirm nominees.

The Federal Reserve’s (the Fed) upcoming decision on interest rates will take place just two days after Election Day, adding to the complexity of the economic landscape. The impact of the hurricanes on recent economic data is likely to create challenges for the Fed, as it assesses whether to cut rates and by how much.These storms have the potential to skew the data, complicating the Fed’s task of maintaining economic stability while also managing inflation.

As policymakers navigate these uncertainties, they will need to weigh the immediate effects of the hurricanes alongside longer-term economic trends. The situation underscores the intricate balance the Fed must strike in its monetary policy decisions, especially in the context of an evolving economic environment.

I expect the Fed to cut rates by at least 25 bps when it meets on November 7.

Markets and the Economy

On Monday this week, Volkswagen, Europe’s largest carmaker, informed its Works Council—the company’s top employee representative body—that it plans to shut down at least three German plants, cut tens of thousands of jobs, and reduce pay by 10%. This restructuring marks an unprecedented move for Volkswagen, potentially leading to the first domestic plant closures in the company’s 87-year history, underscoring the impact of high energy costs, slowing GDP growth, and intensifying competition from China.

Meanwhile, across the Atlantic, the situation is markedly different. Boeing workers in the US recently rejected a contract offer that included a substantial +35% wage increase over four years—equivalent to an annual raise of more than +8%. This outcome reflects a tight labour market, where American workers have the leverage to push for even higher wages amidst robust job demand and steady economic growth.

This contrast in corporate strategies highlights the diverging economic landscapes: While Europe’s manufacturing sector faces headwinds from energy and competitive pressures, the US continues to experience labour shortages and wage growth as part of its resilient post-pandemic recovery.

It’s not just Germany, France is in bad shape too. France just manages to cover it with perennial borrowing. France hasn’t run a balanced budget in over 30 years (see chart below).

France’s newly appointed Prime Minister, Michel Barnier, has introduced his government’s inaugural budget, featuring €60 billion in measures designed to reduce the national deficit. The goal is to bring the deficit to 5% of GDP by 2025 and down to 3% by 2029, moving toward EU fiscal targets.

Barnier’s approach to fiscal tightening includes a temporary tax increase targeting corporations with annual revenues exceeding €1 billion, as well as households earning over €500,000. France, already the most heavily taxed economy in the OECD, risks further eroding its revenue base by edging onto the adverse side of the Laffer curve. Additional tax hikes, rather than boosting revenue, could likely deter investment, prompt more capital flight, and ultimately weaken France’s tax receipts.

Barnier’s budget now faces the challenge of navigating France’s fragmented National Assembly before year-end. The New Popular Front—a left-wing coalition that recently gained the most seats—is pushing for increased taxation on financial transactions, higher inheritance taxes, and the reinstatement of the wealth tax eliminated by President Emmanuel Macron. Marine Le Pen’s far-right National Rally advocates that budget cuts should prioritize anti-fraud measures and reduced spending on immigration. Macron’s pro-business party, typically opposed to substantial tax hikes, has shown wavering support, underscoring the difficult path Barnier faces in securing approval for his budget plan.

The unfolding budget and political crisis in France sheds light on why yields on 10-year French government bonds are now higher than those for Portuguese and Spanish equivalents. Market concerns over France’s ability to implement fiscal discipline, compounded by political fragmentation, are driving investors to seek stability elsewhere in Europe.

Separately – How bizarre is this—India, which imports 82% of its oil needs, has become Europe’s top fuel supplier (see chart below).

Before the Russia-Ukraine war, Russian oil made up less than 1% of India’s total oil imports. Now, reports indicate that Russian imports account for nearly 40% of India’s oil purchases.
Previously, the EU purchased little to no oil from India, but now they are buying Russian oil indirectly through Indian suppliers.

Next, EU nations might as well join BRICS and abandon the Euro.

Basing foreign and economic policy on faux morality only leads to mounting costs.

For equity investors, 2024 has been a great year to be risk-on

US equities are on track for annual gains of over +20%, a strong rebound that only tells part of the story.

As you can see in the table below, the S&P 500 (SPX) is up +22.4% YTD and +21.2% for the nearly three-year period (2022-2024 YTD) due to the sharp 2022-2023 sell-off when the index fell by -25%.

Looking ahead, the question remains: Can US equities continue to climb?

Market conditions and recent trends suggest there may be further upside potential.

Global Equity Index Performance (2024 YTD, 2022-2024 YTD and 2022 Performance)

High-yield spreads—based on the Bank of America/Merrill Lynch High Yield Master Index—have reached their narrowest levels, relative to US Treasuries, in over 15 years.

At 260 basis points above Treasuries, these spreads are near their historical low, sitting in the 5th percentile of values dating back to 1970. While extremely low spreads can eventually pose risks to equities, history suggests that the adverse effects may take considerable time to fully manifest.

The last time spreads were this low, was in June 2007, just before the SPX hit a peak, ahead of the 2007-2008 financial crisis.

Tightening high-yield spreads generally confirm rising equity markets, however, spreads cannot narrow indefinitely without increasing risk. Extremely low spreads may indicate a potential market correction but may take months or years to impact equities meaningfully.

A historical analysis shows that when high-yield spreads have reached the bottom 5% range, the SPX has typically experienced mixed performance over the next one to three months (see table below). However, six to twelve months later, the index was consistently higher, with gains ranging between +7.4% and +27.2% across three previous occurrences.

Source: Bespoke Invest

While these patterns suggest potential short-term volatility, the longer-term outlook has historically remained positive, provided the market can absorb short-term adjustments.

Also, there’s a growing debate, if one should move to the equally weighted index when investing in the S&P 500 index, given the high weight of technology in the market-cap weighted index.

Below, is a look at the differences in sector weightings for the SPX (cap-weighted) and SPX Equal Weight indices. By default, the sectors with the largest number of stocks in the index will have the highest weightings in the equal-weight index.

While the Tech sector makes up nearly one third of the cap-weighted index, it’s only 13.7% of the equal-weight index. Industrials and Financials each have a larger weight than Tech in the equal-weight index, while they combine for a weighting that’s just 2/3 of Tech’s weighting in the cap-weighted index.

When looking at the pie charts below, it’s the equal-weight version that appears more balanced and diversified now.

No sector has a weighting below 4.4% in the equal-weight index, while the cap-weighted index has four sectors with weightings below 3.3%. Movements in Materials, Real Estate, Utilities, and Energy have virtually no impact on the cap-weighted index these day.

Source: Bespoke Invest

Since 1990, the equal-weighted SPX has outperformed its cap-weighted counterpart (see chart below).

Notably, during the late 1990s dot-com bubble, the cap-weighted index surged well above the equal-weighted version as tech mega-caps soared. However, after the bubble burst and the 2003-2007 bull market unfolded, the performance dynamic shifted, allowing the equal-weighted index to take the lead as broader sectors recovered.

Today, while mega-caps have driven market gains in recent years, a prolonged period of underperformance among these giants could shift favour back to the equal-weighted index.

S&P 500 (Cap Weight, SPY) Index vs. S&P 500 Equal Weight (SPT) Index: 1994-Present

Source: Bloomberg

That said, with artificial intelligence and related innovations still in early stages, I expect the cap-weighted index to continue delivering strong returns in the near term, supported by the tech sector’s growth potential.

Just consider the capital expenditure plans of the hyperscalers, which are essentially checks written to Nvidia (NVDA).

Last week, Tesla announced its capital expenditure plan for the upcoming year, setting it at $11 billion.

• Meta’s expected CapEx ranges from $35 billion to $40 billion

• Microsoft’s CapEx has seen a significant jump to $58 billion, up from $28 billion two years ago

• Google plans to allocate $50 billion for CapEx in 2024, up from $30 billion just two years ago

These substantial increases underscore the tech giants’ aggressive investment in AI and infrastructure, particularly in relation to NVIDIA’s advanced Blackwell chips.

Notably, a Blackwell GB200 CPU+GPU combo chip can cost between $60,000 and $70,000, reflecting the high stakes and costs involved in this tech race.

Gold has risen over +30% year-to-date, while the SPX has gained more than +20%. If both assets maintain these gains through the end of the year, it will mark the first time since 1976—when the US fully left the gold standard—that both assets achieved such simultaneous strength.

Gold’s recent rise aligns with a technical “cup and handle” formation, a bullish pattern that has developed over a decade for the gold ETF (GLD). This long-term pattern suggests further upside potential, as longer formations tend to lead to more substantial and extended gains once a breakout occurs.

While it looks good for Gold to rally more. What’s the bear case?

There are several scenarios where demand for gold as a safe-haven asset could weaken. A more stable trade environment with reduced market uncertainty would likely make gold less attractive as a hedge. Additionally, if fears about the US deficit are exaggerated and Trump’s policies emphasize spending cuts rather than expansion, this could bolster confidence in the US dollar and overall economic stability, further reducing gold’s appeal. Improved US-China relations would similarly boost market optimism, potentially steering risk-averse investors away from gold.

Finally, if China’s stimulus efforts successfully fuel stronger growth, Chinese investors—who are significant buyers of gold—might shift toward growth-focused assets like domestic equities, making gold less appealing, especially since it performs best in times of economic uncertainty or downturns.

Source: Bespoke Invest

Bloomberg News reported that, Taiwan Semiconductor Manufacturing Co. (TSMC) has achieved early production yields at its first Arizona plant that surpass those at comparable facilities in
Taiwan, marking a key milestone for TSMC’s US expansion—a project initially plagued by delays and workforce challenges.

This development holds significant, if understated, implications for US strategic positioning and Taiwan’s role in global tech supply chains.

Potential Implications:

• Strengthened US Chip Manufacturing: With high production yields in Arizona, the US could secure a critical foothold in semiconductor manufacturing, reducing reliance on imports

• Taiwan’s Strategic Value Shift: As the US builds local capacity, Taiwan’s strategic importance to the US might lessen, potentially altering the region’s geopolitical dynamics

• Taiwan-China Relations: Taiwan could see increased pressure to integrate with China through non-military means, as its unique strategic leverage diminishes

Investor Relief: TSMC shareholders may find reassurance in the successful launch of US operations, despite previous hurdles

Source: Bloomberg

This shift will be gradual, but the path forward is clear. Both TSMC and ASML remain central to the US, in securing advanced chip technology. Although ASML, a Dutch company, is subject to US export restrictions due to the inclusion of American-made parts, this reinforces the US approach to securing semiconductor technology through both domestic production and international controls.

Whatever the outcome on November 5, the US remains the world’s most innovative economy, with a system capable of resetting and correcting its mistakes and excesses. Europe, on the other hand…resembles a pensioner gradually spending savings, with a little less money each day.

In China, things rarely progress as expected. The next major policy shift is likely in Q1, but in the meantime, the P The People’s Bank of China will keep supporting asset prices, helping to maintain a floor under Chinese equities.

If Chinese policymakers succeed in boosting China’s consumption and asset prices start growing again, gold could face significant downward pressure.

 
Best wishes,

Manish Singh, CFA

“Employment risks now overshadow inflation challenges, a 50-basis point rate cut this Wednesday could be a prudent adjustment.”

Summary

As US job openings revert to pre-COVID levels, employment risks now overshadow ongoing inflation challenges. Amid this shift, businesses serving lower and middle-income groups face increasing pressures, and the personal savings rate has dipped to 2.9% in July, its lowest since 2007. This context places the US Federal Reserve at a crossroads: Continue the stringent measures of the current tightening cycle or ease up as the unemployment rate surpasses expectations and the road to +2% inflation appears clear. A 50-basis point rate cut this Wednesday could be a prudent adjustment.

While the U.S. economy reportedly grew around +3% last quarter, not all segments of the population are experiencing prosperity. Potential further softening in the labour market might necessitate larger rate cuts, potentially at odds with the Fed’s long-term objectives. Regardless of whether the cut is 25 or 50 basis points, market sentiment is tilting towards additional reductions over the coming year, as evidenced by the 2-year Treasury yield dropping to +3.54%, significantly below the current upper boundary of the Fed Funds Rate.

Contrary to some expectations of a looming US recession and market downturn, several factors suggest resilience. Households are seeing the lowest mortgage debt relative to property values in nearly seven decades, bolstered by rising home values and consistent mortgage payments. Additionally, the restrained cash-out refinancing and low turnover in mortgages have lessened real estate leverage. This robust financial footing, combined with gains from high home prices, stock market improvements, and steady incomes—all amplified by high interest rates—continue to drive consumer spending.

Meanwhile, a U.S. fiscal deficit nearing 10% of GDP offers substantial support, reducing the likelihood of a sharp demand drop. With consumer spending remaining strong, the probability of a recession appears low, suggesting equities still have room to grow.

Why the US Fed must cut rates in a “Healthy” Economy

In 1959, economist Milton Friedman addressed a joint session of the US Congress, explaining that monetary policies “operate with a long lag and with a lag that varies widely from time to time.” He compared changes in US Federal Reserve (Fed) policy to “a water tap that you turn on now, and it only starts to flow six, nine, 12, or 16 months later.”

Friedman further stressed the uncertainty of these lag effects, stating, “…we know too little about these lags or what the economic situation will be months or years from now, when the chickens we release come home to roost, to effectively counteract the myriad of factors causing minor fluctuations in economic activity.”

Today, with the Federal Funds target rate (FDTR) held at +5.25% for 14 months, following  the steepest interest rate hike cycle seen in over four decades (see chart below), Fed Chair Jerome Powell and his colleagues on the Federal Open Market Committee (FOMC), face the challenge of navigating these “long and variable lags.”

The task, however, is not how much to raise rates to combat inflation but determining when and by how much to cut rates, without tipping the economy into a future recession.

All signs point to a rate cut starting this Wednesday. Current market pricing indicates a 70% probability of a 50 bps rate cut.  

We have a flurry of communications from “Fed surrogates.”

Last Friday, two strikingly similar articles were published in The Wall Street Journal (link) and The Financial Times (link) written by Nick Timiraos and Colby Smith respectively.

If you know the Fed meeting coverage well, you will know Nick Timiraos and Colby Smith are two well-respected members of the Federal Reserve press corps. Timiraos, in particular, has often been viewed as a key channel through which the FOMC indirectly communicates its thinking to the market.

Both articles focused on the rate-setting decision—whether to cut rates by 25 basis points (bps) or 50 bps—and both articles presented a clear and balanced discussion of the arguments for a 25 bps versus a 50 bps rate cut, highlighting the risks and benefits associated with each option. Notably, neither story cited an explicit source within the FOMC, indicating a preferred direction for the decision.

Change in the Federal Funds Target Rate (FDTR) during the last five rate-hiking cycles

These were followed by a headline on Bloomberg the same day – [Bill] Dudley Sees Case for Half-Point Fed Rate Cut Next Week.

Speaking at a forum organized by The Bretton Woods Committee in Singapore, the former NY Fed President, Bill Dudley said – “I think there’s a strong case for 50. I know what I’d be pushing for.”

I strongly agree with Dudley.

Last week’s US jobs report revealed that the focus must shift to jobs and economy.

With job openings returning to pre-COVID levels, the risk to employment now outweighs the persistent challenges of inflation, which is projected to reach +2%.

• The hiring rate has decreased from 4.5 to 3.5
• Job openings have dropped from over 11 million to 7.6 million
• Job openings per unemployed worker have halved, from over 2 to 1.07
• Layoffs are trending upward, rising from 1.2 million to 1.7 million
• The unemployment rate has climbed by 0.5% since the start of the year.

Any tolerance that leads to further weakness in the labour market, could prompt more substantial rate cuts down the line, which is not ideal for the Fed.

The housing market has been soft in recent months, and while the construction sector added jobs in August, declines in new residential construction, point to another source of potential weakness ahead for hiring.

Businesses and financial companies that cater to low- and middle-income consumers are pointing to signs of greater strain, and the personal savings rate fell to +2.9% in July, near its lowest level since 2007.

Let us look at the data (see chart below):

• Federal Funds Target Rate (FDTR) Upper Bound (White) is at +5.5%
• US inflation, as measured by US Consumer Price Index (CPI) is currently at +2.5%
• US 2y Treasury Yield is at +3.57%
• Spread 1 (Yellow): US 2y yield – FDTR is at -190 bps
• Spread 2 (Green): US Inflation – FDTR is at -300 bps

The spreads are at historic levels and point to how high the Fed fund rate is with respect to other key data.

The last time, US 2-year Treasury yield traded 190 basis points below the upper bound of the Fed Funds Rate was on January 18, 2008. Just four days later, on January 22, 2008, the Fed made an unscheduled 75 bps rate cut, followed by another 50 bps cut eight days later, on January 30, 2008.

We are not in such a crisis, so we will not get a 75 bps cut.

Whether it is 25 or 50 bps cut on Wednesday, the market is now expecting a lot more rate cuts in the next year or so. The 2-year Treasury yield is a good measure of where the market expects the Fed Funds Rate to be in the next year or two, and this week the 2-year yield ticked down to +3.57%.

Price chart: Federal funds rate (FDTR) , Spread between US inflation and FDTR, Spread between US 2y yield and FDTR

Source: Bloomberg

I’ve heard arguments against cutting rates in a “healthy” economy, but what defines “healthy”?

For those benefitting from deficit spending or in the upper and middle classes, the economy may seem robust—where inflation is minor, and lifestyles are stable. Yet, many aren’t seeing these benefits.

Essential costs have surged 20-30% recently, with Dollar General (DG) noting sales declines among customers averaging $35k a year. CEO Todd Vasos attributed weak sales to financially strained core customers.

Moreover, the end of pandemic-era food stamp benefits in March 2023, alongside two years of inflation, has pushed consumers to focus on necessities over discretionary items.

Despite a +3% GDP growth last quarter, the economy isn’t “healthy” for all, highlighting the disparity in economic health across different societal segments.

As per the New York Fed’s Survey of Consumer Expectations (see chart below), the mean probability of missing a debt payment, hit its highest level since April 2020.

Source: Bespoke Invest

For those worried about inflation if the Fed cuts rates, consider this:

Rate cuts are unlikely to hit historic lows soon. I anticipate about 200 basis points in reductions over the next year or more. Contrary to some beliefs, low rates alone don’t drive inflation. Instead, inflation ties more directly to the M2 money supply, heavily influenced by government spending and debt levels. Over the last four years, the cumulative effects of Trump’s tax cuts and Biden’s stimulus significantly increased the U.S. deficit.

Moreover, high rates can trigger recessions or even depressions, as seen in the late 1920s. Economists broadly agree that the Fed’s sharp rate hikes in 1928 and 1929 contributed to the subsequent global economic collapse.

During the Great Depression, the Fed’s reluctance to cut rates exacerbated the crisis. From 1929 to 1933, consumer prices fell by -27%, yet the Fed kept rates at 3 to 5%, with mortgage rates at about 6%. This resulted in effectively +32% real interest rates during deflation, suggesting that negative rates would have been more appropriate.

Now, with rates significantly above neutral and inflation decreasing towards a 2% target, a more substantial cut than the typical 25 bps may be warranted. We need to question whether it’s justified for the Fed to maintain its most restrictive stance during a clear move towards 2% inflation.

Lastly, considering the massive U.S. federal debt—now at $35.7 trillion—do big rate cuts make sense? Given the circumstances, they do.

Markets and the Economy

Some people think a new high for the S&P 500 (SPX) and the National Association of Security Dealers Automated Quotations (NASDAQ) indices, means we are in “bubble” territory and the equity markets must correct.

Far from it.

It must be emphasised that while the stock market has been trending upward over the past couple of years following the 2022 bear market, the current environment is far from a “bubble,” when viewed through a long-term lens.

• Cap-weighted indices like the S&P 500 and Nasdaq 100, driven by mega-cap stocks, have shown strong performance. In contrast, their equal-weighted counterparts have been consolidating sideways since late 2021
• Charts of the S&P 500 Equal Weight ETF (RSP) and the Nasdaq 100 Equal Weight ETF (QQQE) show this extended consolidation over the past five years
•  The S&P 500 Equal Weight ETF recently surpassed its early 2022 all-time highs, whereas the Nasdaq 100 Equal Weight ETF is still just below its late 2021 highs
• Both equal-weight indices might see significant upward movement if they break out of this multi-year consolidation phase

5-year price chart: S&P 500 Equal Weight ETF (RSP) and the Nasdaq 100 Equal Weight ETF (QQQE)

Source: Bloomberg

Last week, Nvidia (NVDA) CEO Jensen Huang declared: “We’re at the beginning of a new industrial revolution.”

While NVDA sceptics may not want to hear it, the surge in tech spending on Artificial Intelligence (AI) is driving what many are calling the 4th Industrial Revolution.

Oracle founder Larry Ellison’s recent insights on AI demand and Oracle’s expanding pipeline are particularly revealing. Ellison noted that a few major tech companies—and potentially even a country—will be vying for AI model “technical supremacy” in the coming years, each planning to spend $100 billion.

Ellison emphasized that the AI boom shows no signs of slowing down anytime soon. “If you’re looking at the next five to ten years, there’s no need to worry,” Ellison said during Oracle’s earnings call. “This business is growing bigger and bigger. There is no slowdown or shift on the horizon.”

The most significant news is that Oracle’s AI infrastructure efforts now have full backing from Nvidia.

Nvidia’s chips are in extremely high demand across the tech industry. During a dinner with Tesla (TSLA) founder Elon Musk, Ellison personally appealed to Huang to secure more GPUs for Oracle’s AI supercluster.

“I’d describe the dinner as Elon and me begging Jensen for GPUs. ‘Please take our money. No, take more of it. We need you to take more,’” Ellison said. “It went well. It worked.”

At the Oracle CloudWorld conference on Wednesday, the two companies – Nvidia and Oracle – announced that Oracle Cloud Infrastructure (OCI) will deploy the largest-ever GPU compute cluster. Set to be available in the first half of 2025, this cluster will feature up to 131,072 Nvidia Blackwell GPUs, enabling customers to train and run AI workloads on an unprecedented scale. Oracle stated that the cluster would be six times larger than what any other cloud provider currently offers.

For context, Meta used just 16,000 Nvidia GPUs to train its latest Llama 3 model, highlighting the massive leap Oracle is making in AI infrastructure.

So, all looks good on tech and AI stock front, but the talk of “bubble” will not go away.

Those expecting a recession and hence a market correction are going to be disappointed.
Households have the least mortgage debt relative to their property value in almost 70 years, with appreciation of those homes and steady amortization of mortgage debt (alongside low cash-out refinancing activity and low turnover in mortgages overall) driving down the leverage in real estate. Consumer balance sheets are rock solid, which is another reason to question the narrative of impending recession.

Source: Bespoke Invest

Unlike past recessions, yields on high-yield bonds have shown minimal movement so far (see Chart below). As long as consumer spending remains strong, the likelihood of a recession stays low.

While recent jobs reports indicate early signs of weakness, the unemployment rate remains historically low. The wealth effect from high home prices, stock market gains, and steady income driven by high interest rates continues to support consumer spending.

In August, the US federal deficit hit $380.1 billion, on a non-seasonally adjusted basis, significantly above the $292.5 billion expected, driven by a +9% increase in expenditures. Only a few periods have recorded larger deficits.

Relative to GDP, the deficit is approaching +10%. With this level of fiscal accommodation, it is hard to believe that final demand will slow significantly. Federal deficits are propping up strong real income growth and investment, regardless of what the payroll numbers indicate.

Furthermore, in Washington, there is a broad consensus that deficits can be expanded when needed. No politician wants to champion a balanced budget or spending cuts—it would be political suicide. As a result, the reckoning for US yields and the dollar keeps getting pushed further into the future.

Source: Bespoke Invest

2024 is eerily like 2023… Is a dip next? or a rally with a Fed cut on the horizon?

I am expecting a 50 bps cut on Wednesday.

S&P 500 (YTD): +17.95%

As I have mentioned above, I do not anticipate a recession taking hold within the next 6 months.

A Fed rate cut would boost sentiment, and the US economy is showing no signs of a recession.

While the un-inversion of the yield curve is often seen as a worrying indicator, the effects of COVID and the policy responses have disrupted all historical models.

So, be cautious about relying too heavily on past patterns and models.

Source: Bespoke Invest

A magazine advertisement placed by The Teachers Insurance and Annuity Association of America (TIAA) and College Retirement Equities Fund (CREF) from 1996, predicted that people would pay:

– $16 for a burger and fries
– $12,500 for a vacation
– $65,000 for a “basic car”

The ad continued:

“No problem.
You’ll eat in. You won’t drive.
You won’t go anywhere.”

Reality is:

We eat out more than ever.
We drive more than ever.
We go anywhere more than ever.
So, do not get bearish on life in general. Hold on to your long equity positions. Recession is not on the horizon and equities have further to run.

For specific stock recommendations and insights related to structured products, please do not hesitate to reach out to me or your dedicated relationship manager.

 
Best wishes,

Manish Singh, CFA

“Chairman Jerome Powell’s recent remarks, recent market movements and what these developments might mean for the future”

Summary

July has proven to be a rollercoaster month for the markets. Despite numerous fluctuations, the S&P 500 has impressively advanced by +16% this year. In a typical year, such a return would be highly celebrated; however, this year’s AI-driven tech stock surge and broader market gains have heightened expectations. Notably, the market’s breadth-the balance of advancing and declining stocks within the index-is improving. This suggests that market pullbacks may present buying opportunities, indicating potential for continued upward momentum in the coming months.

This month’s market dynamics reflect the effectiveness of past rate hikes in tempering inflation, amidst evolving supply and demand conditions. Recent data pointing to a softening labour market has weakened wage bargaining power, advocating for potential rate cuts to uplift market sentiment and enhance housing affordability.

At the beginning of this year, the probability of rate cuts at the Federal Open Market Committee (FOMC) meetings in March, May, June, and July was over 80%. However, no cuts were made at any of these meetings, including the one in July. At the July meeting, Chair Jerome Powell emphasized the downside risks related to the labour market and the FOMC’s close monitoring of labour market trends. It sets the stage for cuts at the September meeting.

Market volatility and drawdowns are not anomalies but rather inherent features of investing and should be anticipated, embraced and strategically addressed. Investing isn’t about overreacting to quarterly earnings but about understanding the long-term growth potential of the markets in which the companies you invest in operate. While massive spending on AI may not benefit every firm equally, such spending still generates substantial revenue for vendors like Nvidia and Microsoft. Moreover, major tech firms have demonstrated their capacity to endure setbacks and continue to thrive, as evidenced by the recent performances of Meta, Alphabet, and Netflix.

A Bronze medal for the S&P 500

The 2024 Olympics officially kicked off on July 26, and, as always, the event was surrounded by its share of controversies.

First, arsonists sabotaged the rail network, followed by relentless rain that threatened to turn the opening ceremony into a soggy affair. There were further blunders, such as the Olympic flag being hoisted upside down, South Korean athletes being mistakenly introduced as North Korean on live television, and the uproar over the “Last Supper” and other scenes, which led to an official apology from the organizers.

A spokesperson for Paris 2024 stated, “There was never an intention to show disrespect to a religious group. If people have taken any offense, we are, of course, really sorry.”

To that, I’d add that an apology including the word “if” falls short of being a true apology. Sports, with their numerous health benefits and enjoyment, are best kept free from political controversy.

The Cauldron of the Olympic Games Paris 2024

Source: 2024 IOC

There were plenty of very good bits too – the “mystery torchbearer” running over those slippery rooftops was glorious, as was the majestically hoisted Olympic “ring of fire” torch floating 200 feet high up in the air. It wouldn’t be safe to get a real flame up to 200 feet high, as it would require pipes feeding gas or another combustible to fuel the fire, so it’s not a surprise that the “ring of fire” isn’t actually burning – it’s an illusion made up of clouds of mist and beams of light.

It’s worth noting that the first hot air balloon carrying a human, flew in Paris on November 21, 1783. About a week later, the first manned hydrogen balloon flight, took off from the Jardin des Tuileries in Paris – the same place the Olympic cauldron is today.

Final point- if you’re an organiser and want to host event outside, just presume it will rain.

Turning now to the markets.

By indicating a possible interest rate cut in September, as it did on Wednesday, the US Federal Reserve (Fed), risks becoming entangled in the US presidential election.

A rate cut before the election could attract criticism from Republicans and former President Donald Trump, while delaying a much-needed reduction, might hurt the economy and frustrate Democrats.

With the labour market weakening, inflation approaching +2%, and the Fed aiming to avoid a recession, these are delicate times. These challenging optics will likely push Fed officials to carefully manage expectations and communications over the next few weeks.

This week’s earnings reports from major companies have been significant, with Meta and Microsoft taking centre stage. However, the big report everyone is waiting for is Nvidia (NVDA), scheduled for August 28.

Let’s revisit the market reaction from this Tuesday following Microsoft’s earnings:

• Right after Microsoft announced its earnings, its stock fell over -7% due to Artificial Intelligence (AI) revenue not meeting expectations
• However, when Advanced Micro Devices (AMD) projected increased spending on AI chips, Microsoft’s stock bounced back by+ 5%. Nasdaq futures climbed +1.5%, and NVDA surged about +10% from its after-hours low, to its premarket high, even outperforming AMD, which had just reported positive earnings

“Is the market reacting judiciously?”

More on big tech and the Fed in the Markets and Economy section below.

On the broader market level, July has been a tumultuous month. Despite the ups and downs, the S&P 500 (SPX) has still managed to climb +16% this year. In any given year, a +16% return would be cause for celebration. Yet, with the recent AI led tech stock rally, and overall market gains, expectations have been set higher.

Although the SPX is down -2% from its mid-July peak, it remained positive for the month of July.

The SPX in July therefore only deserves a Bronze medal.

S&P 500 price chart, (Dec 2023 – YTD)

Source: Bloomberg

Encouragingly, despite the market volatility, the “breadth of the market” – the relative number of advances and decline of stocks in the index – is getting better.

The chart below from BespokeInvest, illustrates all days since 1990 when the SPX fell by at least -2%. It compares these declines to each day’s net advance/decline reading – the difference between the number of advancing stocks and declining stocks.

As expected, on days when the SPX dropped by -2% or more, the number of declining stocks generally far exceeded the number of advancers. Typically, on such days, only about 33 stocks finished higher, compared to 465 decliners, resulting in a median net daily advance/decline reading of -432.

However, mid last week’s -2% drop, was an exception to this rule. Despite the SPX ‘s over -2% decline, nearly one third (165) of its components ended the day with gains. This resulted in a daily net advance/decline reading of -171, which is significantly stronger than the historical norm, and ranks as the fifth strongest among all days since 1990, with a -2% drop in the SPX

The most recent comparable instances of strong breadth during such declines were in October and November of 2000. Notably, there was also a day in May 2000 with even better breadth on an over -2% decline, and in April of that year, there were days when the SPX fell by -2% with positive breadth.

This type of price versus breadth action hasn’t been seen since the Dot Com Bubble burst. A rebound in breadth is a positive sign, as recent market gains have been driven primarily by large technology stocks, leaving the rest of the index behind. Increasing breadth indicate, a healthier and more sustainable bull market. Participation in the rally has broadened, particularly among cyclical sectors.

Increasing breadth readings suggest that pullbacks or corrections should be viewed as buying opportunities, as upward momentum often continues over the next few months, just as a narrowing breadth indicates oversold and bottoming market.

Source: Bespoke Invest

In more positive news for inflation, which could help the SPX outperform its bronze medal status, the New York Fed’ measure of inflation persistence -the Multivariate Core Trend (MCT) rate -declined again in June, reaching +2.1%. This drop is particularly notable due to significant shelter disinflation observed in June. The broad-based declines in inflation are encouraging.

The NY Fed’s MCT model evaluates inflation persistence across seventeen core sectors of the US personal consumption expenditures (PCE) price index. It is crucial for US policymakers to understand whether inflation is transient or persistent, concentrated in a few sectors, or widespread.

The NY Fed’s MCT model evaluates inflation persistence across seventeen core sectors of the US personal consumption expenditures (PCE) price index. It is crucial for US policymakers to understand whether inflation is transient or persistent, concentrated in a few sectors, or widespread.

Key findings for June include:

• The Multivariate Core Trend (MCT) inflation fell to +2.1% in June from +2.4% in May, with a 68% probability band of (+1.6%, +2.6%
• Compared to pre-pandemic levels, housing contributes +0.12% to the MCT estimate, while services excluding housing contribute +0.22%. Core goods had a slight negative impact of -0.06%
• The remaining inflation persistence in housing and services excluding housing is largely driven by sector-specific factors

It can be argued that rate hikes have largely fulfilled their role in moderating inflation, given past supply and demand constraints. Lowering interest rates could enhance sentiment and improve housing affordability.

NY Fed’s Core Trend of US Personal Consumption Expenditures (PCE) price index

Source: Bureau of Economic Analysis (BEA)

After breaking through the 5,500-support level to the downside last week, the SPX made two unsuccessful attempts to reclaim that key psychological level. This recent bounce won’t be worthy of a gold medal until the SPX can break back above (as it did Wednesday) and hold those levels.

On a brighter note, the SPX briefly fell below 5,400 on two occasions, but each time, buyers quickly stepped in to support the market.

Markets and the Economy

Earlier this year, the likelihood of rate cuts at the Federal Open Market Committee (FOMC) meetings in March, May, June, and July was over 80%. Despite this, no cuts were made at any of these meetings, including the one held just held in July.

However, looking ahead to the upcoming meetings, the markets now almost guarantee a rate cut at each of the next four meetings – Sept, November, December and January 2025.

At the press conference on Wednesday, Fed Chair Jerome Powell, underscored his comfort with the idea of near-term rate cuts, suggesting that a reduction “could be on the table at the September meeting”, and “the reduction of the policy could be as soon as September”, concluding “base case [is]that policy rates would move down from here” and that the policy could be adjusted as early as September.

Rather than contesting market expectations, Powell explicitly supported the September rate cut, thus fuelling the day’s rally. In his economic analysis, Powell focused heavily on the downside risks associated with labour markets and the FOMC’s close attention to labour market trends. He characterized the current economic adjustments as “normalisation”.

The Fed’s next meeting is September 17-18, and the one after that is set to begin the day after the November 5 election.

So, what do the bond yield spreads, often predictors of an oncoming recession, have to say?
Let’s look at the data.

• The spread between the 10-year and 2-year US Treasuries has been negative for just over two years, marking the longest period of inversion on record
• However, since the end of June, the curve has steepened significantly, narrowing from around -50 basis points to -15 basis points this week its least inverted level in over two years

Inverted yield curves are often linked to recessions. The chart below illustrates the 10-year vs. 2-year US Treasury yield curve since 1968.

Historically, recessions (indicated by grey shading) have followed periods of curve inversion, though the timing of the economic downturn could range from a few months to several years after the initial inversion. The red dots highlight the most inverted points during each period of inversion.

While yield curves are generally associated with recessions, a more precise recession indicator is when the yield spread turns positive after being inverted.

We are currently just -23 basis points away from this transition.

Source: Bespoke Invest

While an inverted yield curve returning to a positive slope is often viewed as a stronger recession signal than mere inversion, it’s important to assess the market’s behaviour following this shift before one turns bearish, on account of a possible recession.

Despite the market volatility in July, the SPX index is still up +16% year-to-date (as shown in the table below), which matches its gain over the past 30 months from December 2022 to the present.

This is because SPX’s performance was flat during the 24 months of 2022 and 2023, but we are now seeing positive returns for this year.

Global Equity Index Performance (2024 YTD, Cumulative 2022-2024 YTD and July 2024)

The June US JOLTS (Job Openings and Labor Turnover Survey) report was released on Monday. The Hires rate is beginning to signal potential recessionary trends (chart below with periods of US recession highlighted in red), a scenario the Fed is likely to take all measures to prevent.

• There are currently 1.2 available jobs for each unemployed worker, down from a peak of 2 jobs per unemployed person about 18 months ago
• The job openings rate remained steady at 4.9% in June, with 8.184 million positions available, slightly down from 8.23 million in May. At its peak in Dec. 2020, the job openings numbered 12.2 million
• The hiring rate decreased to 3.4% from 3.6% last month, with 5.341 million new hires. The quits rate has reached a cycle low, suggesting that wage growth may continue to slow in the coming quarters

The ADP Jobs report released this week further confirms the slowdown in the US labour market, showing an addition of just 122,000 jobs—well below the 150,000 expected and down from the 155,000 added in June.

This softening labour market has diminished employees’ bargaining power, leading to smaller wage increases. The 12-month pay growth for individuals remaining in the same job dropped to a three-year low of +4.8% in July. Nela Richardson, ADP’s chief economist, commented, “with wage growth slowing, the labour market is aligning with the Federal Reserve’s efforts to curb inflation.”

This is music to the Fed ears, as the FOMC prepares to embark on a series of rate cuts.

US JOLTS (Job Openings and Labor Turnover Survey) report: Hires Rate SA

Source: Bloomberg

Continuing from our discussion on big tech:

Earlier this week, Microsoft reported a notable +15% increase in overall revenue, with Azure cloud revenue rising by +29%. Despite these impressive figures, the stock saw a sell-off, which might be attributed to overenthusiasm from investors and analysts.

• A critical detail to note is Microsoft’s capital expenditure, which reached $19 billion last quarter—up +78% year-on-year and equivalent to what the company spent in an entire year just five years ago
• Microsoft closed the fiscal year with a record $109 billion in operating income. That’s $2 billion per week
• The company achieved an annual operating margin of 44.6%, a level not seen in over two decades
• On its earnings call, Microsoft projected another year of double-digit growth in both revenue and operating income for fiscal 2025

CFO Amy Hood stated, “To meet the growing demand for our AI and Cloud products, we will scale our infrastructure investments, with FY25 capital expenditures expected to exceed FY24.”

This suggests that those anticipating a slowdown in AI spending impacting Microsoft or Nvidia might be in for a surprise.

Nvidia, which sold off –25% and is now -13% from its recent high, seems to be a bargain at current levels and is likely to rebound toward its peak following Q2 results at the end of August.

6-month price chart: Nvidia (NVDA) and Microsoft (MSFT)

Source: Bloomberg

Those predicting a slowdown in AI spending may find themselves writing about missed opportunities in 2034, if they didn’t invest or hold on to MSFT, NVDA, AMD, Broadcom, Amazon etc. in 2024.

Investing isn’t about overreacting to quarterly earnings but about understanding the long-term growth potential of the markets in which the companies you invest in operate. While massive spending on AI may not benefit every firm equally much like not every child becomes a piano prodigy despite excessive sums spent on tutoring such spending still generates substantial revenue for vendors like NVDA, MSFT.

Moreover, big tech companies have the resilience to weather mistakes and continue thriving just look at Meta, Alphabet, and Netflix more recently.

Investing in large-cap companies with established revenue potential offers greater stability than chasing smaller, emerging opportunities. Microsoft and other tech giants possess the resources to outlast or acquire competitors, much like the auto manufacturers did in the 1920s.

Market volatility and drawdowns are not anomalies but rather inherent features of investing and should be anticipated, embraced and strategically addressed. Predicting short-term market movements can be extremely challenging. Hence, I highlight the value of equity structured products as a highly effective investment tool to manage and potentially capitalize on increased market volatility.

These products offer a degree of capital protection while helping to identify advantageous entry points. They also present opportunities to generate returns, even in flat or declining market conditions.

For specific stock recommendations and insights related to structured products, please don’t hesitate to reach out to me or your dedicated relationship manager.

 
Best wishes,

Manish Singh, CFA