Footnotes – December 2024

Footnotes is a monthly publication which summaries our “First Friday” webinar presentations each month.  The goal of the Footnotes publication is to capture our “First Friday” presentation’s most important data points, which will make it easier for The Abernathy Group Family Office members to make intelligent decisions based on facts and data – as opposed to potentially conflicted opinions from the mainstream media.

Click here to view the corresponding First Friday Video

As a short reminder to each Family Office member, The Abernathy Group Family Office has now sponsored 20+ “First Friday” webinars.  All of them are available on our website and “YouTube” Channel if you would like to go back and see how we have interpreted the economic signals, while doing our best to cancel the noise over the last year plus. Our goal: to help you spend less time making intelligent financial decisions, by focusing on causal, predictive data (signals); and ignoring the clamor of biased, irrelevant data (noise).

Commentary from the December “First-Friday” meeting:

Steven Abernathy:

Today’s Presentation is titled “2025 Economy, Valuation, Geopolitics.  What’s Next.” 

This month we want to spend our time together by taking a look at three of the most important variables which determine each family’s investment allocation. 

Slide 2

We will start by taking a shot at understanding what investors might expect from the new administration entering the White House in January. 

This was the most often asked question – and for good reason.  New administrations tend to make many promises.  These promises tend to engender incredibly lofty expectations. 

Over time, however, reality sets in.   The realization that most of the promises are unobtainable.

I am not trying to be a glass-half-empty analyst; it is just that over the last two hundred years, we have seen this movie before and despite the best intentions of each new administration, the results tend to be less impactful than the campaign’s promises. 

However, the administration set to move into the White House in January has promised actions that could change the course of the U.S. for the better in our opinion.  Slashing the incredibly bloated government in the U.S., implementing an immigration process that requires all immigrants to properly register for citizenship, streamlining U.S. regulatory over-reach, sending educational decisions back to the state level, taking advantage of our natural resource wealth, and reducing our reliance on the rest of the world by bringing back strategic manufacturing capability to the mainland U.S. and to those countries aligned with democracy, seem to be intelligent objectives. 

With that said, let us bring in Matthew Daley to give us a few prepared remarks which will hopefully help each of us create reasonable expectations about the future of our U.S.

Matt, given the good intentions of the incoming administration, would you do your best to give us a realistic overview of what is obtainable and what is unlikely to be achieved during the next 4 years? 

Matt Daley:

We have said every month on the First Friday Meeting for the past 4 or 5 months that history shows a new president has little to no effect on the overall health and trend of the economy.  This hasn’t changed.  However, we do want to acknowledge certain unusual aspects of the incoming administration, identify some events and actions that could take place, and discuss briefly what ripple effects or consequences could affect markets.

I think it is a fair statement that some recommendations of the new administration, the people involved, policy projections, and potential actions that have been proposed could be considered unprecedented.

We also have a fair amount of evidence from Trump’s first term of what his actions may be like.

For investors, I think constructive advice regarding most aspects of the administration is to not be reactive; remain patient and see how things shake out.  I don’t think it would be wise to take every announcement as something that is going to happen, and I don’t think the effects overall will be as drastic as the words.

For example, we know that Trump uses threats of tariffs and threats of sanctions or even direct hostile action as deterrents and/or bargaining chips.  We should expect more of this in the upcoming 4 years.

If the people who have been nominated for cabinet and advisory positions are confirmed, significant changes may be on the horizon.  Americans have little trust in U.S. government.  Substantial changes are often painful in the short term, yet if executed with the right ideas and intentions, they could result in greater returns and market efficiency over a longer period.  

Regardless, the proposed changes will lead to either increased or decreased trust.  It is likely that information will be released that is uncomfortable for certain government officials, agencies, and private companies or industries.  For example, things related to covid and the media’s response, the pharmaceutical industry’s activities and communications, our military-industrial and intelligence apparatus, the food and beverage industry, the mingling of money and politics, government corruption and inefficiency, and more.

Virtually all that we mentioned here have the opportunity to cause short-term movements, higher or lower, and we believe it is reasonable to expect short-term volatility which could be initially painful in pursuit of a more effective U.S. government.

Thanks Matt –

Next, we will take the temperature of our U.S. economy, as the fate of our economy tends to influence both the short and longer-term performance of our investment portfolios.  After that we will spend some time on the valuation of publicly traded assets because current valuations determine long-term investment results.  We will follow this discussion with a short look at the geopolitical landscape and what has changed since our last online seminar. 

Slide 3

First – as always, we want to discuss the data – as current data combined with historical experiences tend to be reliable guides and form the foundation for future expectations. 

Slide 4

We often start our analysis with research that focuses on leading indicators – as signals for what lies ahead.  We want to note that no signal is a guarantee of future outcomes.  Yet, focusing on signals as opposed to noise – will help create much more valuable expectations. 

The leading indicator index combines several of the most reliable variables which tend to lead economic activity – for instance, variables including applications for new building permits, new manufacturing orders, and the yield curve (which describes the ability for businesses to borrow money at realistic levels or not) all offer descriptions of events which often lead to economic activity. 

In short, the leading economic indicators (LEI) are dependable – yet not a guaranteed signal of our future economic activity.  

Slide 5 

Here is what the LEIs are telling us about our economy.  These data are through the first quarter of 2024 and show that our economy is moving along well after being in the doldrums for almost 2 years of forecasting a recession.  This is good news. 

As each of you know, the LEIs have been telling us to expect a recession for the past 2 years or so.  A combination of the incredible amounts of stimulus pushed into our system by the administration in Washington and an always resilient U.S. consumer may have helped the U.S. avoid a recession in 2024.

Slide 6

Let’s take just a brief moment to notice this is only the second time in the last 50 years that the LEIs have signaled a recession, yet none arrived.  We believe our U.S. economy remains habitually dependent on deficit spending by the U.S. government and/or the U.S. Federal Reserve.   

As said, the LEIs are fine signals, yet as in life, they are not perfect.  This slide points out the two episodes where the LEIs indicated an economy poised to begin a recession, yet a recession did not follow.  Both instances (the early 1980s and 2022) where the LEIs offered a “false-positive” seem to have little in common.  In short, there appear to be few similarities in the two instances the LEIs offered a false signal, and thus little to learn other than a reminder that there is “never a never,” and “never an always” when dealing with markets driven by a component of emotion.

Let’s take another moment to look at the statistical data from another angle.  This is a perspective created by Eric Basmajian, an intelligent and diligent economist.  Eric’s insights are always worth being aware of and he can be found at (https://www.epbresearch.com/). 

Slide 7

Eric has put together a series of charts which show the time progression of each relevant indicator most economists watch.  This is important from a timing perspective, as many of the actions imposed on our economy by the U.S. Federal Reserve tend to have lags in their impact.  Sometimes these lags can take as long as 2 years or more before creating the impact desired by the U.S. Federal Reserve – and as each of us knows, a lot can happen/change in two years. 

Important: Here is how to read the charts above. 

The green bars indicate the data from 24 months ago.  The yellow bars indicate the same data 18 months ago.  The light blue bars indicate the same data 12 months ago, and the red bars indicate the same data 6 months ago.  The dark blue bars indicate the data from September 2024 and represent the most recent data.  In summary, this chart shows the researcher a time-varied progression of each of the 4 major indicators.  Time-varied progressions tend to offer information about current momentum and thus, more often than not, offer leading information.

What are these indicators? 

On the left, you will find the five bars which represent the components of the LEIs at 5 different points in time – each bar getting closer to the current time.  The LEIs consist of leading indicators like new manufacturing orders received, new building permits issued, and the yield curve – each of which tends to offer a reliable signal as to what lies ahead – yet is not a guarantee. 

On the second group of bars from left, you will find the Cyclical Indicators.  Cyclical Indicators describe the economy as if it is emerging or just beginning to develop.  The cyclical components of our economy may be the most important variables to follow after understanding what the LEIs are saying.  The reason?  The cyclical economy includes residential construction, manufacturing employment, current overall employment, and current production statistics, among others.  All variables tend to continue once put into action. 

The third group of bars from the left represents the aggregate data from the U.S. economy and gives us a similar data point as our GDP data – meaning all of the many dissimilar categories of data are mixed into this category titled Aggregate Economy.  These data tend to be coincident data points at best and at times may offer slightly lagging information.

In the last section, we call the lagging indicators, and they cull together all of the indicators like the services and consumption data – or everything that is an output of the aggregate demand.  These data describe what has already taken place.  They tell us how our economy actually performed over the last period – hence these data points are lagging indicators. 

Slide 8

Here is what I want to show you.  The red circle shows you that there is weakness beginning in September 2024. 

We do not know whether this weakness was the beginning of a downturn, or whether it was a one-off, yet you can see the trend over the last 24 months has been slowing as the height of the green bars moving to the right all the way to the dark blue bars indicates a slowing economy – and it’s worth watching.

Again, these indicators are sending us mixed signals.  In aggregate, the U.S. economy tends to be in decent shape.  However, economic activity is slowing – there is no question about this. 

Yet no one knows whether it will slow to the level of tipping us into a recession – which every member of the U.S. is hoping to avoid, as recessions create larger spending deficits and increase the economy’s aggregate debt – which is far beyond record levels. 

The crucial point to remember is that overly indebted economies are far more volatile than economies with little or no debt.  As we have said many times before… leverage tends to make good events great, and negative events disastrous.

What are the current expectations already priced into the market today? 

This is important for each intelligent investor to consider.  The reason?  Because current valuations describe the market’s expectations and define the base case.  The base case says – if current expectations become reality, there will be no depreciation and no appreciation – as the base case defines current expectations. 

So, what are the current expectations?  Are expectations realistic?

And what do current expectations tell us about what is likely to come? 

Slide 10

In 2025, earnings are projected to grow at almost 15%.  How realistic is this? 

We believe it’s unlikely.  

Earnings over the last 100+ years have been growing at a bit less than 4% per year.  This does not mean we can’t have some years in which earnings grow at 15% or more.  It is just that as we showed in prior webcasts, we have been having earnings growth of 9% or better for several years now.  This remarkable period of unusual growth was fueled by lower corporate tax rates and lower interest rates.  Both of which created profits that fell straight to the bottom line, providing the springboard for this above-average growth.  In 2025 and beyond the gifts of lower tax rates and lower interest rates are unlikely to be available to provide the same level of stimulus as in years past. 

Slide 11

Current expectations also call for inflation to come back down to 2%, or nearly 2%. 

In short, the expectations are describing a perfect landing – and one we all want to see happen… While perfection is the desired outcome, for most intelligent investors perfection is not the base case. 

Slide 12

To add fuel to the fire, here are the expectations built into current prices for the next 5+ years. 

As you can see the current prices are expecting earnings to grow at over 7% per year for the next 6 years or so.  AND they are pricing in no recession over the next 6 years.  This is great, yet incredibly unrealistic.  No recession – when recessions tend to take place every 3-5 years?

I am not trying to be a negative analyst.  It’s just that when assets are pricing everything for perfection, there is little to no upside left… and everything has to go right – or the downside is significant. 

To us, this describes an unattractive investment offering.  Make note: unattractive valuations combined with highly leveraged marketplaces are NOT to be used as market-timing mechanisms.  These conditions can persist for longer than most expect, making rational, intelligent investors look stupid for as long as conditions exist.  However, history clearly shows that periods of irrational expectations combined with over-leveraged marketplaces end up making those categorized as stupid – for not indulging in the silly fool’s game – look like intelligent oracles in the end.

Slide 13

To illustrate my point, let me show you a quick chart put together by our friends at Zacks Research.  This chart shows the progression of earnings estimates when they are first made.   It then shows the reduction process Wall Street is famous for, over the next several months, to get to an earnings growth estimate that is closer to reality. 

This shows Wall Street’s magic of overly optimistic expectations at its finest…

As all of you know that have been investing with us for the last 40 years, we are not fans of Wall Street’s consistently overly optimistic expectations.  We believe they have, and have always had, an incentive to tell you the best news possible and then let reality set in.

Where are current valuations relative to recent historical valuations? 

Slide 14

Slide 14 shows you current valuations relative to historical valuations.  This chart clearly shows that in almost every dimension, current valuations are excessive.  Current valuations based on elevated earnings leave little room for reduced earnings expectations. 

Let us check another indicator which is flashing red.  Margin interest – is another form of increased leverage.  Throughout history, margin levels, when at extreme levels indicated excessive speculation. 

Speculation tends to end badly.

Slide 15

Slide 15 shows you that not only are valuations expensive – leaving investors who own public equities little room for appreciation, it also shows that speculation – defined by owning securities on margin – is at, or near, record levels.  The reason I am showing you this chart is that when highly priced assets are mixed with speculative leverage, outcomes become leveraged both good and bad. 

While most of us would readily welcome the good outcome on leverage, none of us would welcome or even survive a leveraged outcome that is negative… it is for this reason that we offer caution and temperance when considering your risk levels. 

Slide 16

Here is a slide – courtesy of one of the most noble analysts in the financial community – he lives in Oregon and has retired, leaving the financial community years ago in favor of growing thousands of acres of trees. 

In short, he has no bias to sell anything.  His website is free.  He is as smart and levelheaded as anyone I have met to date.  Here is a link to his website for those of you who value intelligent, unbiased analysis. 

This chart was put together by taking the current valuations of public securities at the beginning of Q4 2024 (the market is even higher now) and applying three different price earnings multiples to them based on historical earnings levels. 

This analysis used reversion to the mean to determine how stocks are likely to perform over the next 5, 7, 10, and 20 years if we revert to the mean.  Keep in mind that the returns on this chart are in nominal terms (meaning they include inflation). 

In short, they are not real returns (meaning in order to get “real returns” you would need to subtract inflation from the three columns titled “Ending P/E Ratio” on the right of this chart).

This chart, and others like it, create a realistic picture of what stock market investors should expect from investments made at current levels. 

It is easy to see why our Family Office has opted to focus on the value-based components of the market.  It is also easy to see why we have opted for value-based companies with significant dividends that deliver returns while we are waiting, and most increase their dividends each year in excess of inflation. 

If you would like to discuss any of the math or logic used in creating this presentation or outlook, please let me know – we are glad to share it with you. 

Slide 17

Last month we spent a full session on the geopolitical dynamics confronting us today.  Let’s take a few minutes to discuss what might change under the new administration. 

Keep in mind – every forecast at this point is mixed with a reasonable degree of speculation.  We have tried our best to sort through the unlikely objectives and discuss some of the topics you will not hear from the talking heads on TV and in the press. 

For this I will turn it over to Matt with my first question. 

Matt – what movements are taking place that seem to be bifurcating the world as we know it today – and are they likely to continue? 

Matt:

The immediate top-of-mind concerns for everyone are the hot conflicts between Russia and Ukraine, and Israel and the terror organizations to its North and East.

In the past two weeks there have been murmurs about peace deals in both conflicts.  It is reasonable to assume if these conflicts reach some sort of agreement in the near term (less than three months) we can potentially expect a lowering of the global temperature.

However, regardless of what happens with either hot conflict, the fight for global supremacy between the U.S. and China will escalate.

If I were Xi Jinping and I wanted to take Taiwan, I would have done it at the beginning of 2024, in the middle of two significant hot conflicts, with scarce resources and distractions in abundance.  With a weakened and discombobulated United States that has demonstrated multiple foreign policy blunders over the past few years, it seemed to be an opportunity lost from the Chinese point of view.

The future might be likened to the Cold War of the 20th Century, and it may prove to be our best outcome.

The United States and The Soviet Union spent decades recruiting countries to their respective sides, and in several cases, this resulted in military conflict.  The Soviet Cold War was all about ideology, communism vs democracy.  That theme is still prevalent, but no longer the dominating factor.  

“China has learned from the failings of the Cold War and, thus, has avoided focusing their efforts on spreading ideology.  Instead, they have focused their initiatives on more objective forms of recruitment using a combination of financial, political, and infrastructural leverage.”  We explained this clever and effective tactic in a recently published paper entitled “One Belt-One Road Initiative.”

The U.S. ultimately won the Cold War because our team was better than theirs, not just because we were better than Russia.  The U.S. and China will likely engage in accelerated influence campaigns globally to recruit new allies and partners or solidify standing relationships.  Currency, natural resources, technological components, energy, and technology – especially AI – will all be divided up and competed for.  Relationships will be based on these factors as well as economic and military power.

It could be important over the next few years to focus more research on supply chains, where production components originate, and where final production itself takes place.  It would not be wrong to assume that, globally, economies will look to bring production closer to home.  We have been labeling this as Mercantilism – and it promises to create more emphasis on a bifurcated global economy

It is important to note that the U.S. is particularly well suited for this type of global bifurcation or mercantilism.  The U.S. is well-endowed with energy.  The U.S. is well-endowed with a vibrant consumer.  The U.S. has some of the most fertile farmlands in the world, with the Great Lakes providing the largest body of fresh water in the world.  We have the most vibrant technology industry in the world and the strongest military.  The U.S. has friendly neighbors to our north and south, while the two largest oceans on our planet provide a natural barrier dissuading conflict.  If this global bifurcation continues to evolve, countries most dependent on exports are likely to populate the disadvantaged column, while the U.S. will certainly be in better shape than most.

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