Investing, in many ways, is a waiting game. As the late rock star Tom Petty reminded us, waiting can be the hardest part.
The waiting is the hardest part,
Every day you see one more card.
You take it on faith, you take it to the heart,
The waiting is the hardest part.
For investors, the most important thing is the future. It is where all investment returns come from, and it is what provides the time value of money. In this sense we are all playing the waiting game. While time is our ally, it is the unknown aspect of the future that can be frustrating. We really do not know what is out there. To relieve their frustration, investors attempt to pull the future forward to the present, by discounting or building into valuations, certain assumptions about how the future will unfold. This of course is risky because the future remains unknown and provides a wide range of potential outcomes. Currently, we find ourselves waiting for a number of economic and market issues to be resolved, the outcome of which is likely to have a major impact on future returns. Meanwhile, the markets have discounted some very favorable outcomes.
WAITING FOR 2% INFLATION. This has been the long-standing target for the Federal Reserve (Fed). It was the target when inflation was below 2% and it remains the target now when inflation is above 2%. This target level is assumed to be high enough to give the Fed policy flexibility to fight deflation but low enough to allow for consistent and stable economic growth without being too harmful to standards of living. This all makes sense. The important thing is to get inflation to 2% and keep it stable. Accomplishing this would go a long way in providing confidence to consumers regarding their buying intentions and to companies as they make their investment plans.
Currently, inflation at the headline level is running near 3%, considerably above target. The Fed, even though they just reduced the federal funds rate by 25 basis points, believes they are still in a mildly restrictive mode and that some of the inflation is “transitory” due to what they believe will be one-time increases in prices due to tariffs. In our opinion, this is a risky assumption. The fact that the Fed has now decided to tilt policy more in the direction of labor market weakness than inflation-fighting gives us pause and prompts the question of whether the 2% target is being downgraded in importance. We certainly hope not. A more hardline approach until target is achieved would be our preference. The strength of our conviction on this issue stems from the fact that every person in our economy is affected by inflation and the harm that it does to their standard of living. We also remember from past episodes just how painful it is to rein in inflation once it becomes entrenched. The wait for 2% inflation may be longer than we would like, but if achieved it will be well worth the wait.
WAITING FOR LOWER INTEREST RATES. Our wait on this issue has been shortened a bit by the recent Fed action on federal funds. We know that investors always prefer lower interest rates. It cannot be overstated how important interest rates are to the investment equation. Mostly, it has to do with the discount rate, that is, the rate at which future earnings of companies are discounted. The lower the discount rate, the higher the current valuation of those earnings. It also has a major effect on the investment plans of companies. It is always positive when companies invest in new plants that begin a self-perpetuating cycle of investment, jobs, and consumption. All things being equal, lower interest rates are a good thing.
As to where interest rates should be, it is not just about federal funds. Perhaps of more importance is the level of longer-maturity interest rates because these are the rates that have greater influence on investment plans. The 10-year U.S. Treasury note, considered the benchmark long-term interest rate, currently resides near 4%. While this is high relative to post-Great-Financial-Crisis levels, it is not particularly high compared to history. The level of longer-term interest rates is determined by many things, among them: how fast the economy can grow, what is the sustainable rate of inflation, what is the shorter-term rate, and the balance between savings and investment. Our belief is that longer-term rates can decline further if the Fed is lowering rates because the economy is slowing. Looking ahead to the period when the Fed has completed its cycle of reducing rates, longer maturity rates may need to be higher to accommodate some structural changes in the economy.
WAITING FOR ARTIFICIAL INTELLIGENCE (AI) PRODUCTIVITY GAINS. The true value of AI will be realized when its use results in higher productivity in the economy. Nobel prize winning economist Robert Solow famously said in 1987, “you can see the computer age everywhere but in the productivity statistics.” The same may be said of AI today. It seems to be everywhere but has yet to show up in the productivity figures. Wall Street is putting great faith in what is believed to be widespread adoption of AI and resulting gains from it. Companies are utilizing it in various ways, individuals are using ChatGPT, and massive amounts of capital are being committed to building data centers that will provide the capability of producing AI. It needs to work; otherwise a lot of capital will have been underutilized, and a lot of hopes will have been dashed.
There is another reason that AI needs to work. The economy needs it to keep growing at an acceptable rate. Recall how growing Gross Domestic Product (GDP) is produced: it requires an expanding labor force combined with that labor force being more productive. Labor force growth plus productivity growth equals economic growth. The problem is that the labor force is growing very slowly due to declining birth rates and reduced immigration. Immigration has been almost halted, so productivity needs to pick up the pace to compensate for the slower labor force growth.
It is possible that the needed productivity gains are already happening under the surface. For instance, there are tentative signs that economic growth is picking up, even in the face of a weakening labor market. Higher GDP growth while labor force growth is slowing implies higher productivity. Like the computer, which was slow to deliver recognizable productivity gains, AI may do the same. Because AI has amazing capability, it is hard to imagine that its widespread adoption won’t eventually lead to a more productive workforce. We assume it is coming and that its promise can be realized. The question is, how long will the wait be?
WAITING FOR POLICY STABILITY. Uncertainty is the worst of all worlds for investors. It can freeze planning and inhibit the deployment of capital. It can also affect consumption as people adopt cautious attitudes until things seem more normal. Currently, uncertainty is high because of the challenges the economy faces in adapting to new and different policies. For instance, higher tariffs are attempting to remake the global trading system. Tighter immigration policy has led to an abrupt slowdown in labor force growth. There have been changes in taxes, spending, and regulation, all of which have implications for economic growth and productivity. We are being forced to wait until all of these policies eventually settle out so we can see what their lasting effect will be on the economy.
Without passing judgment on the new policies, what we can say is that uncertainty extends the waiting game, whereas policy clarity tends to shorten the wait. The more stability in policy the better.
WHAT TO DO WHILE WAITING? Our investment approach has always been based on the fact that the future is uncertain, and it therefore presents a wide range of potential outcomes. What we attempt to do is invest in a certain way that tends to narrow the range of outcomes. The narrower the range of outcomes, the greater our chances of success.
While we are all forced to play the waiting game, we do not have the option of waiting for all the answers to be absolutely clear. What we must do is, as Tom Petty says, “every day see one more card, take it on faith, and take it to the heart.” That means monitoring and interpreting events as they occur. It also means doing intensive research on every portfolio holding and candidate for ownership, being aware of all the cyclical and secular changes that are going on in the economy, and using our best judgment on how to proceed. All of this is encompassed in our search for quality, the characteristic that best reflects stability and sustainability in a company. The result of our waiting may be a booming economy and stock market, or it may be a recession. Either way, while we are waiting for returns to materialize, we prepare for the best and worst. We do this by putting together portfolios of securities that, in the composite, can participate on the upside and protect on the downside. And because we do not know when the future will arrive, we must stay invested and be ready. Playing the waiting game does not mean being out of the game.
While the issues raised in this letter are complex and the answers we are waiting for may not come as soon as we would like, we look forward to favorable outcomes as we maintain our baseline confidence in the resilience of our economy and the ability of quality investments to accomplish your investment goals.
Thanks so much for reading, and we look forward to the next occasion.
P.S. A brief word about Tom Petty’s song. It was written in 1981, not too long after the founding of our firm on September 30, 1980. That means we just celebrated our 45th anniversary. Rock historians tell me the song was written based on a comment from Janis Joplin that all she wanted to do was “perform.” So it is with Crawford; all we want to do is “perform” on behalf of our clients. This has been our driving ambition since our beginning and will continue to be as long as we exist.
Crawford Investment Counsel (“Crawford”) is an independent investment adviser registered under the Investment Advisers Act of1940, as amended. Registration does not imply a certain level of skill or training. More information about Crawford, including our investment strategies, fees, and objectives, can be found in our Form ADV Part 2and/or Form CRS, which is available upon request.
This material is distributed for informational purposes only. The statements contained herein reflect opinions, estimates and projections of Crawford as of the date hereof, and are subject to change without notice. This material is not financial advice or an offer to sell any product. Forecasts, estimates, and certain information contained in this commentary are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Any projections herein are provided by Crawford as an indicator of the direction Crawford’s professional staff believes the markets will move, but Crawford makes no representation such projections will come to pass. Crawford makes every effort to ensure the contents have been compiled or derived from sources believed reliable, and contain information and opinions that are accurate and complete; however, Crawford makes no representation or warranty, express or implied, in respect thereof; takes no responsibility for any errors that may be contained herein or omissions; and accepts no liability whatsoever for any loss arising from any use of or reliance on this report or its contents. Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or individual portfolio needs.
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