Good morning. I hope you and yours had an enjoyable Memorial Day. I took the day off so this quick note is my post for the week. I'll be back on schedule next Tuesday.
- Brandon
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As you’ve likely heard, the Trump Administration announced early Monday that it reached an agreement with China where both sides would decrease tariffs on each other during a 90-day pause while trade negotiations continued. Markets around the world cheered this announcement and major indexes here at home opened yesterday up around 3+% and held that through the close. The NASDAQ rose over 4%.
Here are some of the tariff details as reported yesterday by the Wall Street Journal:
- We’re lowering our “reciprocal” tariff on Chinese goods to 10% from 125%.
- We’re still planning to tack on an additional 20% fentanyl-related tariff on Chinese goods.
- China is reducing it’s retaliatory tariff on our goods to 10% from 125%.
- These tariff reductions are supposed to last for 90 days while talks continue.
- Combined, it’s reported that our average tariff on Chinese imports would be nearly 40% (existing and new tariffs) if all this actually sticks.
Going into the weekend markets anticipated a tariff reduction to maybe 50% or 80% from 145%, so the outcome of the Trump Administration’s talks with the Chinese delegation in Geneva over the weekend was better than expected. However, these new tariffs will still have a meaningful impact on pricing and profitability for a wide variety of imports and the businesses and consumers who rely on them (so pretty much everybody).
Who knows what ultimately comes of this agreement over the next 90 days. Investors may be assuming that cooler heads are prevailing and the ultimate tariff amounts might be substantially less than 30%. Whatever the final number, the surge of uncertainty in recent weeks is reverberating through the economy. Numerous anecdotes tell of business plans interrupted, paused and cancelled orders, and so forth, even business closures. The busy Port of Los Angeles expects a 25% reduction in imports during May following reductions in April. This is expected to create shortages for certain goods this summer, but how this plays out across the country and in macroeconomic numbers is anyone’s guess.
Along these lines, the CEO of Flexport, a logistics management company, has an interesting perspective on these supply chain issues and has been making the media rounds talking about the real-world impact on importers. Here's a link to the company’s X (Twitter) feed where you can watch some of the CEO’s interviews on CNBC, the PBS Newshour, etc.
https://x.com/flexport/status/1920883274206826847
One of many takeaways for individual investors from this turn of events is the importance of staying the course amid uncertainty and fear. We’ve now had yet another reminder of how quickly markets can fall before climbing rapidly and in surprising fashion. We’ll likely see more volatility in the near-term, but it’s a cost all long-term investors must bear. It’s unpleasant but I think it’s worth it over the long run.
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This week let’s look at inflation psychology. Even though the Consumer Price Index has improved almost to normal levels since 2022 when inflation spiked, consumers still report being overwhelmed by it. This makes sense when we consider egg prices, for example, which are about twice as expensive as a year ago. And people are rightfully concerned about looming tariff-related inflation. Still, prices are lower for most of what we buy so we shouldn’t be as concerned about inflation as we are.
This concern shows up in surveys where consumers continually express how bad they feel about the direction of the economy, the markets, and their own prospects. (The chart below shows before "Liberation Day", by the way.)
However, what’s really interesting is what consumers have been saying hasn’t necessarily matched up with what they’ve been doing.
Historically when consumer sentiment, a leading economic indicator, reaches low levels like we saw in 2022, a recession soon followed. That didn’t happen – consumers, at least on average, were incredibly negative about the economy but still continued to buy more which helped keep our economy growing. Consumers have remained negative and are currently more pessimistic on the economy than during covid and almost as negative as during ’08 and ’09, although I didn’t include that in the chart. (Again, before Liberation Day.)
Have things really been that bad, or could surveys be showing the lasting impact inflation has on our psychology?
Economists, analysts, and journalists have wondered about this for some time but a recent study by the Federal Reserve examined this issue more closely. I’m reproducing sections below and including a link as well. The full article has a number of charts and explanatory information that wouldn’t show up well in this blog format, so please check those out if you’re interested.
To summarize in advance, the psychology around inflation and inflation expectations can be as impactful as rising prices. People can fear inflation so much that they develop a distorted view of how bad it is, both for their situation and the whole economy. This perception problem impacts people differently but, perhaps strangely, doesn’t necessarily change one’s level of consumption.
From a personal finance perspective, I think it’s important to understand the psychological issues at play and to develop methods for combatting the anxiety inflation can create. This is also important to prepare for a potential tariff-induced spike in inflation this summer.
One approach would be to test your financial plan for sustained inflation. Can you afford that? At what point should you be concerned? You can also analyze your annual spending. Has it gone up because everything is more expensive, or were there other contributing factors?
Ultimately, inflation is certainly an issue but it shouldn’t cause so many people as much concern as it seems to, especially at current levels.
From the Federal Reserve…
Despite low unemployment, moderating inflation and anchored inflation expectations, and rising incomes since mid-2022, surveys at the end of 2024 continued to report that consumer sentiment remained unusually low, below levels at the onset of the pandemic and on par with levels during the Great Financial Crisis. Why was there this discrepancy between consumer sentiment and the real economy?
This note summarizes the results of a household survey that aims to understand how changes in household incomes and spending between 2019 and 2024 and how behavioral changes households made to adapt to the economic environment shaped their economic sentiment. It includes nearly 10,000 representative panelists responses to various questions collected over two waves in October and November 2024. Using micro spending data, we link survey responses to respondents' total annual spending to gauge how actual spending and household-specific price levels for everyday retail purchases changed between 2019 and 2024. Being able to connect sentiment with verified spending is a novel contribution, above and beyond previous studies that explored economic sentiment in the post-pandemic period.
Our results indicate that:
- The more people thought the prices they paid rose faster than their incomes, the worse they said they were doing.
- Consumers were more likely to overestimate than to underestimate the inflation they experienced. Those consumers who overestimated their verified inflation said they felt worse about economic conditions.
- Most respondents reported higher household incomes in 2024 versus 2019 but still said they did not feel good about the economy due to the effort they exerted to adapt to the economic environment.
- After adjusting for inflation, verified spending on everyday retail items remained strong even among those who reported having lower incomes or among those who said they felt worse about the economy in 2024 compared with 2019.
Taken together, we show that what consumers have been saying differs from what they have been doing during the post-pandemic period; consumers say they feel worse, but through the end of 2024, they are buying more – not just spending more – than they did in 2019. This disconnect between what consumers have been saying and doing suggests that consumer sentiment surveys on their own have become weaker indicators of future consumer behavior and of the health of US consumers.
Historically, consumer sentiment moves in tandem with concerns regarding lower income and higher prices on household finances, and sharp drops in consumer sentiment tend to precede or coincide with recessions. This time, the sustained drop in consumer sentiment following the pandemic has not preceded or coincided with a recession.
[…] during inflationary episodes, consumers seem to put more weight on higher prices than on higher incomes when assessing their current economic conditions, and as long as income growth remains robust, consumers continue spending even though in sentiment surveys, they say they feel pessimistic about the economy.
[…] 80 percent of panelists said they put a lot or some effort into cutting expenses. Only 5 percent percent said they had not been trying to cut back on expenses. Second, as Figure 5 shows, negative sentiment increases with the number of "Yes" answers to the changes households made to cut back: the more changes households made, the worse they feel.
People's negative sentiment seems to be driven by the perception that incomes have not kept up with prices, even though real spending has increased, and by the effort they exerted to adapt to rising prices. Although sentiment improves with higher incomes, the more people said they had to make changes to their behaviors since 2019 to reduce spending, the worse is their sentiment. Moreover, those who experienced increases in their incomes still reported negative sentiment, citing the need to work more hours or take on additional jobs to earn extra income. In contrast with much of the history of consumer sentiment measures since the 1960s but similar to the history of consumer sentiment during other inflationary episodes, consumer sentiment in 2024 was more closely related to concerns about higher prices than to concerns about lower income. This situation may reverse as inflation continues to decline or if the labor market weakens.
Here's a link to the full article.
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You may have heard over the weekend that Moody’s, one of our country’s three main investment-related credit rating agencies, downgraded the US to one step below AAA. S&P was the first to downgrade us back in the summer of 2011, then came Fitch in 2023 and now Moody’s. We’ve completed the set, so to speak.
While S&P’s downgrade shook the markets back in 2011, the reaction this time is more of a yawn; it’s newsworthy but not necessarily news because it confirmed what most already understand to be true. The US is on a long-term unsustainable debt path but we’re still the “cleanest dirty shirt” in the laundry basket of western economies, as was said back in 2011. We’re growing, have good structure, and our currency is likely to remain the most trusted for the foreseeable future. All that and more is probably why the markets have mostly shrugged off the Moody’s announcement.
Still, some of the details and analysis since Friday are interesting, and perhaps a little soothing given some of the headlines in recent months, so I’m reproducing snippets from Moody’s and my research partners at Bespoke Investment Group.
From the Moody’s press release – a link to the full document is below [emphasis mine].
Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs. We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration. Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government's debt and interest burden higher. The US' fiscal performance is likely to deteriorate relative to its own past and compared to other highly-rated sovereigns.
The stable outlook reflects balanced risks at Aa1. The US retains exceptional credit strengths such as the size, resilience and dynamism of its economy and the role of the US dollar as global reserve currency. In addition, while recent months have been characterized by a degree of policy uncertainty, we expect that the US will continue its long history of very effective monetary policy led by an independent Federal Reserve. The stable outlook also takes into account institutional features, including the constitutional separation of powers among the three branches of government that contributes to policy effectiveness over time and is relatively insensitive to events over a short period. While these institutional arrangements can be tested at times, we expect them to remain strong and resilient.
While we recognize the US' significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics.
A significantly faster and larger deterioration in fiscal metrics than we currently expect would weigh on the rating. A rapid move out of dollar assets by global investors could precipitate such a deterioration if it resulted in much higher interest rates, causing the interest burden to rise faster than we currently expect. We do not consider this to be a likely scenario since a credible alternative to the US dollar as global reserve currency is not readily apparent.
And now some analysis from Bespoke.
Just after the close on Friday, Moody’s downgraded the US from Aaa to its next-highest rating, marking the third time since 2011 a major ratings agency has removed the AAA (or equivalent) from US sovereign debt. The new Aa1 rating is still extremely high in the scheme of things, and the sort of downgrade that would force sales of UST by existing holders [such as pension funds and others who are required by their own investment policy to buy AAA-rated bonds] would require a far larger cut to ratings. That’s not on the horizon. Moody’s had previously had the US on credit watch negative but has shifted that outlook to stable.
Back in 2011, S&P originally removed the AAA rating for US credit over risks that the US would not actually pay its bills and a default might take place if the debt ceiling was not extended by Congress. This sort of ratings downgrade makes some sense at the margin. Debt ceiling brinksmanship is messy enough that it’s not hard to imagine a scenario where Congress doesn’t raise the debt ceiling by accident or a day late, and Treasury refuses to make payments on debt due thanks to this cap. While that scenario’s likelihood is very low, we think it is materially higher than one where the payment of debt in US dollars is threatened, either by strategic default or because cash is not available to meet outstanding obligations.
US federal debt is denominated in dollars, and the issuer of that debt also issues dollars. To be sure, schemes like monetizing the debt (the Federal Reserve issuing new reserves to fund purchases of bills or UST when the market won’t buy them) would hypothetically have huge negative effects. But they’re always an option making the possibility that fundamentals like debt-to-GDP or the fiscal deficit would drive a US default basically zero. Despite that dynamic, Moody’s cited those two ratios among others as the key drivers of concern that led to the downgrade on Friday, which is a bit confusing.
Here’s a link to the Moody’s press release if you’re interested.
https://ratings.moodys.com/ratings-news/443154
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Last week was another good one for stocks, part of a streak of nine positive days that ended when the market closed in the red yesterday. We haven’t seen a nine-day winning streak in about 20 years. We’re not out of the woods yet but it’s wonderful to see positive returns after all the volatility lately.
That said, let’s review some news about Social Security anxiety. Maybe it’s caused by headlines and mixed messages about fraud and waste, personal data security, or simply the health of the system. Whatever the reasons, people nearing retirement and those receiving benefits are understandably nervous about this important income stream.
Apparently this anxiety led to a large bump in March of people filing for their benefits compared to a year ago. I understand the “bird in the hand” idiom but I hope people who file earlier than planned understand what they’re doing.
Most know that waiting to start their Social Security benefits makes good financial sense. People have heard from experts (and from me) for years about how waiting locks in higher benefit payments for life. They’ve heard how one typically only needs to live to 80 or so before breaking even on waiting. Social Security benefits keep growing until age 70, so that’s the ultimate goal here. However, most people file well before then, either at their Full Retirement Age of 67 (typically) or earlier starting at age 62. This latter group willingly accepts a monthly benefit that gets incrementally smaller the earlier they start receiving payments, perhaps as much as 30% smaller for life.
Besides recent headlines, what are some reasons to start your benefits early?
- You need to stop working earlier than planned, haven’t saved enough, and your work prospects are slim. In short, you need the money. If so, take it but hopefully you’ve weighed all of your options with a financial planner, tax person, or perhaps a knowledgeable family member.
- You’re in poor health and don’t think you’ll make it past 80 (as a round number – your breakeven age may be different).
- You’re single. Starting your benefits early could impact what your spouse ultimately receives.
Maybe all three reasons fit your situation. If so, you should still talk it over with someone but filing early is probably appropriate.
Granted, there are multiple ways to think about this and one could (and some do) argue that my viewpoint is overly clinical and focused too much on dollars and cents. If Social Security could blow up any day one might as well enjoy the money now, and so forth. While I don’t have a crystal ball and can’t guarantee that anything will or won’t happen, I can suggest that it’s unlikely the system will implode during our lifetime. The quote attributed to President Trump below is one of many – they don’t call Social Security a third rail of Americans politics for nothing.
The following article excerpts from the Wall Street Journal discuss the recent Social Security filing numbers. A link to the full article is below.
Americans anxious about the future of Social Security are claiming their benefits earlier than planned, even though it can mean less income over the rest of their lives.
The Social Security Administration has been shedding staff and changing requirements for claiming benefits over the phone. President Trump has been pushing to cut government spending, though he has vowed not to reduce benefits.
Pending Social Security claims for retirement, survivor and health insurance benefits totaled 580,887 in March, up from 500,527 a year earlier. While multiple factors likely contributed to the increase, agency officials said at a March 28 meeting that “fearmongering has driven people to claim benefits earlier.”
Many effects of the Trump administration’s swift and sweeping changes to federal agencies aren’t yet apparent, but with Social Security, they are already changing households’ financial decisions. Americans have long been anxious about Social Security’s stability, and Trump’s second term is heightening those anxieties.
“That is leading people to make decisions based on fear,” said Kathleen Romig, director of Social Security and disability policy at the Center on Budget and Policy Priorities.
Economists and financial advisers generally discourage claiming early. Benefits increase with each month someone waits to take them beyond the minimum claiming age of 62. The increases stop at age 70.
Benefits starting at 70 are 76% higher than at 62, according to Laurence Kotlikoff, a Boston University economist and founder of Maximize My Social Security. A person who postpones benefits until 70 instead of 62 would come out ahead if they live to at least 80, he said.
Liz Huston, a White House spokeswoman, cited other causes for the increase in claims in March, including aging baby boomers claiming benefits and a new law that raises benefits for some government retirees.
She said: “There is no confusion. President Trump has been extremely clear: he promised to protect and strengthen Social Security.”
Calls to the agency since the beginning of October are up 19% compared with the same period a year earlier, officials said at the meeting. Website traffic and field office calls are higher as well, they said.
Recent surveys reflect the concern. More than 75% of U.S. adults worry a great deal or a fair amount about Social Security, a 13-year high, according to a March Gallup poll. Democrats expressed greater concern than Republicans.
When Social Security’s finances are referenced negatively in the news, workers tend to report a desire to claim benefits earlier, according to a 2021 study by the Center for Retirement Research at Boston College.
Social Security’s finances have long been under pressure because of the aging of the population. Unless Congress shores up the retirement program, it is projected to deplete its reserves in 2033, which would trigger a 21% reduction in benefits.
Social Security officials said at the meeting that many Americans are visiting field offices for help accessing their accounts on the agency’s website. Some are paying the agency $100 for certified copies of their earnings records, on which benefits are based.
A Social Security official said at the meeting that personal data is secure and the agency has backups. He acknowledged two website outages in March that he said were brief.
Retirees also take Social Security sooner than expected for reasons including deteriorating health and job losses. About a quarter of people filed for benefits when they turned the minimum claiming age of 62 in 2023, the most recent data available.
Here’s a link to the full article.
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The news flow is rapid again this week with markets focused on tariff policy, earnings valuations, and (especially yesterday) the independence of the Federal Reserve. Any of those topics can and do take up lots of time so in the spirit of brevity let’s spend a few minutes looking at valuations – maybe that’s the simplest one.
Most publicly-traded companies offer quarterly reports to market participants explaining how their business has been doing and what their outlook is for the coming quarters. The data is supposed to be accurate and executives typically have a conference call with analysts and journalists to explain the numbers and answer questions. Analysts compare what they learn against their own assumptions and try to determine a fair price to pay for a share of the company’s stock. This valuation process is imprecise and a moving target but is also a foundational part of the stock market.
You can imagine how important assumptions about the economy and markets are for these calculations, and how much harder it is to do this sort of analysis as the range of potential outcomes widens. Still, the process is helpful to get a sense of how decision makers handle uncertainty in the real world.
A good example of this is United Airlines. The company made news (at least in my industry) last week when it gave market analysts a bimodal set of earnings per share expectations for this year, a baseline scenario where the economy slows but remains stable and United earns around $11.50 to $13.50 per share (maybe call it a pre-Liberation Day outlook) and a recessionary scenario where the company earns $7 to $9 per share.
While it’s prudent and necessary to plan for multiple outcomes as a business, it’s rare for companies to give markets such a wide range of potential earnings based on divergent scenarios. The range might typically be 50 cents, for example, and they usually don’t game out two distinct paths for analysts. They did so because “a single consensus no longer exists” for the direction of our economy. Think about that. Currently United stock is priced by the market for earnings growth in the stable economy range and higher in 2026. Is that fair based on current risks to the outlook? Which outlook are we even talking about?
That’s not to pick on United; I fly them frequently and I also like the stock. Instead, it’s a good example of how people in boardrooms are planning, and have to plan, amid a ton of uncertainty. Extrapolate that across the thousands of companies that make up the stock market. It helps explain why stocks rebounded from recent lows but not all the way back to highs from mid-February and seem to be tapering off in recent days. Companies everywhere are settling in for a grind that may not be entirely priced into stocks right now. And investors are trying to absorb that as the news keeps changing.
Here are some notes on this valuation issue from JPMorgan yesterday morning. I’ll try to summarize at the end.
Markets are forward looking, but earnings estimates don’t have to be. Currently, consensus is projecting 1Q25 and FY25 year-over-year EPS growth of 7.1% and 10.0%, respectively. Relative to 10-year medians of 4.4% and 3.1%, both estimates are strong. Unfortunately, they’re based on economic assumptions that no longer hold. Tariffs will slow growth, increase inflation and undermine confidence. Weaker demand will hurt revenues, higher costs will hurt margins and reduced profitability will hurt buybacks. Even if the administration changes its mind, the longer uncertainty remains, the longer spending slumps, and the greater the hit to growth. Equity analysts aren’t immune to this uncertainty. Rather than bouncing estimates around with tariffs, current numbers are effectively pre-policy. As this week’s chart shows, downward revisions to 2025 EPS estimates aren’t any larger than normal. Since January, consensus has dropped 2.5% compared to the 10-year average of 2.6%. As policy clarifies, there’s a risk EPS estimates could hit the ground hard, catapulting valuations. Early impacts of tariffs are showing up in other ways. Retail sales spiked 1.4% in March, the largest m/m increase in over two years, driven by 5.3% growth in auto sales as consumers front-run tariffs. Moreover, 44 companies have reported earnings so far, and tariffs have been mentioned 239 times. Many management teams, however, are pausing guidance until policy clarifies. For now, the range of outcomes is wide, and the impacts are difficult to predict. Companies’ ability to hold the line will depend on their individual supply chains, pricing power and balance sheets, to name a few. In times like these, first principles are paramount: quality, diversification and a long-term perspective.
In other words, the stock market may still not have found a bottom assuming a recessionary scenario.
Assuming so, it’s entirely reasonably to ask whether we should sell everything, hang out in cash for some months, and come back when the waters are calmer. That could work and make you feel better in the near term. The problem is determining when to get back in – that’s the far harder question. Markets tend to stay volatile for a while and rise amid the volatility, often unexpectedly. If you waited until things were “calm” you’d likely miss most or all of the upswing, locking in your losses and making it that much harder to recover from this downturn.
Instead, focus on the structure of your portfolio. Rebalance from cash into stocks as prices fall. This can be new cash you add each pay period to your retirement accounts at work. Or it could be cash within your portfolio. Cash can also come from selling bonds since short- and medium-term bonds have held up well in recent months.
And remember that you can rebalance within your stock allocation as well. Maybe it’s taking from foreign stocks and giving to US small cap or maybe a favorite sector fund that’s of good quality but has been getting its teeth kicked in lately. You’ll only know perfect timing in hindsight, so look to your portfolio as a guide for what to rebalance and when instead of whatever the talking heads are saying on your screens.
Those are examples of investing processes that we have control over, the first principles thinking referenced by JPMorgan. Triple down on that during bad markets to set yourself up for success later.
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