Contrarian Thoughts

Being a contrarian investor means you have an opinion that runs counter to the mainstream beliefs expressed by the financial media, economists, or analysts. So, get ready to exercise your critical thinking skills. You probably won’t agree with all ten of these unconventional viewpoints, but that’s partly the point. These are not popular opinions.

Consumer Debt
Conventional wisdom: Consumers are over-leveraged and racking up debt. At some point they will need to rein in their excessive spending, and when they dote economy will tank. More likely: Household net worth is up about 30% since the beginning of the pandemic. The average American homeowner is sitting on about $300k in home equity, a quadruple from 2011 levels. Credit card debt, relative to wages, is roughly flat since the beginning of the pandemic. If consumers decide to cut back on spending, it will be because they want to, not because they have to.

Recession Odds
Conventional wisdom: If the Fed goes too slow in cutting rates, a recession is almost certain to occur. More likely: Recessions are now rare events, thanks in part to federal deficits: they don’t even happen when the yield curve inverts for an extended period. Another key factor is that almost all past recessions (including 2008-’09) were triggered by an inflationary surge in oil prices that caused the Fed to brake the economy excessively. These days, thanks to the shale revolution, the U.S. is energy independent, meaning that when prices dog up there is a benefit to GDP (and jobs) from the energy sector (which offsets some of the negative effects from other sectors). In effect, the Fed’s job has become easier because they no longer need to react quickly to inflationary threats. Instead, they can take their time, review the data, and make high-confidence decisions.

Building Wealth
Conventional wisdom: If you want to get rich quickly, the financial markets are the best place to try. More likely: The financial markets are a terrible place to get rich quickly. The amount of risk required to double your money in a short period dictates that you’ll be wiped out about 90% of the time. Better to bet on red or black at the roulette table, where the odds of losing all of your money are not much higher than 50%. The stock market works best for those who are willing to get rich slowly.

Market Risk
Conventional wisdom: Hedging against downturns will limit your losses and could improve long-term returns. As such, buffered and/or defined-protection funds offer a more palatable approach to long-term investing. More likely: The market only rewards those who are willing to bear risk, so the greater the hedging attempts, the lower the long-term return. If risk is hedged away completely, at best you are looking at money market rates of return.

Federal Debt
Conventional wisdom: The economy is headed for big trouble if deficit spending is not reined in. More likely: There will come a time when the U.S. will be forced to impose an unpopular national sales and services tax, as other countries with big government debt problems have done(such taxes tend to have the least negative impact on the economy, and they can easily generate more tax revenue than income taxes, wealth taxes and tariffs combined). In the meantime, each additional dollar of federal debt creates an additional dollar on the private equity side, most of which gets reflected in either real estate prices or business valuations (including the stock market).

Tax Efficiency
Conventional wisdom: ETFs, index funds, and direct indexing (indexing with tax-loss harvesting) are good ways to defer paying unnecessary capital gains taxes. More likely: Tax “efficiency” is a marketing gimmick. Any tax you defer during the holding period becomes due when you sell the position – possibly at higher tax rates than today (your heirs might save on taxes, but only if the mark-to-market rule still applies and the value of the investment is below the federal estate exemption threshold). A Roth IRA conversion, in contrast, can actually reduce your tax liability if it can be done within your existing tax bracket. By pre-paying taxes on the conversion amount, you eliminate tax on any future appreciation.

Target Date Funds
Conventional wisdom: These are a great option for 401(k) investors, because you can pick a fund that matches your retirement date and you don’t have to rethink your choice. More likely: Your money should be working as hard as you are during your wage-earning years. That doesn’t happen when returns are diluted with foreign stocks, bonds and cash. If you’re a long way from retirement, put your 401(k) in a broad U.S. stock index, and keep it there until you are within five years of retirement.

Artificial Intelligence
Conventional wisdom: Corporate profits may rise, but the economy will suffer as jobs are eliminated by intelligent automation. More likely: AI technology will allow companies to workaround critical labor shortages, while creating new products and services that wouldn’t have been possible before. Employees will enjoy work that is more meaningful, and their wages will climb faster than inflation over the long run thanks to higher productivity.

Electrification
Conventional wisdom: Transitioning the economy away from fossil fuels over coming decades will be costly and problematic, especially when it comes to transportation and the electrical grid. More likely: The declining cost and improving performance of battery storage will make the grid more robust, and electric vehicles cheaper than gas vehicles. New types of clean energy, such as fusion or deep geothermal, will create an abundance of electricity while reducing the need for new transmission lines, eventually putting downward pressure on power prices.

Inflation Hedges
Conventional wisdom: Gold and bitcoin have the potential to rival stocks over the long run. More likely: Asset classes with no income stream that are based on scarcity are much like collectibles; over the long run their value doesn’t grow much more than inflation. U.S. stocks, in contrast, enjoy reinvested shareholder compensation on top of GDP growth, which sets the stage for them to outperform inflation by seven percentage points per year.

Third Quarter Review
With the Fed’s easing plans coming into focus during the third quarter, value stocks and small-caps rallied on the expectation that earnings growth in 2025 will broaden to encompass all areas of the stylebox (until recently, large-cap growth stocks have been the main contributors). But it was anything but a smooth ride. The Bank of Japan decided it could no longer hold interest rates at zero, and by putting a price on borrowed money it caused a surge in the yen, which in turn upended the global carry trade (sending high-risk speculators scrambling to reduce exposure to assets with high growth potential). But in the end, the S&P 500 gained 5.9% for the third quarter, bringing its year-to-date gain to 22.1%. The Russell 2000 gained 9.3% bringing its 2024 return to 11.2%.

The bond market rallied too, gaining almost as much as stocks. The Bloomberg Barclays US Aggregate Bond Index was up 5.2% for the quarter, ending with a year-to-date return of 4.4%. Interestingly, its gains were booked mainly in anticipation of the Fed’s easing cycle. Once the first rate cut became reality, yields on medium-to-long-term bonds began to creep up, which left only a few short-term bond funds to benefit.

Our portfolios, which mostly remain focused on growth stocks and short-maturity bonds, lagged on both the stock side and the bond side, though less so on the bond side.

Looking Ahead
In recent decades, stocks have tended to rally in the 12 months following the start of a Fed easing cycle, though there have been exceptions. The onset of the Financial Crisis in 2008, as well as the inverted yield curve and trade tensions that occurred in 2019, saw significant declines in the year that followed the first rate cut. The current easing cycle may end up somewhere between those extremes. Because there was lots of time for analysts to price it in, there may not be any well-defined trend, which means the market will probably remain laser-focused on quarterly earnings and analysts’ forecasts.

Some investors look for the November election results to be market-moving. But with the odds favoring a split Congress (which could preclude any major policy changes), the outcome of the Presidential race may not see much reaction in the markets.

Turmoil in the mid-East, and the ongoing conflict in Ukraine, remain unsettling to investors. But with global economic growth slowing (especially in China), a sustained spike in oil prices is probably not in the cards.

As for our portfolios, we are still looking to boost exposure to value stocks, especially in sectors that could benefit directly from lower financing costs. But we’re moving cautiously. Investors seem to be embracing both lower-priced growth stocks and lower-priced value stocks at the same time, suggesting that this market rotation may not be straightforward. On the bond side, remaining on the short end of the yield curve still seems appropriate, as it’s not yet clear where long-term interest rates are headed.

Sincerely,

Jack Bowers
President & Chief Investment Officer