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 January “First-Friday” meeting:
Steven Abernathy:
Today’s Presentation is titled “The All-Weather Portfolio.” During our “First Friday” meeting today, we will discuss the opportunities and risks of investing in an overvalued market.
Our goal is to discuss tactics that will allow intelligent investors to remain invested during overvalued markets while lessening investment risks for those who want to make sure they don’t have to go back to work and make it all over again.
2025 promises to be a challenging year as most public markets are priced for perfection and speculation is abundant.
We want to make sure your portfolio allocation considers the risks inherent in an overvalued market and your return expectations are reasonable based on the challenges which confront us as we enter 2025.
There is a wealth of information and some clever estate planning ideas you might consider… We believe the U.S. is likely to allow U.S. citizens to pass along fewer assets to our beneficiaries in the future. I bring this up because, for many, the exorbitant estate taxes on our hard-earned money we have saved will be a bitter pill to swallow. We want to ensure each family is entirely able to pass along as much of their wealth as they desire to their chosen beneficiaries.
Also – we recently started a new company focused on reducing the costs of offering employees a corporate 401k plan while offering each employee the education they need to make intelligent decisions about their future.
Our goal is to turn the staid and boring 401k plan – from a cost center – into a benefit that will increase employee retention and help recruit valuable new employees.
If you have a few minutes, and if you have a retirement plan, give me a call or stop by our website and read one of our many research papers published recently.
Slide 2
As Marissa said – this month we want to discuss the All-Weather Portfolio, which is another way to describe investing in an overvalued market.
It is a tricky proposition. Risks are higher because overvaluation typically comes along with euphoria and the fear of missing out – or FOMO.
The investment challenge in an overvalued market is that the risks are higher than normal, and the probable rewards are lower than normal. This is the opposite of the investment set intelligent investors are working hard to find.
However, because of the consensus siren song of propaganda from the talking heads and Wall Street expressing nothing but the potential upside associated with the euphoria and the FOMO, it doesn’t seem as if the risks are higher than normal, OR the rewards are truly diminished – and please note: in some cases, the rewards available are more likely than not to offer negative returns, as you will see.
So, today we are going to discuss the investment landscape, beginning with current valuations.
The first place to start is always to thoroughly understand “what is priced into current valuations?” Current valuations tell us about what investors expect – in returns – over the next 5-10 years. This allows us to decide whether expectations are realistic, possible – yet marginal, or ridiculously optimistic.
We will then spend some time discussing the U.S. and Global economic backdrop supporting our stock and bond market.
Today’s investors are confronted with a new administration entering Washington with a considerably different playbook.
The new administration must fix a shattered immigration system, a failed educational system, a bloated government, and a geopolitical environment teetering on a knife’s-edge of becoming a global conflict.
And they must solve all of those problems with an inherited $2 trillion deficit planned for 2025.
And if that task seemed insurmountable, the new administration would have to tackle these challenges while paying the ever-increasing interest charges on the $35 trillion of U.S. debt aggregated over the last 25 years by each administration since the early 2000s continually spending more than we saved.
Next, we will discuss the geopolitical arena we enter 2025 with, because this is the one variable that could change our lives.
And we will end our discussion today with some thoughts about an All-Weather Portfolio. We will discuss some tactical themes which may be helpful to some investors on the call. We will discuss the questions each investor should be asking BEFORE they make any investment decision, and we will end with an idea or two that we believe offers a high probability of becoming true combined with a valuation which is welcoming, thus offering both current income if we are wrong, and appreciation (and income) if we are right.
With that said, let me turn it over to Matt Daley to introduce our first topic.
Slide 3
Matt Daley:
Elevated Price-to-Earnings Ratios: The S&P 500 is trading at 24.82 times expected earnings over the next 12 months, which is well above its long-term average of 15.8 times expected earnings.
While valuations are high, they are still below the peak seen during the dot-com bubble. This provides some context for the current market environment.
These valuations are heavily concentrated in growth sectors, which is also similar to the dot-com bubble.
The elevated valuations mean there is less room for error or disappointment. As Matt Rowe from Nomura Capital Management states, “We are priced for perfection,” and any deviation could result in a significantly negative revaluation.
That said, let’s start by understanding investors’ expectations for future earnings when investing in the stock market at today’s valuations.
Are investors being offered investment prices that provide some meaningful upside? Or are prices fully valued and potentially counting on a future that is near perfection going forward?
Steven:
Slide 4
As always, before we begin to allocate capital, it’s a very good idea to understand the investment environment in which we are entering.
Is the pricing environment welcoming? Are the current risks a good reason for the investment environment to offer low prices? Are these reasons temporary, or longer lasting?
Or, as in today’s markets, is the pricing environment overvalued? Yet are there good reasons for the stock market being overvalued? Is it likely that the market is justified for being overvalued?
And finally, how does the current valuation backdrop compare against historical valuations? *Keep in mind – valuation is NOT a timing mechanism. However, valuation is quite helpful when predicting future returns. History indicates that when investors pay more than they should for investments, future returns are lower than average, and when investors pay less than historical averages, they tend to reap higher returns.
This slide shows us that current pricing is at the higher end of what is typical.
The solid blue line indicates the average valuation, and the dotted line indicates one standard deviation above the average. So currently we are at levels where investors should be expecting to return significantly less than the market’s average return over the last 100+ years.
So, what is the market expecting? In the last “First Friday” meeting we highlighted the fact that Wall Street tends to suffer from the “Incentive Dictates Behavior©” phenomenon – meaning they tend to be overly optimistic because they intend to sell you something.
Slide 5
As slide 5 shows, over the 25+ years, current valuation levels have indicated downturns are to be predicted as current expectations have most often disappointed investors.
As we all know, a combination of a) expected earnings and b) emotion determines the valuation of every asset.
In our current environment, it is clear that FOMO is abundant, as we discussed in last month’s “First Friday” meeting. Speculation is everywhere, from digital currencies to Artificial Intelligence.
However, what tends to overwhelm FOMO is earnings.
So, let’s take a look at earnings expectations and what they tell us about Wall Street’s current expectations.
Slide 6
Here are the earnings expectations for the next 12 months of 2025. As you can see Wall Street is expecting earnings to be a full 300% higher than historical experiences tell us to expect, as the market’s earnings have averaged 3-4% over the last 100+ years.
Keep in mind, we are not saying earnings over the next few years will not double or triple the earnings growth U.S. companies have averaged over the last 100+ years, we are saying that this expectation is currently priced into the market. So, in the unlikely event that this occurs, current investors should expect a 0% return. Yes. That’s right; if the earnings of the S&P 500 grow at 10% plus over the next few years, investors should expect a 0% appreciation (dividends are constant and will grow however), as those earnings were expected.
Slide 7
And as we said earlier this slide confirms Wall Street’s tendency to overestimate the future.
Slide 8
Here you can see as recently as June 2024 (merely 6 months ago), Wall Street estimated earnings in 2025 to grow at over 14%; and as recently as December 2024, decreased their estimates to just over 12% (and we estimate that this will continue to shrink as the data come in during 2025).
However, it’s always a good idea to take a look at what historical outcomes offer as a way to ensure our expectations are intelligently well-grounded.
The next chart will show us historical outcomes – when current pricing is mixed with a range of rosy outcomes down to dire outcomes.
Slide 9
This slide is one we shared with you on the last “First Friday” online seminar – and we thought it important enough to bring back for this month’s “First Friday” meeting.
Here is how you should read this slide.
On the right you will see the pricing multiple of 22.5 times earnings – this is only a slight bit under our current pricing… the importance of this?
If we stay within the current speculative pricing environment, and earnings continue to grow at historical levels, with no recession, you will see that expectations should be for returns over the next 5 years of -5%, over the next 7 years of -2% and for those who can live through 10 years or more of little to no returns, they might expect to achieve a 0.3% return.
Of course, suppose the market returns to its normal price earnings expectations of 15 times earnings. In that case, investors are likely to have losses over the next 5 years, 7 years, and 10 years, only to start receiving returns of 2% or so, over a 20-year holding period.
And for those of you who believe the world is overpriced and understand that during most historical periods, overvaluations lead to undervaluation as FOMO turns into a narrative describing “the world is ending” – beware. Just as markets get overvalued based on overly optimistic future expectations, bear markets usher in dark and dismal expectations, often far darker than history tells you to expect.
In short, as you can see, the math tells us to expect terrible returns if expectations turn decidedly negative – delineated by the left column under the header of 10 (which means the market sells at only 10 times earnings).
Please remember this is not our base case, yet history tells us this type of period has happened before during times with less geopolitical risk and significantly less debt.
Let me stop here and see if there are any questions or comments before we move forward.
Marissa – do we have any questions on the valuation dimension and its suggestions for investor expectations so far?
Matt – let’s move on to the next topic.
Slide 10
Matt:
Very well put Steven, let’s move on to touch on three other topics related to the U.S. economy. First off, we think investors have the transition of presidential power on their minds and are curious about what the new administration may mean for the economy.
A few of the major changes that have been mentioned are extending the 2017 Tax Cuts and Jobs Act, imposing 25% tariffs on all goods from Mexico and Canada as well as 10% on all Chinese goods. Also the possibility of even a 10-20% universal tariff, general deregulation, a renewed focus on domestic energy production, and the brand-new Department of Government Efficiency (DOGE).
Most of the forecasts I have seen show an increase in our U.S. budget deficit as a result, along with continued inflation above targets. Can you pick a couple of those proposals and tell us how we might want to frame them or look at them through an economic lens as we head into the new admin?
Slide 11
As we mentioned earlier in the presentation, the new administration faces significant hurdles in achieving what the citizenry of the U.S. hired them to do.
I want to make sure we remind everyone that this is commonplace.
The commentary, promises, and emotions evident on the campaign trail seldom translate into direct activity once the victor inherits the White House. This is true for both parties and is not intended to be a political statement of any kind.
The cabinet that is being proposed by the new administration has to be agreed to by Congress for the most part.
The promises for tariffs across the board have a higher probability of being enacted, yet most political analysts will tell you that it is far more likely that the tariff rhetoric was more a negotiating tool than a surety. We believe – and each of the political analysts we follow will also tell you – that the tariff talk will most likely lead to tactical use, and if used intelligently, may work out to be a general positive. Of course, at times good outcomes for the longer term bring negative short-term consequences as tactical tariffs are likely to usher in another bout of above-target inflation.
The most tenuous of all considerations, in our opinion, comes from the history surrounding the current administration’s ability to listen to its advisors and to share the limelight with others.
History tells us that in the prior administration for this elected official the “Advisory Board” which was erected to share ideas with the administration was comprised of top CEOs across the U.S. It was an impressive list of intelligence and experience.
We all know this didn’t work out well, as the Advisory Board ended up disbanding itself, for any number of reasons.
We hope that lessons were learned and that the current administration, AND the current advisors, will stay on the course. We believe the current list of advisors has the potential to offer the intelligent insights and advice they are capable of offering; and most importantly, we hope the administration will listen and follow the expert advice offered.
Matt, do you have any thoughts which might be helpful on this topic?
Slide 12
Great summary: I think we all hope for the best but there is definitely a healthy dose of uncertainty on the horizon.
We mentioned the potential for steadily high or even accelerating inflation due to some of the policy proposals outlined. We had some rate cuts in the latter part of 2024, what might we expect the Federal Reserve to do going forward? Is it wait and see or does action need to be taken on the recent uptick in inflation, regarding rates?
Interest rates: as the next chart will show you, the market has a terrible track record for predicting the future of interest rates.
Slide 13
As you can see the dotted lines represent the market’s forecasts or predictions of where rates will be, and the solid line represents where interest rates were. The importance of this chart is twofold.
First – we should not assume that anyone can predict where interest rates will be over the next year or more. This means all investors should diversify their holdings in interest-bearing securities.
Remember our house rule which is a tried-and-true philosophy – “the more you know, the less you diversify; the less you know, the more you diversify.”
Second – the takeaway is that as you can see, the last 15 years have been largely years where interest rates were at or near the 0% boundary. When you have investors committing money at 0 or near 0% interest rates, speculative activity runs rampant.
We have yet to witness the fallout from this 15-year period – which was unlike any other period in history. We will see if the speculative activity that took place during this period will shape our future in a less-than-positive way. Keep in mind that speculation in digital currencies, private equity, and private debt have all skyrocketed to record levels. History clearly shows that industries that grow at unsustainable rates have dire consequences. We are hoping for the best, yet preparing to endure the worst.
Matt, the next topic is liquidity as the amount of liquidity in our system significantly influences the stock and bond market.
More liquidity often leads to a strong investment backdrop, and less liquidity tends to lead to a weak investment backdrop – and equally often, a recession.
Matt: Is liquidity an issue in the markets or something investors should be wary of?
Slide 14
From our standpoint, liquidity remains abundant, although over the last 12 months the U.S. Federal Reserve has been continuing to reduce its balance sheet.
The U.S. Federal Reserve has reduced its balance sheet from well over $6 trillion to a bit over $3 trillion during the last year. That is significant…
As said, when the U.S. Federal Reserve reduces liquidity, it typically leads to uncomfortable outcomes.
With the changes in administration over the next several weeks and months, we will continue to keep our eye on liquidity, as the U.S. Federal Reserve may have its work cut out for it.
Slide 15
As you can see from this slide – and we have used it in previous “First Friday” presentations – the U.S. Federal Reserve and the former administrations in power have increased our liquidity over the past 50 years by levels which would embarrass most business owners.
As said previously, debt at current levels is unsustainable. Unfortunately, most investors believe that just because U.S. debt at current levels hasn’t created a problem so far, it will not in the future. We hope they are right. History says the opposite.
Slide 16
And as this slide shows, over the last 15 years we have become even more profligate in our spending by doubling our overspending and doubling the amount of debt the U.S. owes the rest of the world.
As we have said in prior “First Friday” meetings and to each of you privately, this period of overspending will not end well. It must stop. When it does, it will be painful for a citizenry accustomed to low rates and abundant amounts of money available each time our country gets into trouble.
With that said, let me turn it over to Matt for some thoughts on the geopolitical environment and some ideas on how to deal with a set of unknowns that have a low probability of taking place, yet a significant impact if they do take place.
Make no mistake. As investors, we have no control over geopolitical events, yet they remain among the most important determinants of our future.
Matt, would you like to give us your thoughts on the geopolitical future ahead of us?
Slide 17
I believe it is very likely that the next 5-10 years will be defined by global conflict and that Ukraine/Russia and Israel/Hamas/Hezbollah/Houthi are just the beginning of a much broader period of turmoil that will extend much further.
Africa and the Middle East are both tinderboxes with potential conflicts virtually anywhere you look.
The conflict in the Palestinian State has been a major call to action for terrorists across the globe and October 7th has inspired them to rise and believe they can have real geopolitical impact.
From Central Africa across the north, through the Middle East, to the Caucus Mountains and the Stans of Central Asia, thousands of people are joining various terrorist groups. Some data indicate they can’t train them fast enough for the demand.
Intelligence operatives have reported that 10,000 trained Al Qaeda fighters have been deployed to Syria, as well as a thousand trained terrorists to Europe and a thousand to the United States already.
Afghanistan and Syria are two large countries significantly controlled by terrorists. Lithium mines in southern Afghanistan are occupied by Al Qaeda, the Islamic Revolutionary Guard Corps (IRGC), and Chinese officials. This is an alarming development suggesting China may use terrorist proxies to their benefit and disrupt the West (especially the United States).
And we believe the world being on fire benefits Chinese plans to reintegrate Taiwan.
All of this suggests that not only will conflict possibly envelop the globe, but it will likely be coming to our backyard by way of thoughtfully planned and highly coordinated attacks on our soil by a variety of means.
Historical data shows us that terrorist attacks create volatility and market downturns; although the drop in equity prices tends to be temporary or short term and markets recover.
However, it can be assumed with relative confidence that increased or major terror attacks on U.S. and European soil will mean the return of a significant U.S. troop presence in Africa and the Middle East.
Terror attacks will largely affect travel, tourism, and consumer optimism, especially in Western cities. People may be less willing to go to large events.
The result of widespread conflict will be unifying and dividing.
As we have mentioned many times previously, the world will be divided into factions of nations. Mercantilism is a term that will likely be applied to our future economy as mercantilism promotes self-reliance on economies within the country itself – with less reliance on economies outside of government control.
We believe democratic economies will be driven further diplomatically and economically from our perceived and real enemies, and we will be driven closer to our allies. Disrupted trade flows will need to be restructured or rebuilt.
However, one of the hardest things to deal with will be the new-age warfare of cyber and infrastructure attacks.
Asset class diversification, sector diversification, and geographical diversification are all strategies to consider. Embracing assets like gold, defensive stocks, treasury bonds, and cash for a portion of your portfolio could be effective protective wealth preservation measures if geopolitical conflagration becomes a reality.
At this point, we believe it is critical to consider geopolitical risk when allocating investments. If you have international investments, consider geopolitical hedging strategies like putting options or collars to limit downside risk and currency hedging.
It would be wise to deeply analyze your commodity exposure, not only in the direct investments you may have but also by assessing the commodity exposures of the equities in which you may be invested.
Rebalancing and regular portfolio reviews are prudent given the level of global uncertainty.
I’ll get off my soapbox here by stating that there is no need to panic, and actually on the contrary, investors should buckle up and be patient, prepare for the long run, and maintain a wealth preservation strategy that weathers the storm and is not reactionary to every global event.
If you prepare adequately and make wise and reasonable decisions, there is an opportunity not just to get through the uncertainty but potentially grow your wealth despite it.
Given what we know so far and given current valuations, risks, and the slight rewards available, let’s discuss the All-Weather Portfolio, which will likely lower risk and lock in returns that most investors would be comfortable with.
Slide 18
Thanks, Matt.
Let’s discuss an investment stance or an investment allocation that will allow us to continue to grow our assets at reasonable levels while sleeping well at night.
Keep in mind – there is no such thing as a perfect investment, and there is no such thing as a perfect investment strategy. The reason there is no perfect investment or investment strategy? The future is categorically and unarguably unpredictable. Human emotion drives a good portion of investment success and failure; and estimating the human emotions of hundreds of millions of investors, with different amounts of information, different incentives, investment timelines, and different risk tolerances, is impossible to predict.
Markets can and will appreciate, they’ll depreciate, and at times stay flat for extended periods. And equally often there is no distinctly quantifiable reason to justify the movements.
Having the right expectations associated with appropriate timelines is crucial when making decisions about whether it makes sense to invest or not.
Sometimes, investing in the market is not the right choice, and that’s OK; especially when the subset of investment choices offers little upside and higher than normal risk…
Sometimes, it may make more sense to pick an investment or product that has less growth potential and less risk. The important point: don’t let greed or FOMO (fear of missing out) on potential growth lead you down the wrong path.
Here is the message for the next topic:
We are not trying to be glass-half-empty financial strategists. However, we do want to deal with current data and market history because both current data and market history may provide a look at what is likely to come.
History does not tell us, and we are NOT calling for a complete meltdown of the stock market. While history shows that overvalued markets often collapse and deliver significant downturns – at times well over 75%; however, overvalued markets do not have to end in a tumultuous downturn. As often as not, overvalued markets remain overvalued for over a decade with little or no appreciation.
Slide 19
In this next chart, you will see a listing of the periods in which expectations for future gains in the stock market became so euphoric or extended that it took more than 10 years to recover. This means that investors in the stock market had to endure more than 10 years of volatility, false starts, and scary “the world is ending” periods before they received a positive return.
Slide 20
From 1906 – 1924 the market went nowhere while we went through a World War and a pandemic.
Slide 21
From 1929 – 1952 – that’s almost 25 years; the U.S. stock market again went nowhere – again entering and rebounding from a World War and the worst depression the U.S. has ever experienced.
Slide 22
From 1966 – 1978 – another 13-year period where the stock market went nowhere while Paul Volcker fought the most vicious inflationary bout in recent history.
Slide 23
And from 2000 to 2012 the stock market registered near 0% returns with volatility that saw the NASDAQ plummet more than 75%.
Slide 24
The point of these slides and this topic is to remind everyone that we are not able to predict the future of the market, yet we are able to see what history has offered when markets get to be overvalued.
Overvalued markets – whether in real estate, stock market, bond market or any market – mean future returns will be lower than most expect. It could come from a severe downturn – or it could become a decade of no returns.
We are trying to avoid both with this discussion. We want to avoid a downturn of 40-70% if possible, and we want to avoid a decade of little or no returns as inflation promises to be stickier than many expect and if geopolitical conflict takes place, the prices of goods and services may become more expensive than most are expecting today.
*For those of you who would rather see the amount of pain and volatility overvaluation can create – without going through a significant “Crash,” take a quick look at this chart which graphically documents each of the periods in which the stock market became overvalued to the point that it took over 10 years to recover.
Slide 25
Slide 26
This slide highlights each of those periods and it shows you where we are now in terms of valuation.
Above, in the upper right-hand corner, you will see a red oblong circle, indicating our current valuation levels.
Slide 27
So where does this leave us?
Here are some ideas for everyone.
Stick with quality investments. You can define them as investments that pay dividends. Think of real estate over difficult periods. Think of high-quality companies that pay dividends and increase their dividends each year.
Think of investments that will survive a geopolitical downturn.
Questions to ask yourself:
What is my base case outlook for the next 12-24 months?
Make sure each of your investments measures up to your expectations in terms of what you are paying for it, and when applying reasonable expectations going forward will the investment exceed the inflation rate?
Next, ask yourself – for each investment – what happens if I am wrong? Is the income I am receiving going to keep up with inflation? If investing in the stock market, ask yourself if the current dividends allow the company to continue to pay dividends. Are they likely to increase dividends? Will the dividend increases keep up with, or exceed inflation? Do the dividends – or income I am receiving for the investment allow me to continue with my lifestyle?
Top ideas – given the current data and the current valuations.
Energy seems to be at the top of our list. If we enter a geopolitical conflagration, energy will become incredibly valuable. History tells us countries with access to energy often fare well during wars – said differently, the nations in wartime without access to abundant energy tend to fare quite poorly.
If we avoid the unfortunate future of a hot war, energy demand is still predicted to double in the next 20 years due to the demand from data centers.
Does this mean utility companies could become reasonably safe investments? Could utilities become categorized as “growth companies?”
And what will power these utility plants?
Longer-term: if the price continues to shrink and the efficiency continues to increase at current or faster rates, renewable resources may offer a solution. Unfortunately, at innovation’s current rate, this is likely to be at least 20+ years away.
Mid-term: from our (seemingly constant) research on what lies ahead, most thought leaders agree that nuclear energy offers the best possibility of providing the energy mid-term (meaning in 5-10 years).
Small Modular Reactors (SMRs) using updated nuclear operating models offer almost unlimited energy with a minimum amount of pollution. Unfortunately, they take time to build. The best estimates? It will take 5-10 years to create, build, and integrate SMRs into the U.S. grid.
Short-term: our grid needs to handle at least double the amount of energy before 2035. Given the U.S.’s available resources, what can we use to meet this short-term demand? The most obvious choice for immediate availability is natural gas. U.S. natural gas is instantly available. It has among the lowest carbon footprints (called pollution in many circles) of any energy source, and it is the cheapest form of energy (most of you have seen pictures of the well-sites with fire blazing out of the 50-foot-high pipe? That is natural gas being burned off for free). By the way, the U.S. is the world’s leader in natural gas production. Why hasn’t the U.S. taken advantage of being the world’s leader in the production of the cheapest form of energy, with among the lowest pollution levels for any energy source?
That is a question for the next “First Friday” online seminar.