Try The Porridge

January 2025

2024 was a second year of 20% gains for the largest stocks. Bond prices fell slightly, but their interest payments helped them eke out a total return just over 1%. Our balanced portfolios were a blend of these returns.

Last year, equity investors were excited for the future productivity gains from AI. The jobs market has been solid. The Fed helped moderate inflation without risking recession. It’s not a Goldilocks economy - we have ongoing debt issues, 3% inflation, interest rates are a little high - but the porridge is just the right temp.

All new administrations want to introduce helpful initiatives. There will be successes and mistakes. It is too soon to say what the policy new realities, say six months from now, will be. There is no question in my mind that 1) interest rates are still the biggest single factor in the economy’s success, and 2) campaign promises are made in uppercase language, while the reality tends to be lowercase.

Those are experiential observations. Measured psychology bears this out in a different way: people tend to let politics shape their view of the economy. When someone of your party is President, you tend to view the economy positively, and vice versa. This behavior is fascinating, understandable, but more importantly as investors, recognizing these biases is to our advantage - timing the markets is difficult at best.

The AI productivity boost is going to be real, I think more for businesses at the moment than for consumers. That’s great news; productivity is what allows us to increase all that is good in the economy while reducing all that we try to avoid.

I applaud the effort by the new administration to seek more efficient fiscal governance. However, the administration’s finding meaningful cost cuts and then Congress legislating that streamlined budget will be challenging. While I hope responsible efficiency becomes a movement, it may prove to be just another talking point, much like past administrations’ “shovel ready projects” or budgetary “surgical cuts” were. There are risks to success: if Congress is able to agree to a sizable reduction in wasteful spending, say $1 trillion, that’s about 3% of GDP. If you take that 3% away overnight, it would be recessionary. Jobs could be at risk, and Congresspeople don’t like job losses in their districts.

Despite the good economy, the consumer is strapped. New homebuyers are coughing up an awful lot of their pay to take on a mortgage at today’s rates. This makes budgets at the household level run thin. It’s not the end of the world, and if inflation and rates come down, home values should rise and those new buyers will see a bump in their home equity. But we need to watch interest rates here, because our household borrowing hasn’t been this high since the real estate crunch in 2007.

Let’s keep the portfolios diversified. Productivity and modest inflation should help keep the porridge warm.

Sincerely,

Chip