Current Investment Outlook

The stock market continued to rise throughout the first quarter, producing a 10% gain. Since then, the market has flattened out, with no clear trend. The so-called Magnificent Seven has become the Fab Five or the Fab Four, depending on the week. A good sign for the market has been its broadening out as the Magnificent stocks have somewhat stalled. Past laggards such as energy, financials, industrials, and gold have begun to show periodic leadership. The market still faces a great deal of skepticism, and this bodes well for its future direction. We still favor investing in the stocks of companies with strong fundamentals and reasonable valuations, and we believe that there is still room for the market to advance to higher levels.

We continue to have an extraordinary dichotomy between our American elites and middle-to-lower income earners. We also have a similar difference between a group of high technology-oriented stocks and the rest of the market. The economy continues to grow, and stocks continue to rise. But, today, we clearly have two Americas with significantly different prospects. The leadership in the market may be stalling for the moment, but we expect that stocks with exceptional dynamics of growth and profitability will continue to lead.

Inflation is not cooperating in 2024, and it remains above the Fed target of 2%, with the latest readings of the CPI at 3.5%. The outlook for inflation has worsened, with three disappointing readings in a row. Energy prices and an uncertain geopolitical picture are the primary villains. In an approach that has had extremely limited value, the Biden Administration has drawn down the Strategic Petroleum Reserves to keep a lid on oil prices. The Fed is looking for the opportunity to cut rates, but inflation is sending the message that they should actually move in the other direction. Stubbornly high inflation is not good for the market.

Interest rates are following the trends in inflation. Rates may or may not have peaked, but the market is clearly not ready for the Federal Reserve to start to cut. Inflation expectations tend to lead rates, and wage and price inflation has seemed poised to moderate. They just aren't doing so, yet. Only a few weeks ago, the Fed was expected to cut rates six times in 2024, and that number was dropped to three and now to just one or two. It seems that the Fed may have to pause for longer than expected, and maybe all of 2024. Interest rates at current levels are an impediment to rising stock prices.

The U.S. deficit in 2023 was $1.84 trillion, and the CBO estimates are $1.6 trillion for 2024 and $1.8 trillion in 2025. These numbers are staggering. Federal debt has grown to $35 trillion, which is well over $100,000 per family. World debt is now over $313 trillion and is essentially out of control. Debt to GDP is 88% for the U.S. (about triple that with unfunded liabilities) and this is less onerous than France at 127%, Italy at 171% and China and Japan at more than 300%. Spending beyond one's means is a worldwide problem.

Because we still have a dichotomy in the economy between our most wealthy citizens and other more average consumers, it makes it difficult to sort out the effect on our economy in total. High earning Americans are able to deal with our inflationary pressures, plus they continue to benefit from rising stock prices and higher home values. Offsetting the elites is the larger pool of everyone else - many of whom are more or less experiencing a depression. It is impossible to tell whose influence will be greater on the overall economy. Housing prices are rising because there is limited supply for sale. Mortgage rates have crept lower, but remain high at 7%. There is little incentive for homeowners to sell if they are locked in at a 3.5% mortgage. Insurance rates for housing and auto are rising by more than 20%, and the average family is spending an unbearable $700-800 more each month on food, gas, and housing. The employment picture is mixed, with more jobs created for foreign-born workers and fewer for domestic-born workers, plus an increase in part-time work at the expense of full-time employment. This year, we expect more weakening in commercial real estate and a slowing in fiscal stimulus. An offset should be a recovery in capital spending, netting out to very modest growth in GDP.

The 2024 Presidential campaign is shaping up as a rematch between Joe Biden and Donald Trump. This will be a significant political year for many reasons and at many levels. The choice may not seem to be compelling or exciting to many, but the policy differences are profound. A particularly disturbing trend in 2024 has been the blossoming of antisemitism on the college campus across the nation.

The Japanese market hit a recent high and we are told that the Chinese economy may be moving toward renewed growth. U.S. companies are bringing production onshore or moving toward more friendly locations to avoid risks and disruptions in the supply chain. Apple is shifting from China to India, and others are moving to Singapore and Vietnam. Beyond that, the international news is dominated by hostilities in Europe and the Middle East, and things are moving in a very troubling direction. At present, Russia has gained the upper hand in Ukraine, but we don't expect this war to be resolved any time soon. Iran took the extreme step of sending over 300 missiles and drones into Israel, and all but a small number were disabled in flight. The response was brilliant, as Israel took out an Iranian missile launch site at an airport right next to a nuclear power plant. Iran got the message (for the time being) and announced that nothing really happened, just a small explosion. Iranian citizens are actually begging for Israel to take out the Ayatollah, so it seems clear that there will be many more chapters in this book about the Middle East.

GDP should grow close to 2% this year and at a similar pace next year. We do not project a recession, but we are mindful of the conflicting factors by income levels that we discuss in this letter. Earnings are expected to grow close to 10% in 2024 and 10-12% in 2025. We believe that the bull market that began in October, 2022 is still intact. Projected earnings growth suggests that the market is selling at about 21 times S&P 500 earnings. The current level of valuation is high, but it allows stocks with strong earnings to perform well. For this reason and others, we continue to favor stocks with high profitability, good earnings growth, and earnings valuations that are not excessive. This level of valuation allows stocks with strength in earnings to be rewarded and may punish those that fall short. In other words, this market continues to favor careful individual stock selection.

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