Share

LinkedIn

More Quarterly Investor Letters

See More

Market commentators remain puzzled by several aspects of this year’s economy. First, tariffs have not contributed to broad-based inflation. Price increases for some products have increased substantially, but general inflation gauges have moderated, suggesting producers and distributors absorbed many of the increases. Second, despite economic uncertainty, the labor market remains stable. The prevailing characteristic is low turnover as both job creation and job destruction have been subdued. Finally, the Dollar stabilized after a period of intense weakening that began in the Fourth Quarter of 2024. Many economists predicted an aggressive and disruptive “de-dollarization” process that, contrary to expectations, currently appears to be in respite.

 

The S&P 500 posted a strong Second Quarter, it continues to lag several Asian and European indices. International equities benefited from Dollar weakness and fiscal stimulus packages. While Market leadership of the S&P 500 broadened somewhat, but its concentration remains historically high. This poses a challenge to long-term investors who favor diversified asset and sector allocation strategies.

 

Financial media dedicated intense coverage to Federal Reserve policy adjustments during the quarter. The Fed is required to balance risks associated with its dual mandate – i.e., price stability and full employment. For example, if risk tilts to inflation, investors would expect the Fed to tighten policy. Conversely, if rising unemployment is the greater concern, the Fed would shift to more accommodative policy. Until the September meeting, the Fed considered risk to be balanced between the two mandates, justifying its neutral stance. At the September meeting, in response to recent payroll data, the Fed acknowledged a slight shift toward accommodation and cut rates 0.25%. The market quickly adjusted to the rate cut and priced in two additional cuts prior to yearend.

 

The rate cut(s) provide support and liquidity to both the economy and the markets. However, additional liquidity also contributes to inflation. Moreover, structural changes to the labor market, including lower immigration, have fundamentally altered employment forecasts. Combined with data collection issues, the Fed could encounter economic indicators that offer conflicting economic outlooks. A potential policy dilemma, therefore, represents a market risk factor for the Fourth Quarter.

 

Finally, the scale and scope of infrastructure investments necessary to support Artificial Intelligence (“AI”) already exceed prior expansions such as railroads and telecommunications. AI-related activity consumes a disproportionate amount of capital expenditures and corporate activity. Each prior innovation eventually resulted in massive excess capacity, as bust inevitably followed boom. Specious, often circular, financing structures signaled the peak of prior cycles. We note with some caution that recent transactions involving AI companies include similar provisions. An accurate projection of the ultimate impact of AI remains indeterminate. It is important, however, that analysts have begun to raise important questions as to whether current investments will ever generate a reasonable return.

 

The Supreme Court could also contribute to volatility this quarter as they are expected to rule on Fed independence and the legality of reciprocal tariffs. While we remain constructive on both the economy and the markets, we acknowledge persistent uncertainty and, therefore, recommend diversification. Please contact the Firm to schedule a virtual or in-person review meeting.