“Don’t gamble. Take all your savings and buy some good stock and hold it ‘till it goes up, then sell it. If it doesn’t go up, don’t buy it.” – Will
Rogers, famous U. S. humorist
Summer Recap
During the third quarter, most financial assets trended higher after turbulence earlier in the year. The S&P 500 and NASDAQ 100 posted strong gains among US indices. Cyclical averages such the Dow Jones Industrials and Transports showed moderate gains, while smaller cap indices rose sharply in anticipation of easier monetary policies.
Fixed income markets posted modest gains, with 10-year Treasury yields edging down within the 4.00-4.50% range. West Texas Intermediate (WTI) oil lifted slightly, remaining in the 10% band. Commodities such as copper and lumber fell, while precious metals such as gold soared.
The Fog of Uncertainty Lifts, Somewhat
Tax Bill. As mentioned last quarter, the tax bill was passed ahead of expectations and should provide a boost to corporate capex spending and the overall economy next year. Deregulation initiatives, particularly for financial institutions, are moving forward and expected to be finalized during the coming months.
Fed Shutdown. October brought another government shutdown, with Congressional Republicans and Democrats at a deadlock to restore funding. If the impasse lasts less than a month, negative effects should be temporary and reversable once agreement is reached. However, if it continues six weeks or longer, the economy will take a bigger hit. Although government shutdowns have occurred over the past two decades, they are usually resolved once disgruntled voters complain about the lack of services, pressuring one party or the other to capitulate.
Tariffs Negotiations. Tariff accords have been reached with many countries including the U.K., Eurozone, Japan and South Korea. However, these are broader agreements, with details still needing to be worked out. Additionally, the tentative agreements have been subject to court challenges. The US Supreme Court is scheduled to hear arguments in November with a decision hopefully coming by the end of the year.
Sectoral tariffs have also been imposed for a variety of industries, such as semiconductors and pharmaceuticals. Negotiations are proceeding between the Administration and companies on a one-by-one basis. Contentious items with China remain far from resolved, as access to US chips by Beijing and rare earth metals by Washington creating new uncertainties. Our view is that both sides do want an eventual deal — but the process will be messy and take time.
AI – A Glass Half Full or Half Empty?
AI, or Artificial Intelligence, has been a prevalent theme in the markets since late 2022. At this point, some investors are questioning when and whether the spending on this new technology will be translated into sales to end-use customers. While there have been comparisons to the dot-com bubble of the late 1990s, AI has relevant differences that should be considered in market evaluation.
- There is anecdotal evidence of end-use AI, particularly in the finance and healthcare sectors.
- Tech valuations, though stretched, are not at 2000 levels.
- Most of current spending have been by large tech companies with strong profits and robust cash flow, lessening any borrowing needs.
- Initial Public Offerings (IPOs) of nascent AI companies, are still subdued relative to past cycles, especially dot-com. An overheated IPO environment would be indicative of excessive speculation.
- Last, but not least, the Fed is currently easing monetary policy. In other cycles, including dot-com, the Fed was tightening monetary policy by raising the short-term Federal Funds rate.
At this point, we feel that the potential from AI is indeed compelling until red flags, such as the ones listed above, begin to appear. As always, our investments favor seasoned companies with consistently positive profits, cash flow and strong balance sheets.
The Federal Reserve – Policy and Future Composition
We believe that the Fed will lower the Fed Funds rate one or two more times this year. Current Fed Board members are generally leaning toward a gradual, data-dependent approach, especially due to lack of economic reports caused by the government shutdown.
The outlook for Fed policy in 2026, however, is quite murky because of the White House’s insistence that rate cuts remain aggressive. The Administration also seeks to change the composition of the Board by attempting to fire Governor Lisa Cook (which is being challenged in the Supreme Court) and appointing a new, more dovish Fed Chair when Jerome Powell’s term expires in May.
Fourth Quarter Outlook
- Though the government shutdown is causing a lack of current economic reports, private reporting largely indicates moderate economic growth, with a continuation of the “no hire, no fire” labor market. The experience of the last several years demonstrates it takes a lot to push the US economy into a contraction.
- Consumer spending, though impacted by the lower income half of households, is being more than offset by the stronger upper half.
- Corporate profits for the third quarter are forecasted to be robust after a surprise uptick in the spring.
- The Fed will gradually ease rates after pursuing a restrictive policy for the last few years.
- We continue to add to international equities, further diversifying portfolios while taking advantage of growth potential abroad. The White House has stated it wants a lower dollar, which would also provide a tailwind to foreign stock and bond returns for US investors.