This quarter we turn to the Roman philosopher Seneca for wisdom. He gets us started with a familiar line, and I take the liberty of adding a concluding phrase that brings his general thought more closely to bear on the investment equation.
“Every new beginning comes from some other beginning’s end, and in between lies the risk of the unknown.”
The stoic Seneca frequently stressed the importance of accepting the natural flow of life, the transitions that occur within it, and taking what comes as inevitable and adjusting to it. As investors, we face the same challenge, and currently we find ourselves in several economic and market transitions. Since transitions entail entrance into the future, there is risk involved as the future always represents the unknown. This is familiar ground for us, for our investment approach well recognizes the risks in unknown futures and attempts to provide portfolio frameworks that can limit those risks.
TRANSITION IN ECONOMIC POLICY. We can take it from the top. None less than President Trump has stated that we are in a period of economic transition. He is seconded by the Secretary of the Treasury Scott Bessent who says we are in a transition from a government spending-led economy to one that is driven by private spending. President Trump’s plan, in line with his “America first” theme, seeks to fundamentally change the economic order based on tariffs or threats of tariffs. Secretary Bessent is more specific, enumerating his 3-3-3 plan.
The 3-3-3 plan seeks to do the following:
The benefits of success in these areas are obvious. Higher economic growth would be beneficial to all, especially corporate America; lower oil prices would be helpful in taming inflation; and reducing the federal deficit would undoubtedly improve the chances for lower long-term interest rates.
To say the least, this is an ambitious plan. Success will not be easy because there are serious challenges to each of these goals. In some instances, one goal may work against the others. For example, it takes time for deregulation to occur and work its way through the system, and tax cuts have not necessarily led to higher growth in the past. Increasing oil production could be disincentivized by lower oil prices, and budget cutting implies slower overall economic growth. Also, deficit reduction in the face of a proposed large tax cut will prove difficult. While these challenges are real and total success may be difficult to achieve, it is fair to say that any progress toward these economic goals would be a constructive development.
This is an aggressive agenda in that it requires significantly different behavior within the economy. Sometimes pushing for outsized success brings risk to the economic and market environment. There are inherent limits to what an economy can achieve, and straining against these limits may bring unintended consequences. Also, failure to clearly communicate policy fundamentals can lead to disruption in the normal flow of business activity, such as hesitation and indecision among consumers and businesses. We have already seen evidence of this as President Trump vacillated on his tariff policy. Now, however, with the release of his surprisingly assertive tariff program, economic and market uncertainty has been heightened, resulting in a sharp selloff in stocks. Trump’s belief in tariffs appears to be one of his more consistently held views, a position that generates controversy. It is a widely held conviction among economists that tariffs are inflationary and tend to impede economic growth. Markets seem to agree. We shall see on this, but for now we highlight the risks in this policy transition.
TRANSITION IN MONETARY POLICY. Since last fall the Federal Reserve (Fed) has been in the process of transitioning from a restrictive monetary policy to a more accommodating one. However, what looked like a smooth glide lower for short-term interest rates has now been halted, at least temporarily, due to two factors. First, inflation, which had been declining on schedule, has now become uncooperative. Headline inflation seems to be stuck at around 3%, still a good way short of the 2% goal. Second, the Fed has decided that it should be cautious about further federal funds rate reductions until there is more clarity around the Trump economic proposals, specifically tariffs. Chairman of the Fed Jerome Powell has been pointed in his comments, stating that President Trump’s tariffs are already contributing to higher inflation and may delay progress toward the Fed’s goal of 2% inflation.
The Fed’s hesitation is complicated by the fact that there are signs that the U.S. economy is slowing. Consumer confidence has been declining, housing starts are weak, and the Atlanta Fed’s GDPNow measure is currently indicating a decline in GDP for the first quarter. We know that the Fed is far from perfect in its execution of policy, and its hesitation at a time of slowing economic activity raises the risk of a policy error. While it recently raised its inflation forecast and lowered its growth forecast for this year, it still projected two interest rate reductions later this year. Whether we get these cuts or not, we continue to believe the most important task for Fed policy is to reach the 2% inflation target. Lower inflation, everything else being equal, should result in lower long-term interest rates.
In summary, the economic picture is far from clear. The normal uncertainty associated with transitions is heightened by a lack of clarity on just how economic policy will be rolled out by the administration and the path forward for monetary policy. Meanwhile, in the context of slowing growth and increased uncertainty, recession risks are rising.
TRANSITION IN MARKET LEADERSHIP. In the first quarter the stock market was picking up on the risks that we have been highlighting. After a strong January, the popular averages declined across the board, all of them ending the quarter with negative returns. Making note of declines in the popular averages can be less than informative, for it fails to reflect the damage done to individual stocks. Suffice it to say, for many investors it was a very challenging environment.
Fortunately, for us it was a very satisfying quarter. As most of you know, we manage six different equity strategies. I am happy to report that all of these strategies performed very well in the first quarter in a relative sense, and most of them provided positive returns in a negative environment. And, since our emphasis on quality is the predominant characteristic across all of these strategies, we must assume that quality was the most important factor that investors recognized in the first quarter. Actually, this trend toward quality has been playing out for the last three quarters, sometimes obviously, sometimes under the surface.
When changes in market leadership occur, it is difficult to know how long they will last. While investor preferences are often shifting, at least over the shorter term, we keep our focus on the longer term and what we believe to be the best approach to investing through transitions to an uncertain future. Think about the purposes of markets. Markets not only provide liquidity for investors, but they also put a price on an uncertain future. In the last few years markets have priced that future favorably as valuations expanded consistently, reaching very high levels as judged by history. In popular terms, it was “risk on” for investors. Now, however, as the various transitions are occurring with less clarity as to future outcomes, “risk off” has been gaining ascendency.
Shifting attitudes about the future are common, but what does not change is the fact that the future is always uncertain. So, like Seneca, we keep recognizing this basic fact of life and emphasizing what we believe can give us the best chance of navigating the unknown. We seek as much predictability in our investments as we can get, which is our search for quality. Over the last 45 years of our existence as a firm we have endured many transitions, some of which ended favorably, others unfavorably. Quality has been our constant ally as we have navigated these transitions. Also, through these periods the U.S. economy proved resilient enough that it kept on its basic course of expansion and provided corporations with a business environment conducive to success. We expect the same in the future.
We have found that the companies that best navigate these transitions are those that have the resources of balance sheet, management, and product to consistently move forward. Consistency is the key. Importantly, this forward progress can be identified in the consistency of dividends. Companies that can consistently pay and increase their dividends generally have a more consistent record of cash flow generation and earnings, the most fundamental drivers of success in their stock prices. Dividends remain at the heart of our quality-oriented philosophy, one that we believe will stand us in good stead as we move through the current transitions we have discussed.
Thanks so much for reading, and all the best until the next time.
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