October 31, 2024
This newsletter issue identifies some of the major U.S. macroeconomic catalysts and decision points that I’ll be monitoring in the year ahead.
Catalyst 1) The Election
The U.S. election is obviously the biggest near-term catalyst to watch, since it has implications for some of the other catalysts listed below, plus more.
In general, I think investors tend to overstate the importance of presidential elections on broad investment outcomes, but certainly there are sizable differences around the margins depending on the Presidential and Congress make-up.
My highest conviction bet regarding the outcome is that despite all the social and fiscal differences between the candidates, nothing stops this train (structurally high fiscal deficits):
And thus I remain of the view that the economy will operate via fiscal dominance more-so than monetary dominance, although there will be ebbs and flows along the way as described by the next two catalysts.
In some interviews recently, I’ve been asked about some presidential proposals, and have pointed out that since they have to get through Congress, I generally rule out the tail outcomes unless I see them start to materialize. So for example the idea of replacing all income taxes with tariffs, or adding in unrealized capital gains taxes, are pretty tall orders to get through Congress within this four-year period even though they have been proposed by the leading candidates, and thus I down-weight them vs some of the other proposals that have a greater likelihood of being enacted.
Catalyst 2) The Debt Ceiling
The U.S. debt ceiling is currently suspended. In early January 2025, however, it will automatically come back into effect.
That means the U.S. Treasury won’t be able to issue net new debt until Congress raises or suspends the ceiling again. They still have spending obligations, however, and are running structural deficits due to the policies that Congress has put into effect for decades.
And so as a result, the Treasury will begin to draw down their cash levels, since they’ll be paying out more in expenses each month than they receive in tax revenue and can’t issue net new bonds to fill that gap. The Treasury stores its cash balance at the Federal Reserve in what is known as the Treasury General Account. This cash is an asset for the Treasury and a liability for the Fed.
Lately, the Treasury’s policy has been to hold about $700 billion to $850 billion worth of cash in its TGA. And they have certain legal constraints on them to prevent them from gaming the system too much to get around debt ceiling suspensions. And right now, they’re at their target level:
If the Treasury runs out of cash without a new debt ceiling authorization, then it will have to default on something. Social security checks, Medicare payments, Defense payments, or temporary default on Treasuries can be in the cards since those make up the bulk of spending, and so Congress historically acts to prevent that level from being reached during the 11th hour.
But here’s the unintuitive thing. During the multi-month period where the Treasury is drawing down its cash levels to keep paying its bills, that can actually be stimulating for financial markets. It’s a net-plus for liquidity in the financial system while it’s happening as long as it doesn’t hit zero. It’s like a game of inverse BlackJack.
We can think of the TGA balance as cash sitting in an unused void. It represents money that has been pulled in from taxes and bond issuance, but not yet spent. And so when it is drained down, this cash is coming back out of that void and back into the financial system. During a drawdown, the Treasury is spending more money into the system than they are removing from it with taxes and bond issuance, and this money winds up back in aggregate bank reserves. A drawdown of the TGA is actually quite similar to the Fed doing quantitative easing, in that sense.
In terms of modern history, a Republican-controlled Congress has often used the debt ceiling against Democratic presidents, but not the other way around. However, the sample size is small, and this pattern could change in the future. Ever since the debt ceiling started to be used as a political tool, there have been three Democratic presidential terms and only one Republican presidential term, which limits the sample.
But my main point here is that while everyone is focused on tax and spending differences between the candidates, the other big side-effect of the election for asset prices could include whether we have an $800 billion drawdown from the TGA into the banking system, or not. It’s a large variable that I’ll be watching during the first half of 2025.
Catalyst 3) The Expiring Tax Cuts
In 2017, President Trump signed into law the Tax Cuts and Jobs Act, which went into effect at the start of 2018.
This act implemented a broad set of tax cuts for corporations and households, and had the biggest impact on the wealthiest top 10%. Notably, most of the corporate tax cuts were permanent, while most of the household tax cuts were temporary. They expire at the end of 2025 unless Congress renews some or all of them.
Congress is quite polarized in the modern era, and the majority of voters don’t like tax hikes or spending reductions. And so as a result, it’s very hard for either Democrats or Republicans to meaningfully reduce the large fiscal deficit. Things that automatically expire, however, have a bigger chance of reducing the deficit, albeit to a limited degree. Because that means Congress and the President have to agree and act in order keep those cuts in place. The status quo of disagreement means that those tax cuts end, and thus taxes go up.
Donald Trump has publicly stated that he plans to keep most of the tax cuts in place. Kamala Harris has publicly stated that she doesn’t want any tax hikes for households who make under $400k. The majority of the cuts were for that higher end of the income spectrum, which means under Harris there is a greater chance of an aggregate tax hike from this automatic sunset to the tax cuts.
I view the structural fiscal deficit as a sizable portion of my macro outlook. And this alone is not enough to change it structurally, but it can shift it around by a few hundred billion dollars per year, which is a nontrivial amount.
We will likely see other legislative actions by Congress in 2025. Both Trump and Harris have proposed several fiscal policy actions related to taxes and spending, and so we’ll have to monitor those as they start to take shape. But these expiring tax cuts are the most tangible things we have on the forecast for now.
Catalyst 4) Bank Lending
Historically, the U.S. economy has been very credit-driven. The ebbs and flows of bank lending were a big deal.
During 2022 and 2023, there was a significant tightening of credit conditions. Both for industrial loans and consumer loans, most banks were tightening their credit standards to levels that are normally seen in recessions:
However, since we’re in an era of fiscal dominance, we had better market and economic performance than would normally occur in such a tight period for bank lending. And throughout 2024, we seem to be past the worst of it in rate-of-change terms. If we have a positive credit cycle on top of the current fiscal situation, then that would be pretty impactful for markets.
Bank loans are still growing on net, but it’s slow:
On top of that, private credit is a larger market than it used to be, and is widely forecasted to keep growing.
So overall, one of the key things I’ll be monitoring in 2025 is whether there are signs of a new credit cycle emerging or not. My base case is that we’ve seen the tightest credit situation for this cycle, and that 2025 will be a bit easier on that front, but that remains to be seen for sure.
Portfolio Updates
I have several investment accounts, and I provide updates on my asset allocation and investment selections for some of the portfolios in each newsletter issue every six weeks.
These portfolios include the model portfolio account specifically for this newsletter and my relatively passive indexed retirement account. Members of my premium research service also have access to three additional model portfolios and my other holdings, with more frequent updates.
M1 Finance Newsletter Portfolio
I started this account in September 2018 with $10k of new capital, and I dollar-cost average in over time.
It’s one of my smallest accounts, but the goal is for the portfolio to be accessible and to show newsletter readers my best representation of where I think value is in the market. It’s a low-turnover multi-asset globally diversified portfolio that focuses on liquid investments and is scalable to virtually any size.
And here’s the breakdown of the holdings in those slices:
Changes since the previous issue:
- Added Air Products and Chemicals (APD) to the dividend stock pie.
Bitcoin Note:
I use allocations to bitcoin price proxies such as MSTR and spot bitcoin ETFs in some of my brokerage portfolios for lack of the ability to directly buy bitcoin in a brokerage environment, but compared to those types of securities, the real thing is ideal.
I recommend holding actual bitcoin for those that want exposure to it, and learning how to self-custody it. I buy mine through Swan.com.
I don’t have a firm view on the bitcoin price over the next few months, but I am bullish with a 2-year view and beyond.
Other Model Portfolios and Accounts
I have three other real-money model portfolios that I share within my premium research service, including:
- Fortress Income Portfolio
- ETF-Only Portfolio
- No Limits Portfolio
Plus, I have personal accounts at Fidelity and Schwab, and I share those within the service as well.
Note that the annual price for this subscription has remained unchanged for the past five years at $199/year, which is purposely set low relative to most investment research subscriptions to keep it widely accessible.
By the end of this calendar year, the price will increase to $249/year for new subscribers to keep up with five years of inflation, and I plan to leave that price in place for a while. This price change will not affect those with existing active subscriptions, or those that buy between now and the end of the year. It will be the new rate for those that join in 2025.
Final Thoughts: Chinese Stimulus
This piece focused on U.S. macro catalysts, but of course there are ex-US macro catalysts of great significance as well. Some of my future pieces may focus on those, but the one I will emphasize here is China.
China made global headlines during the past couple of months as it announced a series of stimulus efforts to stabilize its economy.
Starting in 2021, Chinese stocks were pretty much left for dead by global investors, and not without good reason. The Chinese government cracked down on most of its major internet companies in 2021. And then with Russia’s 2022 invasion of Ukraine and the resultant freezing of foreign-owned Russian assets, many investors grew more concerned that the same thing could happen if China invades Taiwan.
And during that whole time, Chinese policymakers have purposely been trying to deflate their property bubble. In the United States, we put a lot of emphasis on juicing our stock market, but in China, they’re trying to internationalize their bond market with trade partners, so that they can conduct more of their global trade in their own currency. And so, they have a slower trigger finger when it comes to juicing asset prices with stimulus.
In early September, I started to focus more of my research reports on the rising probability of Chinese stimulus:
I think the bottom in Chinese stock indices is likely already in, and there are myriad catalysts that could propel them higher in the years ahead, including thawing tensions between the United States and China, or significant stimulus from the Chinese government. However, there’s no sign as of yet that Chinese stocks have bottomed vs American stocks, as the more relevant comparison. So that’s still in a wait-and-see mode.
-September 1, 2024 premium report
And then by mid-September, I put more emphasis on it:
Back during COVID-19, China adopted the “Zero COVID” policy, and framed their initial success as an example of the superiority of their top-down system versus the more decentralized system that the United States and “the West” in general has.
But then as repeated waves of major lockdowns in China dragged on into 2022 while the rest of the world started moving on, there started to be widespread protests in China, which are rare. Central authorities backed down rather quickly at that point, ripped the bandage off, and moved toward opening up. The cost/benefit analysis was strongly toward that direction, given the high priority placed on social stability there.
I reference this because China’s current malaise might play out similarly. There is increasing social media noise from unsatisfied Chinese citizens about the state of their economy. And many of them have been very well articulated.
In timed sports games, if there is very one-sided matchup and the game is effectively over due to a big points gap while there’s still time left to play, both teams tend to switch out the best players to avoid the risk of injury, and let their “benchwarmers” play. And so it becomes a weaker game with no stakes. This is known as “garbage time” in sports terminology. In recent months, Chinese citizens on social media have been referring to their economy as being in garbage time. It started late last year, became widely reported in July 2024 when Chinese central authorities were more aware of it and began cracking down on it to censor it, and yet the sentiment persists.
The NYT offered a recent long-form piece around China’s social media garbage time meme, but a lot of media outlets ranging from Reuters to the Guardian have been reporting on it since July.
And as many of these types of pieces describe, with specific examples, many Chinese social media users are adept at spreading their message even amid widespread censorship. Rather than criticize the current non-democratic government or President Xi, they write posts about prior Chinese dynasties, and how they made similar mistakes that resulted in economic malaise, and draw clear parallels to the present state but with plausible deniability in case they get in trouble, and/or to make the critical content harder to identify and censor.
So, under the surface, tensions are simmering. The youth unemployment rate is high, and China just raised the retirement age for its citizens, albeit from a younger age than many other countries.
China is currently providing record low domestic interest rates to assist with the deleveraging, but beyond a certain point, monetary stimulus doesn’t cut it. Fiscal stimulus or other economic reforms can be more impactful, but they require more political levers to initiate, which President Xi has been unwilling to pull.
However, President Xi recently called on government officials in multiple layers of the country’s government to keep striving to reach their 5% annual GDP growth target. As Bloomberg reports:
“All regions and departments should studiously implement all the major economic initiatives and measures introduced by the Central Committee and deliver on the economic tasks for the third and fourth quarters,” Xi said Thursday.
The increasing dissatisfaction with the economy by Chinese citizens, and calls by the president and other government officials to meet their growth targets, is reaching an interesting point.
This has direct relevance for Chinese equity market performance. Their stocks in aggregate are currently unusually cheap relative to their fundamentals, but are fraught with tail risk that international investors don’t have the appetite for. But even for investors that don’t want to invest in China directly, the state of China’s economy and the performance of their real estate and equity markets have all sorts of butterfly-effect implications for the global economy.
I view China as the #1 variable to watch regarding global macro cycles, even more-so than the U.S. Federal Reserve. Whether the Fed cuts 25 basis points or 50 basis points is somewhat meaningful, but how long China’s leaders consider the cost/benefit analysis of remaining in a malaise of deleveraging versus performing a pivot and stimulating out of it, is likely more important.
-September 15, 2024 premium report
Starting about a week after that, China announced their biggest stimulus since COVID. There were a small series of announcements, including both monetary and fiscal actions.
The impact on the stock market was significant:
However, many analysts have pointed out that the stimulus, while significant, is not really all that huge. It’s by no means any sort of stimulus bazooka relative to the size of China’s economy. And I chimed in on social media about that topic as well:
In my view, the most useful way to view this is to see it as a line in the sand or pain point for Chinese policymakers, rather than as a major near-term thing on the state of the economy itself.
There is only so much deleveraging that China can take before they start failing to hit their growth targets, and before the population is increasingly unhappy and talking about it. At that point, policymakers’ risk/reward decisions start to change. And I think this stimulus represents that pain point being reached. What this means is that even if this wears off and the economy sinks down again, we could see another round of stimulus announcements.
I wouldn’t expect fireworks out of China’s economy, but if Chinese asset prices and economic conditions can start going sideways rather than down, that’s a notable trend change to monitor along with what’s happening in the United States.
Indeed, since the initial stimulus announcements, we are already seeing public considerations for more, which validates the thesis that this is a pretty strong pivot. Reuters and other news agencies reported on another $1.4 trillion in multi-year stimulus that China might do.
Best regards,
