Q4 Market Outlook: The Fed, Deficits, Energy, Valuations, and More

Thank you for joining us. This is Mercer Advisors Q4 market outlook. You’ll note that we’ve got a lot of topics here to cover the Fed, deficits, energy, valuations and more, much, much more.

So I’m very pleased to be joined by Don Calcagni, the Chief Investment Officer at Mercer Advisors. I’m Kara Duckworth, a Partner at the firm, and we’re very pleased to be bringing you our update and answering hopefully a lot of the questions that you’ve submitted to us in advance, which we really appreciate. And as we go along, we are also going to be taking as many live questions as we possibly can.

So please use the q and a function to submit those. And as we go along, Don will try to answer as many as possible.

So maybe as we go through the deck here, Don, we can talk about all the information that we are presenting here today is for informational and educational purposes. It should not be construed to be personal financial advice or things related to your own personal situation. Please reach out to your wealth advisor.

So, Don, I know we have a lot of information to get through. We have a lot of great questions and interesting topics. So I’m gonna hand it over to you to get started.

Great. Thank you, Kara. And, appreciate everybody, giving us some of your precious time today. And and, like Kara said, we have a lot to cover, so I’m gonna jump right in here.

Although for some strange reason, my laptop is not cooperating. So there we are. Okay. Now we can move from slide to slide.

Okay. So high level dashboard. What’s what’s happening in the economy? Here we are in the home stretch of this midterm election, and we’re all being bombarded with all kinds of data.

So I’m gonna bombard you with a lot more data and, and, give us a high level update on how we’re doing. So first thing, let’s talk…

I’m not cooperating. I apologize, folks. Let’s talk inflation. So if we look in this upper left hand quadrant, we can see that inflation has ticked up here over the past, over the past, past several months.

We got a pretty hot inflation report in September, Kara, where it came in slightly above expectations. And, and I just wanna draw attention to this chart here for a moment. This one over here in the upper left hand quadrant. Even though inflation has come down, I wanna be clear with everybody.

That doesn’t mean that the price level came down. Right? So sometimes you’ll hear folks say, I don’t get it. How’s inflation down, but I’m still paying a lot at the grocery store?

Again, that’s the price level. Inflation is the rate of change in the price level, whether it’s going up or whether whether it’s, whether it’s going down. And so, again, inflation has ticked up a little bit. Stock market remains near, really all time highs, Kara.

We’ve had a little bit of bump here in the last, little bit of volatility here the past couple of weeks. Gas, it it still hurts to go to the pump. Whether you’re buying gasoline or diesel, it it hurts at the moment.

Likewise, if you’re trying to buy that new home and you’re trying to get that mortgage, you know, the days of two and a half percent mortgages, those those days are long, long gone. And so here we are at the moment. We’re looking at seven, seven and a half percent thirty year mortgage rates. Definitely, that’s putting a lot of, a lot of pretty heavy burden on on families that are attempting to to buy to buy their first home. Unemployment remains still in pretty good shape, pretty low by historical, by historical standards. The Federal Reserve has begun to raise interest rates, Kara. We just had a rate hike in September.

The Fed is actually meeting again today. The consensus at the moment is the Federal Reserve will not be raising interest rates today, but we’ll see. And the one thing we’re gonna talk about here, Kara, is that the Fed actually does not control interest rates, and they don’t even really set interest rates. The bond market sets interest rates. And so we’re gonna talk about that here a little bit in a moment. And so, again, I apologize. My computer is just not cooperating this morning for some strange reason.

Oh, Don, maybe maybe before you go on, we’ve got… Related to a bunch of those factors you just mentioned, we’ve got a question here from William talking about interest rates. So he asks, why is raising interest rates on mortgages, on credit cards, on car loans good for the economy? Maybe you can talk about what the Fed’s actually solving for.

You know, it’s a great it’s a great question. It’s it’s…

And and and just to be clear, it’s not good for the economy. Right? When the Fed raises interest rates, what they’re attempting to do is stop the economy from overheating. So there’s a view that when you have high inflation, that the economy is overheating much like the engine in your car, right, if something’s wrong.

Right? And so that’s what they’re attempting to do. They are purposely trying to cool down economic activity. And so if it is relatively more expensive for all of us to use our credit cards when we go out to eat or to, you know, do our Christmas shopping here at the end of the year, then it logically follows where we’re gonna spend less.

And if we spend less, the economy is gonna slow down. Excuse me. Economic growth will be slowing down. So to be very candid, it’s not good for the economy in the short run.

But in the long run, what the what the Fed is trying to do is to try to bring down inflation. They wanna make sure that prices of goods and services don’t get out of control. And so that’s that’s really what they’re trying to do, and it’s a painful trade off. Right?

It’s it’s basically harming consumption today with the intent of of making sure that prices don’t rise uncontrollably in the future. There’s an argument if we go back a couple of years that the Fed should have raised interest rates much sooner than they did. We all remember when inflation hit 9% back at the end of twenty twenty two, and what the Fed is trying to do, is is to stop that or to ensure that that never happens, again.

Great. That’s helpful.

Thank

Yeah.

Great. Great. Great question.

So in terms of the economy, how are we doing? Well, the economy does continue to grow.

Sorry, folks. There we are. The economy does continue to grow at about 2.2% at an annualized rate.

So, you know, despite the war, despite high energy prices, despite tariffs, despite inflation, the economy continues to grow. And this is the same information that the Federal Reserve is seeing, and they’re looking at that saying, woah. Woah. Woah.

Wait a minute. We need to slow down here. It looks like inflation is starting to pick up, and we need to make sure that prices do not get out of control.

Speaking of energy, left hand chart here shows us the price of oil. Year to date, we can see that big spike just as the war in the Persian Gulf, picked up in The United States and Israel began bombing Iran. And we can see that for the most part throughout the year, energy prices have remained pretty elevated. What I wanna draw your attention to is this October 2027 consensus number.

That is what the futures market is predicting the price of oil will be next year. And there’s probably two things I would take away from this very quickly. Number one is that the market is expecting that the price of energy should come down to somewhere around $80 a barrel this time next year. That’s less than it is today, but interestingly, it’s still significantly higher from where it was prior to the beginning of hostilities at the end of February.

So, my view on this is the market has no idea what’s gonna happen geopolitically in the Persian Gulf, and so I would be careful not to read too much into into the futures market with respect to where we think energy might be next year.

On the right hand side here, we can see that really we’re not seeing any tanker traffic come through the Strait of Hormuz. You know, some folks have tried to claim, oh, we are seeing some tanker traffic come through. We’re actually not seeing that at all at this point. It’s very, very anemic. Iran has attacked tankers that have attempted to exit the Persian Gulf. And despite a U.S. military escort, the truth the truth remains is trying to get energy out of the Persian Gulf right now is painfully is painfully difficult.

Okay. So, Kara, back to our question on interest rates, which I love by the way. The Federal Reserve sets really short term interest rates. The Central Bank, that’s the Federal Reserve Bank of the United States, they they set the interest rate that banks have to charge one another for overnight loans on their reserves.

And so that that interest rate set by the Fed, it influences interest rates, but really only at what we call the short end of the curve. That’s the left hand side of this slide. These are bonds that mature very quickly, like a three month bond or something like that. These are tend to be like money markets and things like that that hold those types of…

That type of paper. One of the things you’ll see here is where the curve was at the end of December, at the end of last year. So the curve here is just showing us interest rates at different maturities. What we can see here is that it’s materially higher today from where it was at the end of December.

All of this increase in interest rates, that’s what these two curves are showing us, was due to the bond market. Who’s the bond market? It’s all of us. All of us here on this call.

It’s all of you that own US treasury bonds in your portfolios. It’s millions of investors the world over. So the bond market collectively has decided to begin raising interest rates on U.S. government debt. And that in turn raises interest rates on credit cards, on mortgages, on automobile loans, and everything else.

And so so there’s some question around, well, who is this mysterious bond market? It’s all of us. And then why then are we suddenly raising interest rates on bonds? Like, why do we think that things are riskier today than perhaps they were in the past?

And one of those is right here on the screen. It’s inflation. So you can see that inflation is currently around 3.7%, and like we said, it ticked up a little bit here.

So that’s one, headwind or one tailwind depending on your perspective that’s pushing interest rates higher.

Another one is the U.S. federal government’s deficit. So if you look at these two towers here on the left, the left hand tower shows us what we spend all of our money on. So all of the politicians that right now are begging for your vote that we’re getting ready to send to Washington, they’re the ones that determine how we’re gonna spend money here on the left hand side of the screen. The right hand side of the screen is our sources of income. Where where where does the federal government get its get its money? You can see income taxes, payroll taxes, little bit in corporate taxes, custom duties.

Some of that is…

That’s tariffs that we’ve heard a little bit about here over the past couple of years. And this big gap deficit spending, that is the bond market lending us money so that we can spend money on national defense, military spending, things like that, infrastructure, and things like that. And you can see there’s a big hole. Almost $2,000,000,000,000 right now.

The deficit is about $2,000,000,000,000 every twelve months. The current debt is $40,000,000,000,000. We’re adding to that by $2,000,000,000,000 every year, and a lot of that debt needs to be refinanced now and next year and in the next couple of years. Alright?

This is a lot of a lot of capital that needs to be borrowed in financial markets over a relatively short period of time.

Add to this the nearly $700,000,000,000 AI hyperscalers are borrowing to invest in AI data centers. Right? So right now, we have this situation where we’ve seen inflation tick up. We have the US government borrowing an additional $2,000,000,000,000 every twelve months, plus we need to refinance about a third of our debt, a third of that $40,000,000,000,000 in debt over the next several years.

Combined with that, the demand from AI companies to build data centers and invest in AI infrastructure. Kara, this is a lot of money that a lot of people are trying to borrow in a very short period of time. This is basic supply and demand. So the demand for money is sky high.

The supply is limited, and what happens? Interest rates interest rates go up.

So we’ve got a couple of questions about about federal debt in in general, Don. I mean, that number that you use, that $2,000,000,000,000 is a huge trillion with a t. And so both Peter and Steve are asking variations of when do you think the market is going to start treating the federal debt as a serious issue?

I think we’re there. I think we’re there now, Kara. Like, we go back to this yield curve. And first off, what I love about that question is there’s no clear answer. So I’m gonna try to give you a clear answer, but there really isn’t one. You know, there’s a saying in the bankruptcy world that you go bankrupt very, very, very slowly and then all at once.

And I think it’s very true when it comes to sovereign debt. And when I say sovereign debt, I mean debt issued by governments. Right? And and I’m not saying that that would happen here.

I’m not here to tell you that we’re on the cusp of some major collapse. But when the bond market is increasingly, letting you know that, sure, we will happily finance your debt, but for a price. And we’re seeing that here. And so we’re seeing the bond market raise interest rates.

Alright? Now to be fair, and my my colleague, David Krakauer, raised this not too long ago, these interest rates aren’t abnormally high.

What we’re what we’re actually seeing is a return to where U.S. government interest rates were prior to the global financial crisis. Right? And so for the past fifteen or twenty years, what we’ve actually been in is a very abnormally low interest rate environment.

Right? That was exacerbated by the global financial crisis. We pumped a whole bunch of cash into the economy to really offset a depression.

And then we had COVID, and we did it again. And so we… We’ve had this period of time where interest rates were really unusually low, so we’re seeing a return to where rates were in the eighties, nineties, and earlier in in the two thousands prior to the global financial crisis.

So one could argue that this is just a return to a normal, yield curve, but at the same time, when we look at, when we look at the federal, treasury for a moment here, our actual… Our our income statement. I’ll draw your attention to the bottom left hand side of the bar on the left, net interest.

Our government today spends over a trillion dollars just on interest payments on its debt.

That number is going to get a lot higher in the next couple of years because now we need to refinance that this debt. If you look… If you do the math here, you’ve got, you know, let’s call it $1,415,000,000,000,000 in debt that needs to be refinanced at today’s higher interest rates, and the bond market knows that.

And so what that means is that interest expense is gonna go up, and it’s gonna put a lot of pressure. It’s gonna put a lot of pain on on our spending. And so I’m I’m not in the business of telling anybody who to vote for, but the folks that we send to Washington next week when we go into the vote…

Voting booth have to begin…

You know, we need to send adults so that we can actually tackle this problem. And it will require a combination of more inflation, higher taxes, and government spending spending cuts, and that’s gonna be painful. And I know we as citizens, we don’t like either of those three things. But this is this is the world that we’re in, unfortunately, at this point this point in time.

So, Kara, you said there’s a few questions. That was one. Is there another?

Well, I think that that’s helpful context. There’s some other questions about bonds, but I think we’re gonna address it in a couple other issues. And one one of the questions that came up with one that we were submitted in advance, and I I saw the Buffett indicator on on the next question. And this was a great question from Mark. And he said the thought… What are your thoughts on the Buffett indicator exceeding 200%, and how does it impact any investment committee decision? So I know you wanted to kind of just talk about what it is, but… And then give it some context as well.

Yeah. Let’s let’s talk about first what is… First, thank you for the question. I love that question.

What is the Buffett indicator? You know, we’ve all heard of Warren Buffett, this famous investor, the Oracle of Omaha. He’s been a famously successful investor for so long, but the…

His indicator is the ratio of the value of The U.S. stock market to US nominal GDP. GDP is gross domestic product. That’s all the goods and services produced within the country’s borders, within a given year. And so, you know, the the view is, well, gee, if that gets too higher, the higher that is, then potentially we’re in a bubble or the stock market is in a bubble.

And I think that might have been true perhaps in in decades past. And, you know, I wouldn’t challenge Warren’s wisdom on this, but I really think what Warren is trying to drive at is really what is the set of investment opportunities available? What kind of…

You know, what’s the value of all the companies that we’re investing in relative to the size of the U.S. economy?

And is The U.S. economy keeping up, or are we seeing stock prices get way too elevated? Right? And you can see here that that that things look elevated if you look to the right hand side of this chart.

And I think the challenge with that thinking is that there was a time when companies would remain private for a period of time and then go public, and they would become part of The U.S. stock market. The challenge, however, though, is over the past two to three decades, really the past two decades, we’ve seen more companies’ car remain private for longer. Right? We… Remember SpaceX. SpaceX went public a few months back. SpaceX was a private company for twenty four years.

So the challenge I think with the Buffett indicator is that had SpaceX gone public, say, fifteen years ago, it would have now been included in the Buffett indicator, would have been part of The U.S. stock market. Right? And so I’m not really sure that this indicator really tells us much at this point. I think we would have to zoom out and also include the the investment opportunity set of all privately held companies that are investable.

And so I grabbed this slide here, Kara, to help answer this question. You can see this bubble here on the side, the planet Earth. You can see that that the private set of investment opportunities available to investors is about five times larger than that of The U.S. stock market. And so, again, I think the indicator…

Like most indicators, I think they’re interesting. They tell you a little bit of something about the world, but they don’t give you a full picture. And so to the first part of the…

Or the second part of the question, you know, our investment committee doesn’t pay much attention to these things. Do we follow these things? Are we aware of these things? Absolutely.

Do we make investment decisions based on a single indicator? Absolutely not. Right? Only because of what I just said.

These indicators give you a glimpse of something that’s happening in the market or the economy, but by themselves, they’re not really actionable. And so that’s where you need to do a lot more homework and understand what are the strengths and weaknesses of any given indicator and what is it really trying to tell us and do you wanna make an investment decision based on that information.

Don, you mentioned private companies and IPOs. So I’m looking forward to diving into kind of valuations and talking about that. We’ve got lots of questions about that, but I know you wanna give us an overview.

We’re we’re we’re we’re gonna get there. We’re gonna get there. Lots of great slides here today.

Valuations, since we brought up valuations, and I think this is one the things that mister Buffett is is is hinting at is, hey, wait a minute. Maybe valuations are out of control. Right? And so if we actually look at the S and P 500 index, what we’re sharing with you here on this screen is actually the valuation, the the forward price to earnings, which is at one measure.

Again, this is one indicator, Kara. There’s lots of indicators. This is one. Right? The forward price to earnings ratio.

You can see that it’s come down here. So if you look at the far right here, you can see October 13. As of October 13, it was 19.2 times next year’s earnings.

Now that is elevated relative to its history. You can see that in the middle of the screen, the thirty year average was about 17. Right? So I think that the Buffett indicator is is hinting at this, this phenomenon that, hey, wait a minute, the market is trading at a premium relative to its long term average.

And there’s a couple things I would mention here with respect to this chart. First off, if you look at this chart over the last thirty years, there were very, very few times where the market actually traded precisely at 17 times earnings, its average. Right? The average is…

It’s just that. It’s an average. Right? There’s highs, there’s lows, and there’s everything in between.

And most of the time, the market is trading somewhere in between. Okay? So that’d be my first point. My second point, you look on the right here, you’ve seen that the the value the valuation of the stock market has come down.

You may look at that and say, wait. That doesn’t sound right. The stock market’s up this year. Yes.

It is. It’s up, you know, depending on the day, 13%, 12%.

So what happened is that the e in the p e, the earnings, actually grew faster than stock prices. So valuations can come down, and this is the good way that valuations come down is when companies are doing a great job earning money, making sales, selling stuff to all of us.

And what we saw here is that the value relative to earnings actually has come down a bit. So back to my final comment answering the Buffett indicator question. This is why you wanna be really careful not making investment decisions in a vacuum, just point, looking at one indicator. Doesn’t mean that the the Buffett indicator was wrong.

No. It’s telling us that, hey, stock prices are elevated relative to the economy, perhaps relative to their history. This is where you have to do more you have to do more homework. Alright?

So just a high level overview. And, Karen, I wanna touch on bonds before we get into IPOs, but I… I’m sure everyone wants to know about anthropic and, you know, should we be getting in line to put our life savings into a into a new IPO.

In terms of year to date returns, it’s been another blockbuster year for the most part. Most portfolios have, you know, an equity allocation between 50 to 80% depending on your age and your risk tolerance and things like that. We can see that emerging market equities, these are stocks issued by companies that are domiciled in places like Southeast Asia and The Middle East and India and Africa and Latin America and and these other these other markets. You can see they they they really at the top of the leaderboard at the moment, up almost 21%.

Yes. We do invest in emerging markets at Mercer advisors. If you look at your portfolio, you’ll see that you, should have an allocation to emerging market equities. You can see U.S. large companies and small companies doing somewhere between 13 to 15% depending on the day.

So a a really great year for…

From an equity investors perspective. Non U.S. developed equities coming in at slightly less at around just under 10% returns. I mean, are great returns for equity investors by any objective measures. Now what about the bonds on the page?

We can see bonds. Bonds are negative about 2%, maybe 3% depending on the portfolio. Carol’s looking at the Mercer returns. Our bond portfolios are either flat to maybe negative about a quarter of a percentage point at the moment depending on the strategy.

That’s not all strategies. We do have more aggressive bond strategies. They tend to be less popular, those… But those strategies would be a little bit more negative than what I just what I just mentioned.

But why? Why have bond prices gone down? Well, we just talked about it. It’s because interest rates went up. When rates rise, bond prices fall. There’s an inverse relationship between the two.

And I’ve had, you know, casuals on the road for the past month speaking to many, many clients.

I think one of the most popular questions I was getting was, gee, why should I own bonds? They’re they’re negative year to date. Why should I invest more money into bonds? Because now you’re earning much higher yields.

And this really comes back to, well, why do you own bonds in the first place? And I encourage you and your adviser to have this conversation. You should be unequivocally clear on why you own bonds in your portfolio. And bonds do really, one or two of three things. And you can see here on the right hand side, we have this cute little triangle. Bonds, more more often than not are used for portfolio diversification.

Right? We have these these portfolios. We own lots of stocks. We use bonds to diversify that allocation to bring down the overall risk level in our portfolios. Diversification is about risk management. It’s about risk reduction.

So that’s why we own bonds predominantly is for diversification, but you can also own bonds for capital preservation. If you own very high quality bonds, and by high quality, I mean companies with strong balance sheets or governments that can easily repay their debt, capital preservation might be your objective. Right? So that’s why you would wanna own those types of bonds. But at the top here, you’ll see higher income.

Right? Many of us are on the cusp of retirement. We want income. Bonds provide income.

That’s the great thing about today, Kara, is that bonds actually provide income again. You and I remember being an advisor when bonds weren’t paying anything. That was no fun. That was no fun.

Right? And here we are today. You can actually own U.S. government bonds, and you’re earning…

I was just looking at the ten years earning a…

Paying a little over 5% per year. That’s pretty good. I remember when it was, you know, really, really low. And, and rightfully so, investors would question, why do I own these?

The great thing about today is that you can actually own U.S. government bonds, which are great portfolio diversifiers.

They do provide capital preservation because they’re highly liquid. They’re the most liquid bond in the world. Right? Despite the fact that we have some dysfunction, we have some challenges.

The reality is is U.S. government bonds are highly valued the world over, so they’re very liquid. So they…

They’re very good at helping you preserve capital when you own short term bonds. Think of bonds that mature over a one and a two year period, something very short. And they’re also now providing higher income. So, really, today, you’re actually a really good place.

You can actually check probably three of these boxes if you’re owning shorter term, high quality bonds in your portfolio, and that’s what we try to do, in our Mercer portfolios.

So let’s pivot a little bit. Let’s get back to equities. We touched on bonds, then, Kara, once we go through the IPOs, we’ll talk midterms a little, we’ll try to open it up for some more Q and A. First thing I just wanna highlight here is, look, market leadership changes.

Many of you have seen us walk through this slide before. We have two new companies here, the orange over here on the right. These are these are the top companies in the in the S and P 500 index. Why am I sharing this with you?

Sharing this with you just to remind you, do not fall in love with any companies in your portfolio. They will not love you back. Things change. Right?

So that’s the whole purpose here. Just keep that in mind. I know we have new companies coming to market, new IPOs. We’re gonna touch on SpaceX here in a moment.

But these companies, the leaders in The U.S. stock market change from decade to decade to decade. And what you want to do is always at all times maintain a well diversified portfolio instead of trying to chase the market’s big winners. That is usually a recipe for, financial ruin. So we wanna be very careful, with doing that. The magnificent seven, we’ve all heard about these companies.

Why am I sharing this slide with you? I want you to look at the right hand side of this slide.

What we’re showing you here is the returns on the the magnificent seven companies like Nvidia, Meta, which is Facebook, Tesla, Amazon, all the big winners from the AI trade over the past several years.

And what you’ll see is that the returns were highest in 2023, and since then, they’ve come down. They’ve come down dramatically to that green perforated line that you see there in the middle. And you may be thinking yourself, well, wait. How can they… How comes their returns aren’t just as spectacular today as they were several years ago back in 2023? And if you look at the bottom left hand chart, your question is a good one because earnings… Look at those green bars. The earnings for these companies have been amazing relative to the broader U.S. stock market. And the answer is this, is that these outlandish earnings, these crazy high earnings that these companies are reporting, all of that was baked into the price several years ago.

Right? And this is an important point is that stock prices already take into account the future.

They’re already baking into the price higher earnings in the future. You’re paying for it. So for example, Anthropic, a company that has just filed to go public, has argued that they have an addressable market, you know, they’re trying to explain to their potential investors how big their opportunity set is, of $40,000,000,000,000.

Geeks like me actually read this stuff. $40,000,000,000,000. That’s bigger than The U.S. economy.

And so if indeed investors accept that as truth and say, okay, Anthropic is right, that’s gonna be baked into the price when it goes public. Alright? So just keep that in mind. When these companies go public, they’re oftentimes priced for absolute perfection. These AI companies back in 2023, the reason they had spectacular returns is the market priced them for perfection. And so a lot of these great returns, the earnings calls that we’ve had here over the past year, all of that was baked into the price several years ago. I do wanna touch on AI.

AI, as you can see here on the left hand side, you see this bar chart, it’s just going up into the right. It’s gonna go all the way to the moon. These are all the data centers that we ultimately are gonna be building. These are the gigawatts that we need to produce in order to fuel the demand for AI. I mentioned earlier that AI companies are borrowing a fortune from the capital markets to finance this AI infrastructure build out.

That’s comp… That… That’s one of the things that’s ultimately pushing interest rates higher. One other thing that I’ll just touch on is that the energy consumption necessary or I should say production necessary to fuel the AI economy is also likewise off the charts. And it’s coming at a time when the AI portfolio of The United States is… Has changed dramatically.

And I’ll draw your attention to this pie chart down here. These are the additions, the bigger pie chart here. These are the new sources of energy that are coming online, and you can see 50% of that is solar. You can see natural gas, 14% wind at 8%.

Things like…

You don’t even see coal on this particular…

Or petroleum really here. That’s probably the 2% here on this particular chart. Very, very minor. So the old world of using coal coal, if you look at the right hand chart, coal is that that Gray Mountain, and you can see that Gray Mountain is in a steep decline relative to these other sources of energy.

So accompanying this build out of data centers needs to be a heavy investment in energy infrastructure, and we’re seeing that. We’re seeing heavy investment in things like solar and wind, also natural gas and things like and things like that.

But, Don, before we move move off of AI, when we’ve been talking about this, by far, the most questions that we got are are about AI. And so I’m seeing questions from John and Hank and Gary just about literally this. Has the AI bubble burst?

Has it burst? Well, there’s a lot in there. So one, I don’t know that we’re in a bubble. Right?

We can debate that. There’s lots of debate around that. I will say that I think prices are pretty elevated. Like, these companies are priced for perfection, but they may actually just deliver on it.

Right? We could actually see these companies actually stick the landing and actually do a good job.

I understand that investors look at this technology boom, and it feels a lot like the late nineties. I feel that.

That there’s… But there’s some big differences. These companies, are actually profitable in that they are growing their consumer base.

In the late nineties, many of those companies didn’t even have, like, meaningful clients. They didn’t have meaningful revenues. They certainly were not profitable.

Has it burst? We are starting to see… In fact, there was just an article today, I think it was in Bloomberg, showing the breakdown in correlations across different companies within the AI sector. Right? I think they were focused on the mag seven. And so what you’re starting to see is there’s gonna be winners and losers, certainly, right, to to to the question.

There will be winners and losers. You’re gonna see some companies do amazingly well. Think of Microsoft. Right? Late nineteen nineties, that was an Internet company. And today, Microsoft has been an outstanding company for the past thirty years. It’s delivered great returns to investors.

So I think you’re gonna see companies like NVIDIA perhaps. I I don’t know this for sure, but NVIDIA perhaps continue to do well and perhaps be a winner. And you may see others, and I don’t know exactly who they are. But CoreWeave was one that has run into trouble that are ultimately going to perhaps not fail, but maybe be acquired or get delisted and go private again.

So I think you will see winners and losers. When does this quote burst? I can’t tell you that. If I could, I’d I’d short every one of them.

Right? But I can’t. What I will say is it’s gonna get harder for them to execute on their business thesis if their cost of capital increases, which in English means if their if their borrowing costs continue to rise, it’s gonna be harder for them to build out all of those data centers that they’re fighting with local communities to build. Right?

Because it’s just gonna be harder. They’re not gonna raise the money. In fact, there was another article today, think it in the Wall Street Journal, actually talking about how difficult it is now for these companies to raise money in the bond market. It’s getting harder.

And so I think eventually you’re gonna see a bit of a reset here. I do think prices are probably frothy, but a reset is not a crash. I’m not exactly sure how to define a crash. Is it 20%?

Is it 10? Is it 50? But to be fair, I do think you see a bit of a reset here given these higher interest rates that all companies have to deal with.

And maybe just secondarily as a follow-up, we’re getting a couple of other questions about the overall economic impact or what your outlook on AI specifically.

John is mentioning that Microsoft announced that there was a separation package because they are hoping to offset the cost of the employee with, quote, AI benefits. And what… What’s your view on how that may affect economically via AI?

I mean, I I I think it is true that any any decline in AI investment will certainly negatively impact the economy in two ways. One, as the question highlights, you could see layoffs. I And think that’s one of the concerns is one among tech companies that are investing enormous sums of cash in building out their AI infrastructure needs to come from somewhere. So perhaps they start terminating employees to raise the money they need. If they can’t borrow money from the bond market, they’re gonna raise it from themselves, which is code speak for we’re gonna fire people, and we’re gonna put money into building, you know, data centers to, you know, keep it simple. So that’s, like, one place where I think you see some friction.

I think you could see AI negatively impact other companies that perhaps don’t need to hire as many workers because now they’re more efficient. Right? Or maybe they start laying off workers because now we, I don’t know, have robots at McDonald’s taking our order or something like that. Right?

I do think that there’s another big negative economic impact in the terms of the actual construction of all these data centers. Right? The AI investment arguably has really…

Is one of the key reasons why The US economy has remained, GDP growth has remained positive here over the past couple of years. And when you’re building these 500 acre data centers in the middle of Pennsylvania, well, that does create jobs. Right? And and you’re you’re you’re purchasing construction materials and computers and servers, all kinds of things.

So if these companies are no longer building as many data centers because they can’t borrow the money in financial markets or perhaps because they’re running into zoning challenges now locally, they’re getting local pushback, at least here in my my part of Pennsylvania. What what you’ll see is they’re they’re not gonna be able to build all of these data centers, and that naturally is gonna negatively impact the economy. So I think all of that is certainly true, that if we see a a slowdown or if these companies begin to decline in value, that those things naturally are going to negatively impact the economy.

That’s helpful. And you mentioned a bunch of IPOs and Anthropic in particular, so maybe we can talk about your view on those.

Yes. So our view on this is patience is a virtue. This this whole section, if I could retitle it, it would just be patience. Patience. Patience.

Anthropic, I think, is an amazing company. We use an Anthropic product. We like the product. We use Claude at Mercer Advisors, and it’s it’s amazing. I I often refer to Claude as my favorite intern.

And, great product, still needs to be carefully supervised, alright, and audited to make sure that it’s accurate because it’s not always accurate. But I think Anthropic is an amazing company. But just because Anthropic is going public does not mean that you should knock down, you know, the barricades, drain your kid’s college fund, and put it into Anthropic stock. Please don’t do that.

Alright? The vast majority of IPOs, six months after they have gone public, have delivered abysmal returns to investors. And so I’m just sharing with you the data. Right?

You you don’t have to believe me. Right? I’m just sharing with you the data. When you look at IPOs, those companies do not perform well as a group over the first six months that they are publicly traded.

And so I would just urge caution, especially if Anthropic goes public, they’re gonna be here in six months. You can buy it later. Right? There…

You should not be in a rush to buy it now.

And I figured we would look at SpaceX because the last time clients were kicking in my inbox begging for SpaceX for an IPO was when SpaceX went public back in June.

And lots of folks cowered. They were in a rush. They couldn’t wait. SpaceX priced at $1.35 a share, but its first trade in the open market didn’t transact until it hit a $150 per share. So that was the first time that any investor in the public market had an opportunity to buy SpaceX. It quickly rose to $225.64.

Many investors piled into the stock at $202,125 dollars a share, and it has since actually come down. And you can see that it it fell quite a bit here.

Right? So, I mean, if you pay 200 a share, I mean, you’re you’re down 40, 50% in mid July, late July.

If you look at where we’re at today, the stock is still down eight percent from when it first went public. So patience is a virtue.

Just wait. Let all of that pent up demand that’s in the system, let it flush through the pipes. Let all those folks go in front of you. Let them bid up the price.

And after that price retreats and comes back down, when the market realizes, wait a minute, their addressable market, how is it $40,000,000,000,000? The U.S. economy is $32,000,000,000,000. Right? So there there will probably be a time when that stock would come back down to earth.

So so our advice to to investors is always take your time. Your time. Don’t be in such a rush. Investing is one of those few exercises where rushing nine out of 10 times is gonna burn you.

Don’t rush. Take your time. Patience is a virtue. Have a plan. Talk it through with your adviser.

Figure it out. There… There’s there’s no reward for being in a rush to buy any individual individual stock.

Before before we move on from IPOs, Don, I’ve got a question from Tom, particularly about Anthropic and the IPO. It had the document that was released yesterday at ninety pages of risks that they could encounter, and some of them were very dramatic. Got it. So if you purchase shares in Anthropic, how much liability are you taking on as a shareholder if some of those risks come to… I mean, hopefully, it doesn’t end humanity.

But that’s… What…

Should you… How should you think about that as a potential investor when all of these things are listed out?

So, I mean, if if indeed, which is one of the risks that Anthropic highlighted is, you know, existential risks to humanity, like, that’s eyebrow raising. And if it’s not, it should be. Right? I I wanna be here.

But, you know, you know, one way to think about it as well, there wouldn’t be any trial attorneys. So so, you know, you probably wouldn’t have any liability if there’s no courts. But what…

But in all seriousness to the question, when you buy stock in a company, your liability is limited exclusively, entirely to what you pay to buy the stock. Right? So these…

This is a whole foundational tenet of U.S. corporate law is this whole concept of limited liability. Right? So when you provide capital and you buy stock in a corporation, you are by law, your liability is limited. Right?

So if I bought stock in a company, Anthropic, right, or I think…

Let’s let’s use ExxonMobil when Exxon had the Exxon Valdez oil spill for for those of us who can remember that. They had enormous liability. Right? But the shareholders didn’t…

You know, we weren’t pulled into court. Now what did happen is the value of our shares got hammered rightfully so because the corporation had to fork over cash and, you know, pay for cleanup, but also pay penalties and and reimburse all the fishermen and all the communities that were harmed by that by that incident. So the the share price will decline, but our liability personally for the rest of our balance sheets, we are not liable for anything that a corporation corporation does. Right?

So in the event that Anthropic, for example, has a model that inflicts harm on a…

On another business or a community or something like that, our liability is limited to what we pay…

What we paid for the shares.

Right. Well, let’s hop into the elections. That’s the other hot topic on questions.

Alright. I always leave this one for last because this is the one… I was looking for a shirt that had blue and red, but I I don’t have any blue and red shirts. Just blue and green. This is my University of Michigan shirt.

So midterms. So many folks are asking me what happens if this party wins, that party wins, and couple things I would just highlight. First off, we all want to believe that our chosen political tribe has all of the answers to everything that ails The US economy and the stock market.

News flash, they don’t. Alright? Neither party has all the answers. Alright? So I would just urge everyone to just, you know, take a deep breath, hit the pause button.

Politicians, their job is to get reelected. Their their second job is to get reelected again. Right? That’s what they do.

So just just hit the pause button there. What I think is really important for all of us as investors is to keep in mind that regardless of who controlled congress, whether who was in the White House, The U.S. financial markets over time have gone up regardless of who’s been in the White House.

So I don’t care if you’re a Democrat.

I don’t care if you’re

a Republican.

The reality is markets work. The US economy works. Capitalism, it needs to be regulated and monitored, but capitalism is a good thing. Right?

Free markets are a good thing and it works. It it creates enormous wealth for investors over time. And I know a lot of folks don’t always believe me on this one. So I figured, okay, let’s just look at some data. You guys know I’m a data junkie. Let’s look at the numbers.

And if we look at the top here, the top here is the returns on the S and P 500 index, what we call the price returns. And what we did here is we broke it out between Republican, Democrat, and divided government. And you can see here that the Republicans have been better, quote, unquote, for the stock market than the Democrats. Okay.

But it’s not like the market did bad under Democrats. It was up 9.3% on average. That’s pretty that’s pretty good.

I’ll take it. Right? Thirteen’s better, though. I like 13.

And then… But if you look at the bottom, what you’ll observe is that… But wait a minute. Well, who’s better for the economy?

Well, you’ll see that the economy has grown more under Democrats when they controlled government than Republicans.

So who’s right? I don’t know. I think it depends on what you value. Do you think the economy is more important than the market, or is the market more important than the economy? I think all of this is baloney, and that’s because you cannot convince me that, for example, that the current administration is the same as, for example, the George w Bush administration. So if look at the current administration, the current administration has levied tariffs. The current administration has purchased, equity stakes in many U.S. companies using taxpayer dollars.

That… Those ideas would have been heresy to establishment Republicans. Think of the Mitt Romneys of the world, the George Bushes of the world, the new Gingriches of the world. Right? Those folks were typically free market types, anti tariff types. If anything, it was the the union democrats from, like, the eighties and the nineties that would have been pro tariff. My point is this, is that the people that you think are republican today could have easily been democrats in the past and vice versa.

If you look at John F. Kennedy, somebody that I think most Americans hold in high admiration, he was a Democrat. By today’s standards, I would argue he would have been a Republican. Right? He argued for cutting taxes. He wanted to bring down the 90% marginal tax rate.

My point is, like, these parties have switched sides so often when it comes to their different policy prescriptions. So it’s hard to know whether one party is objectively better than the other, and I would argue they’re not.

Certainly not when we look at the data. One other final point that I’ll leave us with, two… Maybe two final points, Kara, on this, is that we need to remember that Americans typically historically have preferred divided government.

And we need to remember that when we build… When we draft legislation in this country, historically, it’s been a very bipartisan exercise. It’s that sausage making exercise. Right? So, typically, when you have a policy that comes out of Washington, things have been a little bit different the last two years because Republicans had full control of government.

But most often, it’s a sausage making exercise. There’s some horse trading. Right? So we need to keep in mind that, you know, still gotta get…

You know, has to come out of the house, needs to get through to the senate, has to get onto the president’s desk, and then the president needs needs to sign it. I’m getting a lot of questions. What happens if one side wins or if there’s a blue wave, if the democrats wave? The first thing I would say is there’s no way the democrats are gonna get a veto proof majority.

I don’t see…

I’m not a I’m not a political expert, but at least all the political experts I follow, it doesn’t sound like they’re gonna have a veto proof majority.

So what does that mean? Well, I think we have divided government for a period of time. I I think it’s just gonna be really hard to get any new legislation through through congress. So what do we do with all that information as investors?

Nothing. You work with your adviser. You build a well diversified portfolio. Make sure you understand, you know, where interest rates at, what should your bond part of your portfolio be doing for you in terms of preservation income or diverse…

That’s what you should stay focused on.

You guys have heard us say this many times before, do not mix. Do not mix politics and investing. I don’t think that that’s gonna bode well for us if we do that. So…

Don, I’m seeing a lot of comments about what will the market reaction be to elections? And I’ve heard I’ve heard you tell this story before about watching the Bloomberg terminal after the twenty sixteen election, and maybe that would be some helpful commentary.

Yes. I mean, I think the twenty sixteen election was probably the most memorable for me in in recent market history. I was up all night, and and, you know, it became clear that president Trump had won the election, and the market had cratered. Right?

At one time, it was probably around four in the morning that Dow Jones was off over a thousand points. And so I had my Bloomberg terminal up, and I’m watching the market. I’m thinking, oh, wow. Tomorrow’s gonna be a rough day.

And it was shortly after then, I think it was maybe around 5 a.m. when Hillary Clinton conceded the election.

And I thought, oh, wait. This is interesting. And the market rallied, and it would… It it totally, gained back all of those losses and then actually went on to post spectacular gains.

And I would off…

The next day, would hear people say, well, that’s because the market was pro Trump or anti Hillary or whatever the case was. And I said, no. No. You got it all wrong.

What the market wants is certainty. The market wants stability. The market doesn’t really care who wins. What it wants to know is that the rule of law is firmly intact and that we’re not gonna have a constitutional crisis in this country.

And I think as investors, that’s what we should focus on, at least as investors. I’m not telling anybody how to how to vote.

But that I think was the takeaway, and I thought that was really amazing. Because at first, if you’re looking at my Bloomberg terminal and it’s all over CNN that president Trump won the election and the market’s off a thousand points, your first reaction would have been, oh, Trump must be bad for the market.

Not at all. What the market was worried about was a contested election. And when Hillary conceded the election, the market was back off to the races. And so so that’s my takeaway, Kara. Like, when I look at the data, when I think about investing relative to politics is we’re just looking for a set of rules that aren’t constantly changing, and we’re looking for stability.

Great. Alright. Did you did you have some takeaways that you wanted to cover?

Yeah. I think we can touch on these, and then let… Let’s open it up in the few moments that we have. But, you know, many of these I’ve touched on. The US economy continues to grow. Valuations have come down. So despite concerns that we all have around valuations, they’ve they’ve come down again. These are these are good things.

Diversified portfolios have performed very well again this year. I mentioned emerging markets. I mentioned those small company stocks, including those in an equity portfolio. That’s been a very good thing.

And so that’s… That remains, Kara, our advice to investors, build highly diversified risk managed balance sheets so that you can achieve your goals over time. This point four, I know that bond returns have been flat to negative.

You have higher yields now. This is this is when you really need and want to own bonds. So if you’re looking for that higher income, 5% yields are pretty darn attractive, and I would encourage folks to have those discussions with your advisors. Talk about your bond allocation, and we should be looking at the forward expected return on all investments, but certainly today on bonds.

And then last but not least, politics and investing don’t mix. I would try to keep those out of the ballot box. Keep your portfolio out of the ballot box. And certainly, everybody…

Would encourage everybody to vote, but keep your portfolio out of the ballot box.

Hope those are all useful. Looking at some of the questions that are coming in, you you touched on interest rates. And Rachel’s asking, what are your thoughts on the housing markets and mortgage rates going forward given what we’ve talked about interest rates?

So mortgage rates will probably begin out… Stay elevated. So those mortgage interest rates are are gonna be a damper on demand. Right? So you’re not gonna see folks rushing out to buy homes.

But there’s lots of other headwinds for residential real estate. Just the price of construction. Right? Lumber and and wiring and all these things right now, home prices are pretty pretty elevated to to begin with.

You know, we don’t have the immigration that we had previously. So for homebuilders who…

That’s who you would look to to bring more supply into the market. More supply would bring down prices for new families or new homeowners. They don’t have the immigrant labor that they used to have. And so what that means is their labor costs have now also likewise increased plus lumber, plus wire, plus everything else.

And here’s the other thing to keep in mind. All of that needs to be shipped in on trucks. Right? Think of those big tractor trailer rigs that burn lots of diesel at $7 a gallon.

So all of those expenses are really putting the lid on supply. So the demand side is really squeezed because you have high interest rates, but the supply side is constrained because it’s just so unbelievably expensive right now to build new to new new construction. And so, you know, I think, unfortunately, for the foreseeable future, it…

I’m pretty bearish on residential real estate. It just doesn’t look attractive, and, that’s sad to sad to say, but that’s the situation that we’re in at the moment.

Maybe one last question on interest rates. Dda is asking. So these potential interest rate changes, whether the Fed holds today, but they’re definitely gone up. Have we made any adjustments in our investment strategies on the fixed income side because of those changes?

We have not yet. Alright. So, and I was gonna be careful. I’m not allowed to tell the whole world what we’re gonna do when we get ready to do it. So, we have not yet. Now the Mercer portfolios, we’re actually pretty well positioned coming into this higher rate environment because if you look at the Barclays AG, which is the S and P 500 equivalent of the bond market, that has a a a a… An average effective duration somewhere around six and a half to seven years.

Our portfolios were short, shorter than that. So we tended to be somewhere in the, call it, mid fours to low fives depending on all of the different portfolios, depending on which portfolio we’re talking about. So we are generally shorter duration than the market. So in English, that means that we’re more conservative and higher quality than the broader market.

And what it also means is that we’re relatively in a better position to weather increased interest rates than, say, the Barclays ag, the the broader the broader market. Now given that rates are rising, I know one of the things we have to discuss and pay attention to as an investment committee is, well, wow, if these rates get really, really high, we should extend duration, which means we should try to capture as much of those higher yields as possible in the form of income in our portfolios. Right? So as the as the return…

As the compensation increases, we’re gonna wanna try to capture some of that for our investors. And so, I would never advocate market timing, but there will come a time when it makes sense for us to extend the duration perhaps out to where the market is or maybe even a little further to try to capture those those higher yields. I don’t think we’re there yet, honestly, at the moment, but I do…

I could see us getting there at some point if we were to see interest rates continue to rise.

Great. Well, I always like to end with asking you a fun sort of actual life question. So we’re we’re headed into Halloween this weekend. I know that that’s a that’s a favorite holiday in your family. So if you think back to your kids growing up, were there ever favorite Halloween costumes that come to mind immediately?

Yes. I think when when our daughter was about five years old, she dressed up as the itsy bitty little spider. And to this day, you know, when I see that picture on the mantle, it… I think it brings a tear to my eye just seeing this little peanut dressed up as a spider with these big creepy legs.

You know? So I I would encourage all of our listeners, you know, if you have kids or grandkids, nieces, nephews, take lots of pictures.

Take lots of pictures. They’re the pictures. They’re they’re the pictures you’re gonna remember as you get a little bit older and your kids are no longer trick or treating. Yep. Yeah.

Always

fun to have a have a focus on the things that are very meaningful in your life.

And for all of our listeners, this this broadcast has been recorded. We will be posting it on our website at merceradvisors.com. You’ll find it in our insights tab. There’s a place for all of our quarterly webinars.

We’ve also recorded all of the questions that you’ve submitted. I always have so many more than we’re able to answer during this hour. So if we have your name, they will be forwarded to your adviser to have follow-up for that. So please continue to speak with your wealth adviser and continue this conversation.

So thank you so much, Don.

Thank you, everybody.

Take care.