Q1 Market Outlook Webinar 

Well, let’s get started here. Welcome to our first quarter market outlook.

What does twenty twenty five hold for investors?

My name is Kara Deckworth, the managing director of client experience here at Mercer Advisors.

I’m very pleased today to be joined by David Krakauer, our senior director of portfolio management.

Our usual, practice is to have these quarterly outlooks hosted, by me and joined by Don Calcagney, our chief investment officer. Dawn is traveling today. So David, who is in and out of our portfolios, manages all of our investment committee, and really is the right hand for all of these, is joining us today. And, David, you and I have done several of these market outlooks today, so I’m I’m so pleased to have you with us. And and I know that we’ve got so much to cover for our clients today.

Yeah. Thank you for having me. Looking forward to it.

Both David and I are located in Southern California, and, we wanted to share that for all of us in Southern California being very aware of the impact of the wildfires in Los Angeles, has has really been on top of mind for for both of us. And for any of you who may have been affected by the Los Angeles wildfires, we do have pro bono resources that are available to anyone free of charge. They do not need to be clients, and you can find those resources, which are things like checklists, how to, file an insurance claim, and the ability to speak with one of our advisers about your particular case or the financial planning implications if you were affected by the fires can be found on our website, mercer advisors dot com. If you look at our locations tab and go to our Los Angeles area office, you’ll find the ability to be able to access, those resources.

And, David, we talked about, just thinking about the scale of the devastation from the LA wildfires and and maybe talk a little bit about what what you’ve reviewed, in terms of how that affects portfolios.

Yeah. So, of course, it’s been devastating. And one of the things we in the investment team, we’re doing right away was monitoring our portfolios and our client strategies, for any type of material impact. So looking through the municipal bond and corporate bond markets, assessing any impact from either Los Angeles, Department of Water and Power, any of the downgrades.

Also then looking on the corporate bond side and even the equity market side to see if there’s any impact from, Edison International, SoCal Edison, and happy to report that, across our client portfolios, virtually no impact, at all, to our clients. So, many of you know that we value diversification, underlying our strategies, and and, certainly, diversification, you know, played a big role in making sure we had minimal impact.

Thank you for for that update. Appreciate it.

The other thing that we wanted to talk about today is if you’ve been a previous viewer of these, you know that we’d like to make them very interactive.

We have asked for questions that were presented before, and, we’d also like to take some live questions as well, if we have time. So if if you do have any questions, please do submit them to the q and a button, which is located at the bottom of your screen, and we’re gonna go ahead and fill those as much as we can.

The other thing I wanted to mention about today’s presentation is that this should should be considered to be informational and educational purposes only. Nothing that we are presenting today should be construed to be personal investment advice or directly related to your own situation.

Any of those types of questions should be raised with your wealth adviser who would be able to give you the specifics on your personal situation.

So let’s kick this off, David. We’ve talked about the questions that people have submitted to us.

And as you can imagine, was we are looking into a a new year. We’ve got a new political environment with the inauguration on Monday. We’re looking at all of the questions that that may affect geopolitical events. And so some of the things that, really came up strongly in our questions that I know that we’re gonna cover today and take additional questions on.

Investment strategies going into a new administration. That’s politics. There’s things about taxes and interest rates and Social Security, real estate, what are the chances of a recession, and and really that big question on the bottom left, what does this all mean for the markets?

So I’m gonna turn this over to you because I know that we’ve got a lot to cover. Please keep those questions coming.

Yeah. Appreciate it, Kara. So what I’d like to do and what I usually open up with is just a reminder, this is not meant to be comprehensive of every single thing going on, but a lot of these topics you see on the screen, we’re certainly going to touch on. So the first thing I’m going to do is give a quick review of twenty twenty four, asset class performance.

A couple of things worth noting, you know, in twenty twenty four when it comes to returns.

And then I’m going to pivot and think about, you know, three big things that, we look at moving forward. So one having to do with the health of the overall economy, another having to do with some excitement that we’re seeing around the potential for accelerated growth and profits in the future.

And then lastly, as usually is the case, we do have some concerns and some potential headwinds that we are keeping an eye on as well. And then from there, I’ll wrap it up with really what should investors, you know, do with this information.

So just a quick start off with the twenty twenty four review. You know, the punchline really is that it it was another banner year for US equities. Equities led the way.

US large cap equities in particular, second year in a row, over twenty percent, you know, returns. So what you see here on the screen is US large cap stocks represented by the S and P five hundred, twenty five percent total return. Small cap stocks, eleven percent, international markets, also positive, but, lower. And then if we look even into the bond markets, you see that, global bonds, long term treasuries actually were down on the year.

So, you know, one of the questions, you know, we get is, well, why were bonds down when the Fed cut interest rates? One thing to note, is that longer term interest rates actually went up, towards the end of last year, which caused long term treasury specifically to go down in value. So one of the big reasons, you know, for that has to do with long term expectations by the Fed in regards to their own interest rates, and inflation, and we’ll get into more of that in just a little bit. But, you know, this is the high level overview for the year.

If we look under the hood of the S and P five hundred, I know there’s a lot on this slide, but, you know, on the left hand part of the slide, what you can see is separating out the magnificent seven. So think about your Amazon, your Google, Apple, Meta, and looking at those stocks separately from the rest of the s and p five hundred. And what you can see is the magnificent seven really drove a lot of the return through the year as, you know, they have been doing over the past couple years as well. So in twenty twenty four, the s and p five hundred, when you just look at the magnificent seven, they returned about forty eight percent and the rest of the index about ten percent for the year.

And so why is that? And if you look on the top right hand portion of this slide, you can see earnings growth estimates for the magnificent seven and then the rest of the s and p five hundred. And what you’ve seen is, you know, throughout, last year and the last couple years, the magnificent seven again has been, really generating most of the earnings growth that we’ve been seeing.

But looking forward into twenty twenty five and you see the breakout of quarters there on the top right hand side, we actually expect a broadening out of earnings growth among other sectors. And so a lot of that is being priced into values right now and and actually have been getting priced into values even over the past, you know, couple months, closing out twenty twenty four. And on the bottom right hand side, again, you can see when it comes to profit margins, you know, lot of the really stellar performance of twenty twenty four has been driven by the magnificent seven and, the rest of the S and P five hundred, although still, you know, healthy and positive, you know, not nearly as, exciting and robust as what we’ve seen out of some of these big tech stocks.

You know, thinking more globally, this chart here shows the US markets versus other major regions around the world. So on the left side is, the annualized fifteen year numbers for equity returns. Then we have twenty twenty three in the middle, and then on the far right, you have twenty twenty four. And the two things I’d really point out here is that when you look at the purple, the purple shows that earnings growth, not just here in the US, but in other major regions around the world, has actually been pretty positive, pretty healthy.

The one thing that’s worth, noting, though, is the dark blue bars. The dark blue bars, especially on the right hand side when you look at twenty twenty four, represent the effect of just currency.

And so what does that mean? What that means is that if you look around the world at stock performance, what you find is that, ex US, if you look to Europe, Japan, emerging markets, they can have very strong equity returns. Companies can generate, you know, great earnings growth.

But the second they generate that earnings growth, we as US investors need to translate that back to US dollars.

And so if you look at the pink box on the left hand side of your screen here, what you can see is that in twenty twenty four, the rest of the world’s equities actually returned around thirteen percent in their local currencies.

But just translating that back to US dollars for us changes the narrative dramatically. It changes that thirteen percent into a six point one percent return for us.

And so the point here being is that when you look under the hood of the health of companies and the health of stock returns around the world, you actually see a pretty robust picture in other areas of the markets as well. If you look down the line at Taiwan, for example, which is very much involved in AI technology, in twenty twenty three and twenty twenty four, really robust returns. So in their local currency last year, forty four percent return.

Translating that back to the US dollar, a thirty five percent return still. And so on the right hand side, you see the index for the US dollar compared to other currencies around the world. And what we saw towards the end of last year was a big surge, in the US dollar, a strengthening of the US dollar, which can be and, often is a big headwind for bringing some of these international profits back to the US.

And so why has the US dollar been surging? Well, a lot of that comes back to the outlook for interest rates here in the US. And, again, the Fed forecast and what they view as their longer term interest rates and views on inflation and growth.

When interest rates are higher here in the US than other areas around the world, it attracts money to the US dollar. And that’s what we’ve really seen in the last few months of last year. And as you can see here, can, again, change the narrative to what it looks like is going on with international equities.

So lastly, this is a quilt, I call it, of asset class performance rankings.

This shows the last ten years for asset class performance.

As as you see on the top right, you know, the S and P five hundred again, back to back twenty plus, years in or twenty plus percent return.

This is actually the first time we’ve seen back to back years of twenty plus percent returns since the mid nineties.

So, definitely something, that we, you know, are all very happy about and something that is pretty unique when you look at the long term returns and what asset classes, tend to do well. So even over the past ten years, the S and P five hundred has actually only taken the top spot, you know, four times.

US small cap stocks have taken, the top spot twice. Municipal bonds actually have led the way twice or three times. And so the point here is is still the somewhat randomness of returns year after year and the importance of still staying diversified. You know, long term treasuries on the bottom right, you know, have a had a tough go of it with interest rates on the long end side going up recently. And so, we continue to watch that area of the market, you know, for many different signals having to do with the outlook on growth, inflation, even, in regards to what’s going on with the Fed and the debt. We’ll get more into that in just a little bit. But, this should help give a a good picture of just where we are and and where we’ve been recently.

So, David, before we move on from this, I’m I’m seeing a lot of questions, in fact, a huge number of them, Donna and Edie and Richard and Rosella, about the influence of any particular administration, any particular president on the outcome of any particular, asset classes. So could you maybe just make some comments on does the president and on a particular administration’s policies have any direct correlation to returns of the market and your view on that?

Yeah. Sure. So we did a quite a bit of research on this leading up really to the election, you know, last year, and we put out a few pieces who is in control of the presidency, if it’s Democrat or Republican, or who’s in control of Congress, or if it’s a divided, government, which is often the case, we see across the board a strong s and p five hundred returns on average and also strong GDP growth, on average. Now if we, you know, dig into the numbers and we really get specific, what we actually find is that, Democrats on average, tend to have a slightly higher, GDP growth, over the last seventy five years, and Republicans on average tend to have a slightly higher, S and P five hundred return on average, over the last seventy five years.

But the the differences are actually very small. So what we find is that, you know, regardless of who is, in the presidency or who’s controlling, you know, Congress and government, it tends to bode well for investors, and, we do tend to get a strong GDP growth. Now, obviously, right now, there is quite a bit uncertainty in regards to policies coming out. So that’s something, again, we’ll talk about in a little bit.

But, the uncertainty around policies sort of goes both ways. There there are a lot of pro growth, things that are gonna potentially be coming out from a policy standpoint.

But then there’s also, policies that could really hinder, growth as well. So, there’s a lot of, of things that we can talk about on that side. But overall, long term, again, over the last seventy five years, you know, there’s no real, big differential for GDP or even stock market returns, positive under all, slices of administrations.

That’s helpful. Thanks.

So looking forward, you know, what to keep in mind. You know, the first topic I I wanna touch on has to do with the economy and interest rates. And, really, the idea that both, have been normalizing quite a bit over twenty twenty four. And, really, where we are right now, is in a position, of healthy, economic footing and also a more normalized interest rate environment, which which sets up the stage, you know, for, you know, potential future growth. And so what do I mean by normalizing?

So if we look at inflation for an for example, in twenty twenty four, we still made some material progress, you know, down, you know, towards the Fed’s two percent target.

The peak, as a reminder, was in June of twenty twenty two when we saw inflation running hot at around nine percent year over year.

So the most recent numbers, have shown headline inflation, just shy of three percent.

And although we’ve seen, you know, some stickiness still having to do with housing and, auto insurance, There are signs that those numbers will continue to come down. Even looking at, you know, recent rent numbers, for rent equivalents, looks like there are some signs there that those numbers should still be coming down further. But, overall, when we look longer term at inflation and where we are right now, you know, it’s important to remember that between two thousand ten and two thousand twenty, that was really the decade of where is inflation. You know?

We did a lot of quantitative easing. There was a lot of stimulus, and inflation wasn’t, showing up at all. And so even with some of the more recent stickiness with inflation over the last couple months, you know, what we find is that where we’re at right now is is a very healthy level and a much more normal level when we look historically. So we’re actually now below the long term trend lines for headline and core inflation as an economy.

And and this is something that, you know, obviously, we’re watching closely to see how policy could affect this moving forward. But, for right now, again, we are in a much healthier stance than where we were even a year ago.

If we look at, employment and labor market and wage growth, again, the picture is very similar. So, just looking at the unemployment rate, we saw a recent up uptick recently from the mid, you know, three point five, three point, three point six now to around four point two percent unemployment.

And what we’re finding is that that number came up recently a little bit, not due to permanent layoffs, but more so due to either temporary layoffs or actually new end entrance into the labor market. And so it’s a little bit of a loosening, you know, that we’ve seen in the labor market, but nothing to be overly concerned about. And it’s actually allowed the Fed because of lowering inflation and some of this looseness in the labor market, it allowed the Fed to cut rates, this past year. And and I’ll touch on that in a few minutes, but it’s certainly something that, we’re watching.

And as you can see from the long term trend line here, the unemployment rate is still well below the long term average, again, in a very healthy spot. And then when we look at wage growth, you know, too much wage growth, you know, can really add into inflation in an economy. And what we have been watching and seeing is that wage growth is now down, you know, to their long term, average. So we’ve seen about twenty straight months of consecutive wage growth, which has really been helping consumers, quite a bit when it comes to their spending and continuing to have robust spending.

So when we think about consumers in general and and wage growth, you know, what we’re watching to see is if they’re starting to tighten up on retail sales or or anything, you know, that could really pull back economic growth, and we’re not seeing that. You know? So even though some of the consumer sentiment numbers seem to be still very negative, you know, consumers are are spending pretty heavily. And, increases in household wealth, the wage growth that we’ve seen over the past, you know, really twenty consecutive months, has really aided the continual spending and pretty low savings levels for consumers.

And so, you know, thinking about the economy in total and GDP growth, you know, this chart here really shows, you know, the last, year and and even quarters before that. And the big point here that I’d like to make is a year ago, you know, everyone was really screaming about recession, recession, recession. And what it seems to be the case is that, you know, we’ve avoided, you know, recession on numerous fronts over the past year. We’ve seen strong consumer spending. We still see a strong business fixed investment, government spending, really boosting, GDP growth. And over the past year for twenty twenty four, we roughly, came out with likely a GDP growth rate of around three percent.

And so the estimates coming into twenty twenty four were actually around two point one percent for GDP growth, so a good amount higher than what, you know, many analysts were expecting, you know, for the past year. And so and one of the detractors that we’ve been seeing from GDP growth does have to do with the US dollar.

You know, we are certainly, importing still more than we’re exporting. That has a slight drag on GDP growth.

So, David, I see this, this little orange bar here marked residential, questions here from Kamal and Kate and Lynn asking about the outlook on the real estate market. So could you make a comment about that in particular?

Yeah. Sure. So the real estate market, you know, it’s interesting because we have, you know, very low mortgage applications, you know, still.

And the affordability, of homes is actually still at pretty low levels, you know, for the economy in general.

And so even with that being said, what we are finding is that, the values of homes, you know, is still rising simply due to tight supply.

And so expectations moving forward, you know, is still low single digit appreciation on average for home prices around the country simply due to the low supply. And we are seeing, you know, some increases in construction and new builds, but there is a big, mortgage lock in effect happening. So mortgage rates, you know, they they really peaked out, you know, over the past year around seven and a half percent. We saw them dip, but then recently over the past several months, you know, because of longer term interest rates and the and the outlook from the Fed, we saw mortgage rates mortgage rates bump back up again.

And so right now, they’re around seven percent, and we have a lot of people that are really locked into their homes that maybe would move or sell their homes, you know, if they were able to get, a decent mortgage rate. But what we find is a lot of people have a three, four, five percent mortgage, and they’re just not moving because then they would have to, have a seven percent mortgage rate. So, you know, there are, you know, some things that we’re still seeing that are dragging on GDP. So when we have a situation where home affordability is so low, then it actually prevents, you know, people from spending money in other areas of the economy, and that’s why you see a slight negative number there.

But, you know, the outlook for appreciation and home prices in general, still slightly positive. You know? Again, low mid single digits from most of the estimates I’ve seen.

But, you know, we still have an affordability problem, and, we still have, you know, low supply for single family, you know, detached homes. And that’s something that, you know, we’re still looking for.

Great. We’ve got a couple of questions coming in here now about interest rates. And I know you’re gonna be talking about this here, but, Kenneth and John, we we, we know interest rates is very important to a lot of the things that that you just mentioned, David.

Oh, definitely. So, yeah, so let’s let’s jump over to, interest rates. And first, we’ll talk about the Fed here and and why I, am making sort of the claim that interest rates have been normalizing. So when we think about what’s going on with the Fed, we have to remember what the Fed’s mandate is. You know, the Fed is focused really on two things.

They’re focused on controlling prices and trying to keep prices stable, and they do that by looking at inflation and trying to bring inflation down to around two percent.

And then at the same time, they’re also trying to ensure we have a healthy and robust labor market. And so they’re constantly balancing, you know, those two things. If you see inflation coming down like we have and we see a little loosening in the labor market, that’s when they view, an opportunity to maybe lower their target interest rate, try to help encourage more economic activity. So when the Fed looks at lowering, or increasing their interest rate, what they’re talking about is the overnight interest rate, you know, for banks. And so it’s very short term. And so the Fed controls the short term, interest rate market. And when it comes to longer term interest rates, like the yield on ten year treasuries, those interest rates are actually affected not only by what the Fed does, but then expectations for growth and inflation and long run expectations.

And so in twenty twenty four, the Fed cut interest rates one full percent.

And really over the last few months, there has been a change in their outlook. And so initially, they were thinking that in twenty twenty five, they were gonna cut interest rates, potentially four more times.

But because of uncertainty having to do with policy, inflation moving forward, some of the stickiness they’ve even seen recently in inflation, they’ve actually changed their outlook and and decided that they they may only cut rates two times in twenty twenty five. And, really, the market is actually questioning whether they’re even going to get to that depending on how things unfold, again, with inflation and policies in general.

And so right now, you know, the target rate for the Fed is just over, you know, four percent. And the big thing that is worth noting on this chart in particular is actually the purple dot on the bottom right.

The purple dot on the bottom right, that is the Fed’s long run expectation for where they think their target interest rate should be in the long term.

And that dot used to say two and a half percent.

And just recently is when they updated that dot to actually show that their long run expectation for their interest rate is actually now three percent.

And that is very material. That half a percent difference then gets factored in across many areas of the bond markets, the credit markets, and just interest rates in general. So when we think about money overseas and money coming to the US dollar for long term investing, you know, they’re looking at that number to determine what the Fed is likely gonna hold interest rates at, you know, for the longer term. And so, the change from two and a half to three percent is also, what has, sparked the ten year treasury to actually go up and some of the longer run interest rates to go up in the bond markets.

And so when I say that interest rates have been normalizing, you know, what does that mean?

What that means is that when you lend your money out to either the bank or to the government, you’d expect to get a higher rate of return if you lend your money out for a longer period of time. So if you go to the bank and buy a one year CD, they would give you a certain interest rate. But if you go out and you lend your money to the bank and buy a five year CD, you’d expect a higher interest rate.

And that’s called an upward sloping yield curve. That’s normal when we think about, lending our money out and we think about getting a higher, amount of return. And so the green line here is actually that curve for the treasury market. It is now very much more so an upward sloping line where you’d expect to get a higher rate of return when you lend your money to the government for longer periods of time. The purple and the the more raspberry lines, those are the past, years where we have seen more of an inverted yield curves and, I would argue, you know, a more abnormal shape to what we would expect out of interest rates. And so, again, when I think about normalizing of interest rates, I think about getting a higher amount of return when you lend your money for longer periods of time.

Another way to think about the normalizing of interest rates is that when you actually look at investing, in bonds or lending your money out in the bond markets, you should get a return that at least helps you cover, the rate of inflation so that you protect the purchasing power of your money. And so on the bottom right hand side of this chart, the gray line is actually showing how in recent years, we were not having interest rates at a level that even covered inflation.

And so if you just were out, buying, bonds, you’re actually losing purchasing power over time because inflation was actually eating away higher than the interest that you were getting. That’s not the case any longer. And so this is called, positive real yields, where we now are seeing interest rates at a level that are at least covering our purchasing power, covering the rate of inflation.

And so high level when, again, we look at, interest rates and the bond markets.

You know, what we’ve seen, you know, across the board is that we don’t necessarily have to reach into equities, anymore to get a decent returns mid single digit returns.

We can actually look at, you know, treasuries. We can look at the aggregate bond markets, municipal bonds, and we can actually get a a more decent return now than what we have experienced over the past few years. You know, I would consider this to be a much more normalized, interest rate environment and and a healthy environment, you know, for us to at least start the new year off at.

So just overall, I’m getting a couple questions about out just general outlook on bonds from Mark. And maybe in specifics, there’s a couple questions about muni bonds and t bills. Could you comment on kind of your view on those asset classes?

Yeah. Sure. So in in general, whether you’re looking at muni municipal bonds, treasuries, corporate bonds, what you find is that, you know, long term, their expected returns are actually highly correlated with their current coupon yields. And so just as a starting point right now, what we see is that the expected return for all three of those areas of the bond markets are actually higher than what they have been recently. Now when we think about longer dated bonds, regardless of municipals, versus treasuries, a lot of their longer term performance is going to depend on what unfolds with the Fed and what happens with longer term interest rates. And longer term interest rates are really influenced by the outlook and expectations of growth and inflation.

And so that’s that’s a big piece to the equation as to what’s gonna happen to performance for longer dated bonds.

For very short term bonds, you know, if we’re thinking about performance there, obviously, if you hold it to maturity, you know, the biggest thing you you wanna be focused on is credit risk you’re taking. So you wanna, you know, try to stick with stuff that’s safer, for shorter term, maturities.

But the Fed’s cutting or raising of interest rates, really has a bigger effect on that short end of, the market. So it doesn’t seem as of right now that the Fed’s gonna be raising rates anytime soon, unless there is some unforeseen developments with, spiking inflation.

So right now, I think the the question is more so is the Fed gonna stay put or potentially cut rates a couple times over this next year? So, really, not a lot of downward pressure we foresee in the at least the short term. Again, the caveat being policy developments and what really happens, you know, on that side.

Great. Thank you.

So bringing a lot of this information together, this is a a dashboard we keep regarding the whole macro outlook, you know, for the US economy and, you know, looking at volatility, interest rates, you know, home prices, GDP growth.

A lot of the numbers, as you can see here, fall into their average, you know, sort of sweet spots when it comes to long term trends.

And no surprise, you know, when we, you know, think about recession, you know, like we were talking about a year ago, we’ve seen a lot of the models, and this is just one of them. We’ve seen a lot of the recession probability models drop quite a bit. So the New York Fed, they run this recession probability model that’s really focused on interest rates and what’s going on with interest rates. But this is just one example how if you look compared to a year ago where we had, you know, sixty, seventy percent probability of recession they were predicting, you know, we’ve seen that number come down quite a bit.

We’re still at a historically elevated number slightly, but, again, as you can see, a lot of the numbers are are pointing to a drop compared to we were a year ago. So, you know, we’re still watching we’re still watching this closely, but a lot of the indicators, you know, we look at across the board seem to be in a pretty healthy, spot and a good footing again heading into the new year.

I’m seeing a bunch of questions about kind of future growth and what are we looking at going forward. So I’m excited to hear what you have to say here.

Yeah. So this this section is is, about exactly that. So, you know, what what makes us potentially even more optimistic than simply having a strong economic footing to start the new year? You know, really the big thing that we’ll talk about, you know, having to do with, AI and AI investment. Obviously, that is sparking a lot of excitement. So have a couple things I’d like to share there. And then, really, more generally, there’s uncertainty still around policy developments, but there are certainly numerous things that have been discussed, from a policy development standpoint that are very pro growth also.

So first off, if we look at just tech spending and tech driven capital spending, this is, an anecdotal example.

But when we look at, some of the biggest tech companies out there, such as Alphabet, Amazon, Meta, on the left side of your screen here, what you see is the amount of spending that they are doing really based around AI and how much of their operating cash flow they’re actually putting back into r and d and CapEx spending for artificial intelligence and other initiatives.

So as of recent numbers, what we’ve seen is that, you know, some of the biggest tech companies across the board have actually been putting forty percent of their operating cash flow, reinvesting that back into the business with most of it focused on AI development and and and technology development. And so that’s a huge amount of money. And even, you know, as recently as yesterday, you know, we’ve seen even more commitments, to AI infrastructure spending. You know, one of the big announcements, yesterday was that OpenAI, Oracle, SoftBank, were actually committing five hundred billion in new AI infrastructure investment here in the US.

And so the amount of spending that is occurring right now, not just from big tech companies, but even, in the financial industries, in the industrial, sector, in health care, The amount that’s being spent, on AI is is truly, you know, eye popping to some degree and exciting to think about what, again, potentially, it could mean, you know, for long term, future growth and earnings growth potential even for for stocks. And so on the right hand side, you know, we also have, the Chips Act that was passed in twenty twenty two. And since then, you know, we’ve seen a lot of industrial production of communication equipment, semiconductors.

A lot of that CapEx also has been coming in, to the mix and really aiding, economic activity here in the US to a high degree.

So, again, this is something that we’re really excited about, and it’s also been adding to the analyst expectations for future earnings growth for stocks. And so on the left side of the screen, that’s where you can see, expected earnings per share growth for US stocks for the s and p five hundred.

And the dark green bars there are, expectations for twenty twenty five and twenty twenty six. And so we see double digit expectations for earnings per share growth, for the S and P five hundred in general. A lot of that, is coming from these big investments and all of this money that is being, reinvested either through r and d or CapEx, a lot of it based around AI and technology.

And so, you know, again, the the theory here, and this is what we’re really trying to wait to see out of the data, is that a lot of of the AI investment is going to be, causing more productivity, you know, for companies.

And where we would expect to see that is actually in profit margins. So on the right hand side of your screen, what you see is, S and P five hundred, average profit margins, and we’re at pretty high levels. So close to thirteen percent, profit margins on average for the S and P five hundred. And if you think about, AI and a lot of the anecdotal evidence and stories we’ve been hearing around, the ability for coders and and software engineers to work so much more productively and and numerous other examples, we would expect to see more output per worker when it comes to, what they’re able to contribute to businesses.

And where we would see that translate likely is in higher profit margins for companies. And so this is something that we’ll we continue to watch closely to see if we see any more profit margin expansion.

And likely, over time, we should see some of that come through from these AI investments. Again, not just in the big tech companies, but even, you know, again, through finance and and health care and other areas.

And then so when we switch then over and think about productivity in general, you know, the big point I wanna make here is that, when we think about GDP growth, labor productivity is one of the biggest factors in helping to drive GDP growth as an economy. And so since really COVID, we’ve actually seen productivity, increase in the economy. And that’s really due to a higher level of business creation, but also a higher levels, of employee churn. And so what does that mean?

When we think about work from home and we think about, people being able to be redeployed into more efficient jobs, that’s actually aided productivity and GDP growth. And when we think about the potential for AI to be added to this equation and for workers to be able to leverage AI, you know, this is, potentially a very exciting development if we are truly at the beginning of a productivity productivity, secular trend due to AI. So a lot of this is to be determined. And so we’re still waiting to see things in the data, but this is where a lot of the optimism, and excitement for future growth really comes from.

And then, lastly, you know, there are a lot of, policy items to be excited about, whether it’s, you know, no taxes on tips or, lower corporate tax rate for, you know, manufacturing companies. You know, the list goes on and on. You know, one of the things I wanted to share was just a recent study from the congressional budget office. It was, released, I believe, in July of last year. And they just, gave a little outlook in regards to the effects on GDP if we were to let the tax cut and jobs act, expire. And as you can see, simply, the idea of us extending the tax cup tax cut and jobs act and not letting it expire should actually have a positive effect on GDP growth at least for, you know, the next five years or so.

So, David, maybe we we can just take a couple questions in here. I’m getting a lot of questions about the outlook on crypto.

Can you share your thoughts on that?

Yeah. Sure. So crypto’s a fun topic, obviously. It’s been a lot of excitement around crypto.

You know, our chief investment officer, Don, he just recently, posted an article that you can find on our website that talks about why from a fiduciary perspective, you know, it’s really hard for us to, really consider, Bitcoin or crypto as an investable asset. And, you know, there’s there’s a lot of, you know, really, important things to note in that article having to do with the fact that the market for buying crypto or or or Bitcoin is an unregulated market.

There’s also not, really any legal protections for investors, you know, when they go out and they buy something like Bitcoin, you know, versus other assets. So there’s there’s numerous challenges when it comes, to, investing, you know, in those types of assets. And and I think the one the one thing I would relate, you know, crypto and Bitcoin to, is actually fine art. You know, when we think about investing in art, you know, on the on the front end, obviously, you know, beauty seems to be in the high eye of the beholder, and that seems to be the case with with Bitcoin. Some people think it has, you know, amazing, you know, value. Other people don’t think you actually even own anything.

When it comes to art, you know, obviously, there’s a lot of subjectivity there as well. But when we think about what drives the art market, it’s really scarcity and hype and and high volatility.

And there’s no cash flows when it comes to owning art. There’s no economic utility, you know, no clear economic utility yet, when it comes to art or even something like Bitcoin, I would argue.

And so a lot of the ways we look at, you know, these types of assets is in still a very speculative nature. And so the only advice I would give, you know, to our clients is that, you know, if you are going to own, you know, more higher volatility speculative assets, you know, make sure it’s a very, very small portion, of your overall portfolio. You know, our outlook, we have on that whole market is really yet to be determined because, again, it seems like the business case even for Bitcoin from when it started to now has changed quite a bit. I’ll give you one example. You know, one of the big arguments for Bitcoin in the beginning was that it allowed for very cheap and easy transactions where you didn’t have to have intermediaries involved. That was that was one of those initial big arguments for why Bitcoin was was really going to be so, you know, wonderful.

But what we’ve actually seen over the past year or two years, stablecoins have actually started to surge in emerging markets and and underbanked markets, and stablecoins are actually pegged to the US dollar. And so they’re using blockchain. They’re using some of the same technology, but they’re actually causing more demand for the dollar. And stablecoins like Tether and USD coin, they’ve actually, been taking a lot of the market share in regards to transactions and and, and commerce.

And so, again, something like Bitcoin, the business case seems to be changing. Utility value, it’s not really clear. There’s no cash flows. It’s an unregulated market, and so, we still have a a lot of trouble ever recommending that, you know, to clients.

So we’re we’re down to ten minutes here, and I’m seeing a lot of questions about potential headwinds in the market and deficits and tariffs. Maybe we can, kind of skip ahead to address those so that we’ve got good time to cover all those.

Yeah. So just bringing this together. So economic activity went from US still a strong point. We’ve seen a lot of upward revisions to GDP growth outlook for the US in particular.

The IMF actually has twenty twenty five as, closer to three percent, you know, growth target. And so, you know, everything in the in the US right now, again, seems to be on strong footing. We do have a few things to be excited about when it comes to growth moving forward. And so now what are some of the headwinds that we’re thinking about?

You know, valuations, you know, has been, you know, something we’ve been watching for a while. So US stocks versus international stocks.

US stocks on the left hand side, you know, pretty high when we look at the different valuation metrics.

A lot of this is due to the high optimism and expectations for earnings growth and and, improved outlook for GDP growth, A lot of the excitement that we just talked about. On the international side, you know, we do we don’t expect to see the same levels of economic growth, you know, at all out of especially, the developed markets on the international side. So, you know, it’s not really a huge surprise to see, you know, this, big change in valuations.

International market’s about thirty percent discount, you know, right now in valuations compared to US.

When we look under the hood of the S and P five hundred at the long term trends, you know, the S and P five hundred right now on average is valued, you know, well above, you know, their long term trend lines.

Again, a lot of this has to do with, the excitement around future earnings growth. And so this doesn’t mean that we expect a sell off, at all in the big tech stock names, or the S and P five hundred.

But what this means is that where we’re at right now with prices in the S and P five hundred, there may not be a lot of upside for a little while. We might need to wait for the actual earnings to occur and to catch up with where valuations are. And so it it doesn’t again, necessarily mean that we see any kind of big downside moves on the horizon, but more so the fact that, we’re really priced for perfection in a lot of ways. And so there may there may not be a lot of upside. If we do, however, get some unexpected downside news, you know, that that could certainly have a big effect on where we are with prices currently.

This slide here breaks out of the s and p five hundred to give you a sense of concentration risk. I think I’ll just tough touch on the top right hand side.

So the top ten stocks in the S and P five hundred right now make up close to forty percent of the S and P five hundred.

And so, again, you know, that is a very high amount of the index. That’s a lot of what we call idiosyncratic risk where, for example, if just something happens with Google or Amazon, just one company alone, if there’s bad news just out of that one company, that could actually have a big pull down on the overall index. And so, you know, one of the the things we’re watching is to see if that broadening out of earnings growth among other sectors starts to occur this year. If that happens, it can bring this concentration risk down quite a bit. But where we stand right now, you know, we we certainly, are a little concerned to see such a high amount of the index exposed. So really only ten companies.

Last, you know, thing on the valuation side, this is what we call our corporate bond valuation monitoring. Valuations aren’t just high in the US on in the stock market. They’re actually high also when it comes to the bond market, specifically when it comes to assessing risk in the bond market. And so if I was going to lend my money, out to, JPMorgan, you know, I would expect a certain interest rate. If I was gonna lend my money to the local grocery store, I would expect a higher interest rate because there’s more credit risk with them than it is with JPMorgan.

And so that difference, in interest rates that I would expect has to do with spreads. That’s what we call spreads in the bond market. And all we’re seeing here is that spreads are very low. I’m not getting a lot more money for lending to the local grocery store than I am versus lending to JPMorgan.

And so there’s a lot of, optimism around the economy in general that’s priced into the bond market. So if you’re if you’re investing in the bond markets, you have to be really careful that, you know, you’re not, overextending risk or or dipping into, areas where there might be more credit risk than you’re getting compensated for.

So I there’s a bunch of questions related to Warren Buffett here and kind of a doom and gloom outlook scenario. And, maybe comment on that in in terms of these valuations.

Yeah. Sure. So, Warren Buffett has a valuation model that is is very simple.

And even he has, you know, mentioned that, you know, there’s no single metric, you know, that really tells the whole picture of what’s going on, you know, in the markets. But the valuation, equation he uses is simply the total market capitalization, the total value of the US stock market divided by, the total value of of the US, economy, which is GDP.

And so if you look at the total value of the stock market right now, we’re a little over sixty trillion dollars.

That’s the total value of of all, US publicly traded stocks put together.

And then our glow our US GDP is right around thirty trillion. So we’re a little over two hundred percent, when it comes to comparing the stock market versus GDP.

And according to him, you know, that is, you know, a warning sign, and it’s it’s a number, where two hundred percent has only been hit a couple times, you know, throughout the past, you know, seventy five or so years. And so we’ve seen Warren Buffett, you know, start to raise a little bit of cash, you know, because of worries about, valuations in general. And, you know, the big thing there is that, you know, that that metric doesn’t take into consideration interest rates, but that metric also doesn’t take into consideration that US companies do get some revenues from overseas. And so you’re somewhat comparing, you know, global companies to just the US economy.

And so it’s not necessarily, an accurate representation, you know, for an apples to apples ratio. So it’s something that, you know, we’re obviously cognizant of. And as I mentioned in previous slides, aligned with, know, some of our views that we have some very rosy valuations at the moment. Certainly worth paying attention to potentially, you know, revisiting diversification and and rebalancing of your portfolios. But, you know, for for Warren Buffett’s, you know, purposes, you know, even he has, again, said, doesn’t really paint, you know, a whole picture of what is really going on.

Well, as we’re getting into our last few minutes, I know that the, the topic here of tariffs is really, lighten up the q and a box here. So, can you talk about outlook on tariffs, how they affect your future view?

Yeah. Sure. So, you know, we’ve been looking at, you know, tariffs, obviously, for a few years. You know, now we had our first, real taste of them in in twenty eighteen, as everyone probably remembers.

And so right now, our average tariff on imported goods in the US is around two point four percent.

And if we think about, you know, some of these scenarios that have been discussed, whether it’s a broad ten percent tariff on all goods plus up to potentially sixty percent, on imports from China, That puts sort of a weighted average tariff cost of around seventeen, eighteen percent on all of our imports. And, you know, from what we’ve seen in the past, a lot of the increase in tariffs, has gotten passed through to consumers. We did see some reshifting, in twenty eighteen in particular when we had, the beginning of the first, you know, sort of trade war that that people like to call it with with China in particular, but also when it comes to US steel and appliances.

And what we saw, in twenty eighteen and some of those beginning years is that there was a lot of shifting around of goods being imported from other countries instead of China, you know, such as, you know, Southeast Asian nations and and some of those other nations around those regions.

And, we did see, an increase in consumer prices, especially when it came to, appliances and and other items like that that almost directly affected the amount of the tariffs. So, you know, we do have concerns around, onetime price increases from tariffs and and how that can affect, the price levels of the economy in general.

And, and so when we think about, you know, some of the things that have been mentioned recently having to do with Canada and Mexico, you know, one of the things that I think is also important to note is that China’s not our our largest, area of imports now. And so in twenty eighteen, China made up over twenty percent of our imports, but now they’re actually down to thirteen percent of our imports. So, most of our imports actually come now from Mexico and Canada. I think most recent numbers actually showed Mexico was our largest trading partner. And so if we think about, for example, a twenty five percent tariff on everything coming in from, Mexico and also from Canada, almost certainly, we would expect to see, higher prices for vehicles, and automobile parts, out of Mexico. And then Mexico is actually, where we actually get a lot of, fresh vegetables and fruits, so we would potentially see some higher prices in the supermarket as well.

When it comes to Canada, we actually get quite a bit of oil, and natural gas out of Canada still in addition to vehicles. And so, there is the potential there to see, some higher prices at, the gas tank, especially sort of on the West Coast and and Midwest regions, when it comes to, what we get from Canada. So, you know, we we have some concerns there. And, obviously, you know, the whole goal, stated goal is to try to protect businesses and and try to reinforce, you know, our own manufacturing.

But, you know, there certainly is the element of inflation and and price impacts that we we watch closely.

Well, we’re at time. So thank you all for joining us. We know that there are a lot of questions that we didn’t have the opportunity to get to, but we have recorded them all. We will make them available to your adviser, as well to reference with you and answer any further questions that you have.

Any of you who may have asked if this is going to be recorded, we do record these, and they will be available on our website, mercer advisors dot com, in our insights section in just a few days, and we’ll also be sending out an email letting you know when that is available.

We also know that you have a lot of interest in a lot of the market topics and other financial planning topics. So in addition to our usual quarterly market update that we do, we’ll be adding in a monthly webinar series as well on other topics. So please keep an eye on your newsletter that you get from us about what those topics will be and how to sign up to attend those as well.

Thank you so much, David, for a great presentation. Thank you all for attending, and we wish you well. Thank you.