Q4 Market Outlook: Federal Government Funding, Tariffs, and Earnings Growth

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Thank you all for joining us. Don, let’s get started. I know we’ve got a lot to cover here on our fourth quarter market outlook. So many of these topics here. So I’m very pleased to be joined by Don Calcagni, our Chief Investment Officer. I’m Kara Duckworth, the Managing Director of Client Experience.

And we’re gonna be covering a lot of topics today, many things that you all sent us as your questions in advance. But it’s important to note that any of the information that we are presenting today is for informational and educational purposes only. It should not be considered personal financial advice or specific to your own situation.

For those types of questions, please contact your wealth advisor directly.

And we hope that you get a lot of information because we got a lot of questions from everyone, Don, as we went into this. So so many of these topics, I know you and I are talking with our clients every day about them. So we’re gonna cover some of those and what we’ve prepared, but we would also invite you to submit your questions here live using the q and a function that is on the bottom of your screen. We’ll get to as many of those as we can as well during the presentation.

So these are probably not a surprise to anyone on on the line that tariffs and politics and investment strategies and recession and interest rates and the markets and international investments are all, as you’ll see, even kind of equally the same size. We got, just as many questions on each of those. So, Donna, I’m gonna turn it over to you to start with our overview here.

Great. Thank you, Kara, and and and thank you to everybody in the audience for giving us some of your precious time. And like Kara said, I mean, we’re we’re excited about about today, and we look forward to sharing a lot of information with everybody on the call. So please feel free to use that q and a function that Kara referenced. And and thank you in advance to everybody who already submitted questions to all of us to to wait to us when you were registering for the for the for the webinar. So let’s kick it off. Let’s kick it off with some high level economic data.

Actually meeting the FOMC, that’s the Federal Open Market Committee. They set interest rates. Interest rates were cut back in September and we are expecting an interest rate cut later today. So before I go any further, just want folks to know I’m having some Internet instability with some technology on my computer. If I freeze, just give me a few moments. Hopefully, I’ll come back to you.

But we’re we’re we’re working through some some tech hiccups at the moment. But like I was saying, the Federal Reserve meeting today, they’re expected to cut interest rates again. There’s also another topic that we’re gonna start hearing a lot about in the headlines called quantitative tightening. Of the things the Federal Reserve has been doing for really since June of twenty twenty two is as bonds that the Fed owns mature and the capital, the principal is returned to them, they are basically shredding those dollars.

They’re not reinvesting those in new bonds in the marketplace. And so what you’ve seen is that the Federal Reserve, expanded its balance sheet dramatically to fight the global financial crisis and then again to fight the economic impact of COVID. What the Fed has been doing is they’ve been shrinking that balance sheet. So we’re down to about six point seven trillion on the Fed’s balance sheet.

This also helps to to tighten interest rates, to keep interest rates higher. So as they shrink the balance sheet, they’re basically removing cash from the economy, and that keeps interest rates higher. If they stop doing that, what it means, it’s gonna make it easier for interest rates to come back down.

U.S. stock market continues to post new records. We’re gonna talk about that here in a little bit. Unemployment ticking up a little bit, so we could we could perhaps touch on that, Kara, throughout our conversation.

And then the U.S. dollar has weakened by about ten percent year to date. This is the most dramatic sell off in the U.S. dollar in U.S. dollar history, and so we’ll touch on that in a little bit.

Just in terms of some other economic data that will highlight inflation, hovering around three percent.

At the moment, it’s actually started to creep back up here really since April, Kara, so we’ll touch on that as well.

Economic growth continues to do amazingly well considering all of the stress and all of the mixed signals that we’re seeing across the U.S. economy. Consumer sentiment, perhaps no surprise. We all tend to be quite sour on the economy at the moment. And this really has not changed, Kara, for for quite a long time.

And I actually think this is probably a little bit more of a commentary on how we feel about our political situation or political environment here over the past ten, fifteen years, really since the global financial crisis. But it’s interesting that consumer sentiment continues to come in quite low. Like I said, economic growth clocking in at around three point eight percent in real terms. So by any objective measure, the economy continues to do quite well despite that blip that we had in the first quarter of this year where it looked like the economy was actually receding a bit Kara.

Since then, it looks like the economy has continued to really fire on all cylinders and continue to do quite well, which is a bit of a shocker, you know, given tariffs and and everything else that we’re seeing in the economy. This is a little bit of a little bit of a shocker. Speaking of tariffs, before we move on, this is naturally one of the biggest changes in global economic policy here. And I say global because the United States is the world’s largest economy.

So this is a big change. The effective tariff rate at the moment is about seventeen point four percent. If we just do a little bit of eyeballing it here, we can see that these are the highest tariff rates since the Great Depression, since the early nineteen thirties. Now the flip side of this that I hear from proponents of the of of tariffs is that, hey.

It’s generating tariff revenue. That’s true. That’s true. Tariffs are a tax, and that tax is collecting revenue from all of us who who shop and buy goods and services that are imported from abroad.

You can see in August, the Treasury collected about thirty billion dollars. If we annualize that, it’s about three sixty billion dollars in tariff revenue that the treasury looks like it is going to bring in.

Before we get too excited about that, first off, I think that’s great. You know, from a tax perspective, right? We all of us on this call, whether we recognize it or not, we’re all lenders to the U.S. government. They have some of your retirement savings that they’re using to finance government spending. So we really want the credit worthiness of that borrower to be quite to be quite healthy.

But that borrower still runs an annual deficit of nearly two trillion dollars. We’ll touch on that here a little bit more in a little bit.

So Tom, before we move off tariffs, there’s a question in the comments from Richard, and he says, I’m surprised that the tariffs have not increased inflation more than it has by now.

Any comments on that?

You have a couple thoughts on that. And I would say that the the impacts of tariffs and, actually, we are seeing some inflationary pressure beginning to build from tariffs. And so, you know, it kinda sets us up for the next slide here. We can see that inflation has actually increased since earlier this year, really since the tariffs were announced.

A a percentage of this increase has been attributed and is attributed by economists to an increase in prices on tariffed goods. Okay? So that that would be my first my first comment. That would be my first comment with respect to the impact of tariffs.

My my second comment is that if you talk to major economists who follow this, their argument, Kara, is that that tariff pressure, that inflationary pressure from tariffs is building in the financial system globally, and that we’re gonna see a uptick in inflation later this year around the holidays and into q one. Whether or not that actually happens remains to be seen, but that is an argument that’s being put forward by some pretty respectable economists. And I think there’s some evidence to that. There’s also another impact here, Kara, that’s not obvious when you look at inflation, and that is the near ten percent collapse in the value of the U.S. dollar.

So put aside inflation for a moment.

If the U.S. dollar goes down ten percent in value, that means for all of us who purchase goods and services that are produced abroad, that those things have now become effectively about ten percent more expensive. Right? On prior calls, mentioned that trip to Italy. Right? So if you wanna make that trip to Italy now, it’s actually gonna cost you about ten percent more on average than it would have on January first. If you shop at a place like Walmart where many of the goods and services are imported from Asia, right, many of the goods are imported from Asia, those things are now that much more expensive.

Right? So the purchasing power of our dollars with respect to those non U.S. goods and services has gone down. So we are seeing it. Think we’ll see some more of it.

History or the future will tell us whether or not we’re right there.

That’s helpful. Thanks. Yep.

So in terms of inflation, like I just mentioned, we have seen an uptick in in inflation. One of the things that’s keeping a little bit of a lid on inflation to, I think Richard’s question, is that we have seen the price of oil come down. Right? So you can see we’ve seen some deflation in energy.

So you can see this this black line, this is the zero line. When you see bars below that, it means we have deflation. Deflation is when prices are actually declining, And we have seen the price of oil come down a little bit here over the past several months. And I was just in a meeting, with several investment banks where we were exploring, well, why is it coming down?

Well, if you recall a couple of years ago, the Saudis, the OPEC plus countries actually cut production to drive up to drive up prices. What they’re what they’ve been doing thus far this year is increasing production, Kara, bringing more of that production online.

And why they’re doing that, we can debate. One of the reasons we suspect they’re doing that is they wanna push the marginal less profitable U.S. driller out of business. Right? They they don’t want us drilling more.

So one of the ways they do that is they overproduce to push down prices. It’s actually it is more expensive to drill in the United States. We have higher labor costs, more environmental controls, things like that. So our breakeven cost per well is higher than it would be, for example, than for the Saudis.

Right? So so that’s one argument is they’re trying to keep the marginal producer out of the market. The second argument is that perhaps president Trump has actually asked them to overproduce, to help bring down the price of gasoline, to bring down the price of petroleum products, to help offset the inflationary impact of of inflation. So either way, things can be true at the same time.

What we what we see in the data is indeed that oil prices have come down, oil prices are projected to continue to decline in twenty twenty six. We think we’re gonna settle somewhere in the low to mid fifties per barrel sometime in twenty twenty six.

Think one of the most interesting things both while while we’re talking about inflation, Don, is to remember when we when we put together financial plans for our clients, we include an inflation factor in this. And that’s really important, I think, to remember as people are looking at that. Like, keeping pace with your purchasing power needs to keep place with inflation and that we do put those assumptions into your financial plan, as as there can be significant factors on that.

Absolutely. And I think, Kara, I’ll add two points to that is remember that when we measure inflation, inflation is measuring The the the truth is that we all buy different combinations of goods and services. So your particular inflation may be different than say someone else’s. I have two kids in college. I deal with inflation in tuition prices. If you have a parent in a nursing home facility, you’re dealing with probably a different set of inflationary pressures. So the second point I would make there, Kara, is going forward.

Forward looking inflation is what we care a lot about. Right? From a like you mentioned, from a planning perspective, we’re building that into the financial planning projections that we do for our clients.

There’s lots of lots of indicators that give us some idea of what we think inflation is gonna look like over the next twelve months. One of those is what we call the one year forward implied inflation rate. We can use U.S. treasury bonds and how they’re trading to give us some sense of what we think inflation will look like going forward. We think it’s gonna be probably close to three percent throughout twenty twenty six. A lot of the forecasts are settling somewhere in the low to three low low to mid three percent range going forward.

Great.

Kara, are you there?

Oh, yep. Don, you froze there for a second, but now you’re back.

I’m glad I gave everyone that disclosure at the beginning, and I apologize for that, folks. Our IT team is working around the clock trying to figure this one out. So it’s, hopefully, we’ll get it fixed here soon. Like I said earlier, Kara, the Fed is meeting today.

So, we’re we are expecting a cut in interest rates. The Federal Reserve, you know, put aside all the political headlines around around the Fed and Fed independence. The Federal Reserve themselves have been forecasting that they were going to begin reducing interest rates here at the second half of twenty twenty five. Indeed, they’ve been doing that.

So it’s never been a question of whether or not they were going to reduce interest rates. It was always a question of speed and how how just how quickly and how deeply would the Fed likely cut interest rates. So we do think that the Fed and the Fed themselves is forecasting that interest rates next year will probably fall to around three percent, somewhere in that in that window.

Kara, I see this question a lot from our clients. That doesn’t mean that thirty year mortgages are gonna be at three percent. Okay?

Was gonna say we’ve got a couple of questions immediately on that. So thanks for addressing that.

Yeah. There’s a big difference. Right? These are very short term interest rates. These are the interest rates you’re gonna be earning on your money market funds and things like that.

These are like ninety day or even shorter thirty day interest rates that the Federal Reserve is trying to manage. That’s very different than when you’re borrowing money for thirty years, right, as part of a mortgage. Right? So, certainly, they’re related.

They tend to influence, they, meaning the the interest rate set by the Fed tends to influence.

Apologize.

Yep. I think I got you back now, Don.

K. Alrighty.

So we were talking about the the federal rate, the interest rate, saw they affect the mortgages on the thirty year rates.

Correct. Correct. So it it there there is an influence. They they work together, but I think it’s important for everybody on the call who is perhaps thinking about buying a home or refinancing that mortgage that you have now, just keep in mind that these are different interest rates. They influence one another.

Point to three quarters of a full percentage point reduction in your mortgage interest rates, going forward. K?

Great.

So a few other comments here. With respect to mention the U.S. dollar is down almost ten percent year to date. This is a direct function of tariffs. It is a direct function of the interest rate cuts that we’ve had thus far this year.

There is a is a view among global participants that the U.S. is perhaps not as a credit worthy lender as we were perhaps at some point in the past. Global central banks, so these are the central banks of other countries, of Europe, of Switzerland, of China, are beginning to lighten their load. They’re they’re on a relative basis are holding fewer dollars as a reserve currency. Now let me be very clear.

The U.S. dollar is still the world’s preferred reserve currency. Right? It’s not binary. It’s not either you are or you’re not.

About sixty percent of global reserves are held in U.S. dollars. Okay? But that is starting to come down a bit because of this decline in the U.S. dollar. So we’re seeing central banks begin to lighten their dollar reserves.

And I think all of these things taken together have brought down the value of the U.S. dollar. What I would also say is that when you look at the team of economic advisors that surround the president, The president of the United States has selected a team of economic advisors who come from a very specific school of economic thinking, in that they are what we call dollar devaluationists. Right? They are the weak dollar camp within the economics profession.

They want to bring down the value of the U.S. dollar. And there’s reasons for that, right? That helps make our goods and services relatively cheaper to other foreign buyers of our goods and services. So I’m not defending their policies.

I just want to explain them to our audience, all right? We suspect that this will continue given the team of economic advisors around the U.S. president and given the policies that they continue to advocate at this time. And so there are certain investment implications for this. One of those is continuing to own non U.S. assets, and we’ll touch on that here, Kara, in a few more in a few more moments.

Before we talk about the performance of U.S., of U.S. and non U.S. equity markets, I did just wanna give our audience a quick refresher on the federal budget. Right? And and this is important because this is also influencing interest rates. As those interest rates come down, it’s actually gonna take some pressure off of the US budget deficit, but only a little bit.

If you look at our if you look at our our budget deficit, we currently spend about fourteen cents of every dollar that the government spends on interest and making sure that we can pay interest on the debt that we’ve accrued. We have about thirty eight trillion dollars in existing debt. That thirty eight trillion represents the sum total of all prior deficits. Deficits is, a deficit is the shortfall that we incur in any one calendar or, I’m sorry, fiscal.

Revenue that is a tax, that’s going to help us hopefully bring down this particular deficit. But we have a long ways to go. So that’s where we’re at at the moment. The one big beautiful bill.

Increase our debt to GDP ratio. It’s basically our debt to income ratio, for us as a as a country.

So I’m seeing a couple of questions. Great. You’re gonna talk about it here. Just what’s the effect of the current government shutdown and and not only currently, but also forward looking?

Yeah. So, I mean, you you have close to what about a million federal workers who are currently have been furloughed. Right? So I think that’s an important point.

Right? That’s a that’s a lot of families. That’s a lot of households that, I suspect are probably not spending as freely as they would if if those dollars, if those paychecks were coming in at least at the moment. So what we’ve done is if you actually look at the three prior shutdowns, one in ninety five, one in thirteen, and one in two thousand and eighteen, what we’ve observed is when we see a reduction in economic activity as a result of the shutdown, it’s actually not that impactful.

I mean on an annualized basis, Kara, it’s maybe about two percentage points reduction in economic activity related to the shutdown is actually very temporary. What we find is after the government reopens, that the the economic activity picks right back up. And that makes a lot of sense because by law, the federal government still has to pay all federal workers their back pay. Right?

So even if the government were shut down for a month or two months, once those workers come back to work, congress has passed a law. This is a law that’s on the books. We can’t just ignore it. We have to pay back pay to federal workers.

So at least for those workers, those dollars, they’re still being injected into the economy, Kara. So coming back to the deficit, the shutdown doesn’t do anything to bring down the deficit. Right? These are dollars that will still be paid to all federal workers once we reopen.

K?

Got it. That’s helpful.

So let’s pivot here a little bit and let’s talk about what’s happening in the market, and let’s also talk about gold. I know, Kara, we’ve got a lot of questions on gold. It’s the asset class that many investors love to love when it’s good, and they love to hate it when it’s not so good. So so let we’ll we’ll we’ll touch on gold. Before we do that, let’s just touch on a little known company called NVIDIA. I’m sure some of you have heard about NVIDIA by now. This morning NVIDIA actually surpassed about five trillion in market capitalization becoming the most value valuable U.S. company of all time.

A couple of things I would highlight here. And you can see this here.

We’re showing you really the biggest companies in the S and P five hundred index. These are great companies, they’re popular companies. Many of you, actually if you’re a Mercer client, can tell you all of you own stock in these companies.

But one of the things I wanted to highlight, alright, is that we should never ever fall in love with our investments. They will not love you back, alright.

If we look at market leadership over time, it has changed and it has changed by a lot Kara. And in fact, when you actually look at if you go back to like two thousand and five, does anyone remember General Electric? Right? I remember in the nineteen nineties folks would say Don, I own GE. I don’t need to diversify because it’s already a diversified conglomerate.

Well, fast forward to today, GE really does not exist. There is a GE, but it’s not the same GE that existed back in two thousand and five and certainly not in nineteen ninety five. The point here is that the leadership in the market changes over time and it can change quite dramatically. The companies that you love today that are driving the market today, there is a very high probability of history as any guide that they won’t even be around at some point in the future.

Right? Who remembers Sears? Right? Sears was the amazon dot com of the twentieth century. Sears is bankrupt.

Sears is not a thing anymore. Right?

Netscape Don, maybe I can remember Netscape. Yeah.

Oh, goodness.

Yes. My very first web browser. That’s good. Maybe I can ask you a question that, and I’m my apologies because I’m probably gonna mispronounce your name that Badar Rahali is asking.

Says, what is your view on if the current magnificent seven is going to stay the magnificent seven?

I don’t think they will.

I think these are great companies. Right? I I these are outstanding companies. Right?

But I I I don’t think there’s any evidence. There is no reason, no logical reason to believe that these companies will remain at the top of the heap in perpetuity. Right?

I mean, if you went back to nineteen eighty five, these were all companies I know that my grandfather owned stock in because he thought they would be around forever and that they would continue to be the very best performing companies in the market. Most of these are oil companies.

Right? General Motors, IBM. So I I don’t think there’s any evidence. When you look at market history, Kara, history tells us that market leadership changes and it changes by quite a bit. Right? Number two is that success will invite competition.

Right? The fact that these companies are so successful doing what they are doing means that other companies are rapidly gonna try to imitate their success and replicate their business models and actually improve upon their business models. Right? If we look at, you know, look at the success of Google, for example.

Right? Google replicated the success of Netscape and America Online. Remember that one? AOL, America Online.

And Yahoo. Right? And then ultimately replace those companies. There’s no reason to think that these companies here on this list will not be knocked out of business by an upstart right now that is perhaps being started in someone’s garage, and in five, ten or fifteen years could easily topple one of these one of these companies. The great thing about our investment approach though, Kara, is you don’t have to try to predict whether or not these companies will remain on top or not.

Right? I I gave someone an example the other day, Kara, that if in nineteen ninety, all you owned, if the only thing you owned was an S and P five hundred index fund, and if you fell asleep for the next thirty five years and you woke up ten minutes ago, your portfolio already has a pretty healthy allocation to these stocks right here on this page. Right? You already own AI stocks, and you did nothing. So you don’t have to try to predict whether these companies are gonna remain at the top of the heap or not, and they very likely will not.

Yeah. We’re getting a lot of questions while we’re sort of talking about NVIDIA and and AI in general. Do you wanna maybe talk about is AI a bubble? What’s your view on that?

I I don’t think AI is a bubble. If you if you look at any new technology that is very promising. Right? AI promises to improve worker productivity. We are investing in AI here at Mercer Advisors to make it easier for our advisors to get answers to things like certain tax law questions or or whatever the case may be.

So I don’t think it’s a bubble. I think it’s a very promising technology that promises to make American workers more productive. And that’s critically important if we’re going to sustain economic growth going forward. We and and just yesterday or this morning, there was an article in the Wall Street Journal highlighting how AI is allowing companies to ultimately start laying off some white collar workers. Now I know many of us as workers, we don’t like hearing that.

But from the company’s perspective, they’ve made certain investments in AI, and that means that in theory, they need fewer workers to do the same job because now they have technology that can arguably do that faster, better, quicker, whatever, than a team of a team of humans. And so bubble would imply that it’s all hot air. That there’s no return on that particular investment. I’m not convinced. I think there will be a return on AI.

I do think it’s gonna take time. I do think the market has probably gotten a little bit ahead of itself.

But I do think in time over in the coming years, many businesses will see a handsome return on certain investments in AI. But Kara, like any other new exciting technology, there is a very high likelihood that investors are gonna overshoot and they’re gonna get too excited and probably over allocate.

So yep.

Thanks, Scott.

Yep. So in terms of year to date returns for the S and P five hundred, S and P is up about fifteen percent for the year, give or take a little bit depending on the day. But I wanna remind us that in mid April, the S and P had collapsed about nineteen percent from where it began the year on January first. And so while many of these companies on the prior slide, the magnificent seven to our clients question, while those companies are certainly responsible for continuing to push the market higher, they also led the market lower during what was then a very violent sell off in U.S. stocks back in mid April.

And so we need to remember to the question around whether or not AI is a bubble or not, with any new exciting upstart technology where the returns have not been realized yet, where where it’s still more of a promise and it’s not very tangible, it is very likely that those companies trading at these very high valuations could could really lead the market lower in the event of in the event of a sell off. And so I just want to remind our investors that what the market giveth, the market can certainly taketh.

Year to date returns just giving us a high level overview, U.S. stock markets about in the middle of the pack, non U.S. investments far and away knocking the cover off of the ball, significantly outperforming U.S. investments for the year. We saw this largely continue in the third quarter of this year with emerging market stocks delivering about eleven percent versus eight percent for US. US stocks did outperform developed market returns, but only in this only in that third quarter. Year to date, we are seeing about ten to fifteen percent outperformance relative to the US market.

Bonds still posting positive returns for the year doing what I think we would expect bonds to do in this particular interest rate environment. So still positive returns, but certainly they pay off compared to what’s happening in global equities. Now Kara, I wanna highlight one thing before we move on from a discussion around equities. I get the question a lot from clients, you know, gee, why would we invest in countries that are heavily tariffed by the U.S. administration, doesn’t it logically follow that they would run into trouble?

And the answer to that is well no, not at all. And in fact if you look at China, if you look at Brazil, these are two of the most heavily tariffed countries by the United States at the moment. China, the Chinese stock market is up a staggering thirty seven percent year to date. Brazil even more thirty eight point three percent positive year to date returns.

Canada despite being heavily tariffed by the United States up twenty four or twenty seven point four percent for the year. So these are three countries heavily tariffed by the United States that are all delivering blockbuster returns year to date to non domestic investors. So for U.S. investors investing in those markets, those are the returns that we have earned thus far year to date. When we look at the entire globe minus the United States, the entire globe is up close to twenty nine percent, U.S. stocks up about fifteen year to date.

So Kara, we should probably talk about gold. Everyone’s probably thinking, yeah, that’s fine, Don. But what about gold? Tell me about gold.

Oh my gosh. The number of questions, Don, here I’m getting, what’s the cause of the rally in gold? Should we be investing in gold? What’s the best way to invest in gold? So perhaps you can cover all three of those.

Yeah. So let’s so the the first thing I would begin with is gold is what I would call purely a speculative asset, and not a very investable asset. You may be thinking, well, wait a minute. I can buy gold easily through an ETF or go up to my corner pawnshop and buy some gold. The difference is this, an investable asset in my view generates cash.

It generates profits. It can pay you dividends or interest. Right? Think of owning stock in McDonald’s or Nvidia. We’re just talking about Nvidia. Right? Nvidia has EBITDA, earnings before interest, taxes, depreciation, amortization, has earnings, let’s just call it earnings for short, for the purpose of conversation, has about a hundred billion dollars in annual earnings.

That’s a lot of cash. So as an investor, you legally have a claim on your fractional share of NVIDIA’s cash. That’s great. That’s why we own companies. We want checks. All of us on the call, we live our lives with U.S. dollars. If you go to Amazon, if you go to McDonald’s, if you go out for sushi, you need to pay your bill with U.S. dollars.

So dollars are king. Gold does not generate cash. It does not generate profits. Right? I could say the same about cryptocurrencies and so on and so forth.

But gold has no management team. It has no balance sheet. Right? And so the question, Carr, why has it gone up?

I think that we have lots of theories, but there’s nothing that’s testable or defensible.

And for that reason, I think it’s a speculative asset. You can’t rationalize logically why it trades at four thousand an ounce versus three thousand an ounce or why not five thousand an ounce. We don’t have good answers for that. There’s lots of theories, but no real good answers in our our view. So that’d be my my my my first my first point with respect to gold. The second point is that when we actually look at very long term data, going back to nineteen eighty.

From nineteen eighty until about let’s say twenty twelve Kara, Gold underperformed inflation. So oftentimes folks are arguing that you should own gold because it’s a hedge against inflation.

Well, objectively, that’s wrong. That’s not true. Not when we look at the data. Right? Gold is doing something, but I don’t think you can convincingly argue that it’s hedging inflation. And you’ll see here on the right, I tried to give us a sense of like how gold has done by decade, Right? For the twenty year period from nineteen eighty to nineteen ninety nine, you lost money on gold.

That’s twenty years you’d have to hold that before you started to make money again. And I don’t know if too many investors that can hold an investment that loses value for twenty years, that that they’re gonna be able to hold on to it for very long.

And in fact, gold didn’t actually even break even with inflation until around twenty twelve. Right? So and a lot of that was because gold did really well during the global financial crisis leading up to and during the global financial crisis. After that crisis largely went away, it collapsed in value again, and underperformed inflation again.

Alright? It wasn’t until really recently during COVID, and here honestly, it went parabolic in the past year.

Now why did gold do that? Nobody knows. We have some theories that central banks are starting to buy gold. Remember I said earlier that central banks are beginning to diversify away from the U.S. dollar. We saw that collapse in the value of the U.S. dollar and central banks are beginning to buy gold to shore up currency, their currencies.

That could be true. I think that is true. I think we’ve seen that in the data. Whether that continues or not is really anybody’s guess.

Okay? We just don’t know. All right? But gold has gone parabolic here. It’s gone up about fifty percent Kara, year to date. We gave back about ten percent here just in the past five trading sessions. Again, nobody knows why.

Right? You know, and that’s where I think I question. You know, when something can go up fifty percent, go down ten percent, and nobody has a real good rationale for why, that’s a very volatile speculative investment. So I don’t like those types of investments. And you can actually see that here on the right hand side of the screen, when you actually look at the returns on gold over the entire period, like let’s not cherry pick, let’s look at all the data, all the real world data, what we see is that gold has averaged about five percent returns with about a seventeen percent annualized risk.

Let me put that in context for our listeners.

Stocks have averaged, let’s say ten percent, actually a little bit higher than that over the same period, it’s actually closer to twelve, but with a risk level of about fifteen percent. And so what gold really offers us when we look at all this data, is bond like returns with greater than stock like risk.

Probably not the best trade off. It would be a real good investment if we could just time specifically when to own it. And I think what gold is doing here, Kara, this is my suspicion, it’s really hard to test, is I think gold is a barometer of stress in the financial system.

I think when we look at two thousand seven, two thousand and eight, that’s what gold was telling us. That there’s stress in the financial system somewhere. We’re not exactly sure where, but we knew that there was stress.

And I think we’re seeing a little bit of signs of that today. The decline in the U.S. dollar, very high tariffs in the United States, central banks beginning to diversify away from dollars.

I think this is a sign that there’s some stress building in the financial system. It could be some inflation that has yet to really rear its head.

It’s hard to say exactly where there might be stress in the system, but there has been a lot of changes in the global financial system here in the past twelve months and I think that the global system needs to needs to digest those.

And related to just kind of a, if a client’s asking, should I buy gold? Can you talk about kind of the different vehicles that exist to actually are we talking about I’ve I’ve got a gold coin in my pocket? Are we talking about some sort of security? What what how would people even do that even if they wanted to?

Yeah. I mean, I think it’s interesting. So if you look at the the chart that we have here, Akhirab, these are actual gold prices.

Now you’re right. You can own gold through a financial instrument, maybe an ETF. There are exchange traded funds that promise exposure to gold futures or to the underlying metal itself.

However, those vehicles charge a fee. The returns here assume zero fees. And truth be told, that’s not realistic. Even if you own physical gold, you’re incurring fees.

Right? So you could own it through a financial instrument like an ETF, which is actually gonna be very liquid. You know, you or I could go into Schwab or Fidelity and Raymond James, and you could place a buy or a sell order. Very liquid.

Physical gold, obviously not so liquid. Right? You have to go to a gold dealer, a pawn shop. I jokingly say the pawn shop, but a gold dealer who’s naturally going to be charging some sort of spread.

Right? They have to make a profit on that exchange, whether they’re buying or selling to you. You know, presumably if they’re buying your gold, you have to offer to them at some sort of price that would entice them to wanna buy that. Right? So it’s illiquid. There’s an illiquidity premium that typically sellers have to pay that the buyer ultimately captures when you try to sell an illiquid asset.

Owning physical gold, you may have to put it in a storage vault depending on how much gold we’re seriously talking about owning. I would not recommend that you have, you know, millions of dollars of gold sitting in your bedroom. It’s probably not a good idea.

But so maybe maybe there’s expenses, Kara, that you our client would would incur by keeping that held in a vault. It’s also just not very practical. You can’t pay your tax bills with gold. You can’t take your spouse out to a nice meal with gold.

So naturally there are just some very, know, some pretty big practical barriers to just to just owning gold.

That’s helpful. Yep.

So, Kara, we’ll wrap it up here, then we can tackle some more questions. Thankfully, we haven’t frozen here. Hopefully, I didn’t tempt the, the technology gods to freeze up our Zoom here. But a couple of takeaways I think is important for all of us to keep in mind.

I know I’ve given you all a bunch of data, a bunch of information here and I’m hoping to continue the conversation. But number one, is true the economy continues to grow despite mixed signals. So you know, I just made a comment that you know, gold is perhaps a barometer of stress in the system. Yeah, I think that’s probably true.

It’s not always true, but I think that’s probably true to some degree.

But despite that, the economy continues to do amazingly well. Three point four percent GDP growth, that’s nothing to nothing to sneeze at. I mean, that is a really respectable GDP growth rate in a year where there has been a lot of change. And so so wow, great. Great to see that the economy continues to motor along.

Market leadership changes. Right? We’re seeing many clients coming to us owning relatively non diversified portfolios, new clients that have non diversified portfolios. Keep in mind, market leadership changes.

These are awesome companies. I love NVIDIA. I love Microsoft. I love these companies, but market leadership does change and it often changes very rapidly.

And so something to just be careful of. Don’t fall in love with your investments, they will not love you back. Don’t ever think that your investments love you.

Broad diversification. It’s worked amazingly well this year. There has been a very long period of time where non U.S. investments gave us very handsome positive returns, but underperformed U.S. stocks. That was not the case this year. And in fact, the the returns in U.S. stock non U.S. non U.S. stocks this year have been so strong that it wiped out the last three years in the out of of outperformance by U.S. stocks, meaning that now U.S. and non U.S. stocks over the last three years are shoulder to shoulder.

That’s a big big change.

We were just talking about gold. It has a very mixed long term record, so be careful. If you’re gonna if you’re thinking about buying gold, we have but and just to be clear, have many clients who own gold here at Mercer Advisors. Okay?

I just think you need to be very careful. Gold can do amazingly well during very very short windows, but for very long periods it just goes into the wilderness and it’s a drought and it gives you nothing. So just be a little careful there. It is not a reliable hedge against inflation.

There’s no evidence that gold is a reliable hedge against inflation. And then the final point here Kara, this is an evergreen point. Careful planning, patience, prudence and diversification. Taking a diversified approach to balance sheet management.

Those are really the best ways to really navigate a very confusing market, and a very confusing economy. I think we need to remember that, you know, we’re managing our wealth to achieve certain outcomes for our families. Right? To to achieve a certain standard of living, perhaps to engage in certain philanthropic endeavors.

Our investments are a means to an end. Right? The the mission isn’t to beat the SMP or to do better than NVIDIA. The mission is to achieve certain outcomes for ourselves and for our families. Best way to do that is through comprehensive balance sheet management. So I would encourage all of our listeners to make sure you’re having those balance sheet level conversations with your advisor.

Well, Don, from the questions that I’m getting here, maybe we can go back to the to the previous slide on kind of the outputs here on on the, broad diversification and reflecting somewhat on kind of those those leaders of those top companies. We have a question from Emil saying if I wanted to reduce a concentrated equity position, are there ways I could do that with without taking a huge tax hit on, say, capital gains or tax efficient strategies to diversify out of a concentrated position?

So, Emile, the short answer to that is yes. Absolutely. There there are strategies, legitimate strategies, where you can diversify a let’s just say a single stock position. Let’s say you had twenty million dollars in Apple or Nvidia. There are strategies where you can unwind that, diversify it across, you know, the entire market, let’s say, and do that in a way without incurring an immediate, tax hit. So there’s something called an exchange fund, which is a private partnership vehicle where you can contribute that stock to the partnership. That is a nontaxable transfer.

And in exchange, you then have an undivided interest in all of the stocks owned by the fund. These are typically funds that own thousands of stocks. So that is a nontaxable transaction. To be fair, I wanna be very clear. This doesn’t mean that you never pay tax.

When you sell your interest in the fund, you could pay tax, And you would pay tax.

You froze up there again. I we got you to the on the exchange fund about when you put funds into it, that’s a nontaxable transaction. So maybe just recap what happens after that.

Sorry about that, folks. So, yes, when you contribute that stock to the partnership, that is a nontaxable transaction.

And when you do that, you immediately diversify that concentrated stock risk.

When you make a withdrawal from the fund, they typically give you a basket of stocks. When you sell those stocks is typically when you would pay your capital gains tax in the year in for the year in which you sold those stocks. But, Kara, there’s many other strategies. There’s something called a long short strategy, and all of our advisors are prepared to have that conversation with our clients.

So there’s a long short strategy. You could use a direct indexing approach where you do slow sales over very long periods of time. You could hedge it with what’s called an options caller. A caller is not really diversification strategy. It’s really just a delaying strategy where you would defer ultimately selling that position to some point into the future.

There are philanthropic strategies, charitable remainder trusts. We have an army of attorneys here that can help our clients with those things.

So, Kara, I mean, short answer to that question is, yeah, absolutely. There are lots of great strategies, very wonderful strategies that can help clients diversify those single stock positions and do it in a way where we really minimize, or defer, the the tax hit.

Right. So sounds like that could be a very substantive planning conversation with with your advisor to dig into that. Maybe on a different topic, I’ve got several questions, Jane, Thomas, Diane, asking about the private credit market.

So there was a recent article in the Wall Street Journal, addressing maybe some private credit loan quality concerns. So how would you how do they protect against a write down on the value of those loans and some commentary about that asset class?

Yeah. Well, first off, I would say is it it’s an asset class that has grown dramatically in value since the global financial crisis.

That asset class exists for very good reasons because major commercial banks, like Bank of America, places like that, simply will not lend money to businesses, to to smaller and middle, you know, medium sized type private businesses. Right? This may this may shock some of our listeners, but the banks really aren’t in the lending business anymore, not like they used to be in the old days. And so, so what’s happened is private credit, private lenders, investors, like all of us, have stepped in to fill that void.

These are businesses that are private. These are businesses that are smaller than, you know, NVIDIA and Microsoft, all the companies we were just talking about. So these tend to be loans of lower credit quality. Right?

Many of you have heard of high yield bonds. In fact, they may be in your portfolio right now. High yield bonds are bonds made to borrowers of relatively lower credit quality. But in exchange, you get to charge a much, much higher interest rate.

So if you look at private credit, Kara, as an asset class, you’re seeing yields of nine, ten, eleven percent on those holdings. Now to the question right? And so my first point is you’re being compensated for taking more risk. Number two, the asset class exists for very good reasons because commercial banks are unwilling to lend to these companies.

Right?

There’s also some regulatory the value of that investment Oh, you froze up there, Don.

We we just finished on kind of the regulatory barriers for Okay. For the private credit.

So with respect to protecting ourselves from a write down, just to be very clear, you can.

Alright? You you if if a company begins to default on the loan, there’s nothing you can do as an investor in a fund to protect yourself from that one write down other than diversification. So if you look at the funds, for example, that we own, we actually own several thousand loans in those pools. If you look at, like, a Cliffwater or a Monroe or some of the other solutions or like a Golub, know, if you look at the underlying, portfolios, first off, you diversify. That’s your first line of defense is lots of diversification. Thousands of loans, not dozens, thousands.

Right? Number two is you work with managers that put in place pretty strong, debt covenants. What that means is we are putting limits on how much the companies are permitted to borrow, not just from us, but from anybody. Right?

So you put, for example, these debt to EBITDA covenants in place that put a a lid, Kara, on how much debt they can borrow. That’s our way of making sure companies don’t get overextended. And, Carol, when you actually look at the loss ratio on the underlying portfolios that we own, it’s less than one percent. So when you look at all the loans in the basket that have actually gone into default, it’s around thirty basis points.

That’s what we’ve that’s what we’ve seen in practice. Now the No. We have not been there yet, so it’s purely a hypothetical at this point.

It froze up just a little bit there, Don. We talked about the thirty basis point practicality and missed the last part there.

Sorry about this, folks. I really am. So what what I’m saying is that when we actually look at the, the actual losses on those portfolios, they’re very minor. Right? Thirty basis points, far less than one percent.

The Wall Street Journal article, the Moody’s article before that, they’re all really asking a hypothetical question around what happens if the whole asset class runs into trouble in the future.

The first thing I would say is, well, we don’t know. We have not been there yet. Right? So right now, it’s purely conjecture. We just don’t know.

That doesn’t mean that we shouldn’t try to manage the risk. We do that through broad diversification. We do that through balance sheet management. Right?

None of our Mercer clients are invested exclusively in private credit. We have very strict limits on how much we allocate to any one asset class. We then have limits on how much we invest in any one fund, and then we make sure that we invest in funds that are highly diversified. So diversification, ultimately, Kara, is really the best way to really protect against any major write downs in in private credit. And and, candidly, that’s for any asset class.

Right? NVIDIA, not to scare anybody, but NVIDIA could go down twenty percent in the next week. We saw that happen in April of this year. And I’m not saying they will.

I just wanna be very, very clear to everybody on the call. I’m not saying they will, but all assets, all companies can ultimately run-in run into trouble. How do we protect against that? We diversify broadly.

Great.

Well, I wanted to do a couple of announcements. We do have an upcoming webinar that I think we’ve got some of the details on. So on year end tax planning strategy with all of the changes that were created, in July with the changes to the one big beautiful bill. We’ve done a previous webinar on it that you can find on our website, but this is kind of a continuation of that plus some actionable tips towards year end tax planning.

And that’s scheduled for Wednesday, November nineteenth from nine AM, Pacific time, which would be noon eastern time. You will be getting an email about that. We’ve also had several questions on, will will we have recorded this, and could we perhaps figure out a way to adjust for some of the choppiness here? And we will do our best to make those corrections, prior to releasing this recording on our website.

As a reminder, each of these, recordings, even all of the historical ones can be found on our Mercer advisors dot com website. Look for the insights tab to find that commentary, not only these recordings, but also things that Don has recorded on particular topics and, articles related to as well. So as we wrap up, Don, I know that it’s been tough with all of the technical difficulties here, but what’s your last advice for clients as we’re looking into the future here? I’m guessing it’s gonna be diversification, but I’m all ears.

Certainly, diversification. I’m just a big believer in having a trusted advisor and then having a plan a, a plan b, and a plan c. Right? So try to make sure that you’re prepared for anything. Right? Take that balance sheet view to managing your financial situation and remain as broadly diversified as possible.

Great. Thank you, Don. Thanks for your patience, all of you, and we appreciate your attendance. If you have any specific questions or some more questions, we can get to. Presentations or not at that time. We have your name, and we will distribute them to your wealth advisor to continue that discussion as well.

Thank you, everybody.

Thanks for attending. Take care.