Insight Archives - Servant Financial

2025 Market Outlook

Written January 2, 2025January 3, 2025 by John Heneghan

As we close another calendar year, it’s human nature to look forward to the approaching new year and share views on the 2025 outlook. Let’s start this short year-end missive with a review of current economic conditions, followed by a summary of Servant Financial’s asset allocation views. We’ll share some contrarian market views and some expert predictions on potential 2025 pyrotechnics for Bitcoin.

Current Economic Conditions

While longer-term Treasury yields remain elevated yet relatively stable, wage growth continues to be robust, and housing inflation remains persistent. Inflation is likely to exceed 2% through at least the first half of 2025. Despite these pressures, gradual interest rate cuts from the Fed are still anticipated in 2025.

Headline inflation rose by 2.7% year-over-year in November, as expected, while core inflation remains persistently high at 3.3%; both measures increased by 0.3% month-over-month. While headline, core, food, and medical care inflation are trending higher, shelter inflation is slowly easing, with housing inflation declining on a month-over-month basis. The 10-year Treasury yield initially dropped on the in-line CPI print and warmer-than-expected PPI reports but later rebounded.

November’s PPI exceeded expectations, rising 3.0% year-over-year compared to the 2.6% estimate. Wholesale food inflation was a key contributor. The Fed cut its benchmark interest rate by 0.25% at its last meeting on December 18th, bringing the 2024 rate reductions to a total of 1.0%. An additional 0.75% in cuts are expected by markets in 2025 with the first 0.25% cut in March 2025 and the equivalent of three 0.25% cuts over the remainder of the year.

Economic growth is expected to be supported by consumer and government spending, particularly in the first quarter of 2025. Consumer spending remains resilient, largely driven by higher-income households. Although consumer loan delinquency rates have shown some stabilization, they remain elevated, especially among younger demographics. Meanwhile, the healthcare sector faces potential transformative changes, with the new Trump administration considering spending cuts amid ongoing industry challenges and years of underperformance.

Asset Allocation

With equity valuations remaining relatively unattractive by traditional valuation metrics and a wide range of potential geopolitical, policy, and economic outcomes on the horizon, sticking to first principles is key as we turn the page on another year and another occupant in the White House. We intend to remain focused on broad asset class diversification, avoiding unnecessary risks, and potentially fading extremes in asset classes and sectors (healthcare). We maintain that diversification should include healthy exposures to risk and minimal longer-term bonds (given that lower long-term interest rates and bond price upside appear limited). We anticipate significant regulatory changes in two key areas. Bitcoin and digital assets, where the regulatory and political winds appear very constructive. And healthcare, where the regulatory and policy changes are likely to be adverse.

Please see the linked slide below for a more detailed discussion of asset allocation views.

Asset Class Outlooks

Contrarian Market Views

Major Wall Street firms’ 2025 outlooks (based on simple word counts of published research) have primarily favored artificial intelligence (AI), China’s economic recovery, and midstream energy plays. Meanwhile, Bitcoin, biotech, nuclear/uranium, and small caps appear to be under Wall Street’s radar (or not on their books for sale.)

Of these contrarian asset class plays, we believe Bitcoin and the digital asset class more broadly have considerable tailwinds from the change at the White House, going from a clearly antagonistic regime to one that is clearly supportive of American technological innovation and a transparent, clear regulatory framework.

Bitcoin Friendly Nominees

The following triumvirate of Trump 2.0 nominees suggests a strong foundation for the further institutionalization of Bitcoin and digital assets in 2025 and beyond.

David Sacks, Digital Asset (and AI) Czar – David plans to provide regulatory clarity for the Bitcoin and crypto industry, focusing on compliance, taxation, and operational guidelines to enable sector adoption and growth in the U.S. Sacks seeks to position the U.S. as a global Bitcoin & cryptocurrency leader, supporting Trump’s vision of making America the “Bitcoin capital of the planet,” with a more transparent and clear regulatory approach.

Scott Bessent, Treasury Secretary – Bessent has been advocating for tax cuts, reducing government spending (and deficits), strong national defense, targeted and gradual tariffs, and a focus on lowering inflation. He plans to preserve the dollar’s global reserve currency role but has not publicly stated how Bitcoin fits within that mandate. Bessent emphasizes that deficit reduction is essential, starting with fiscal reforms. He has proposed a “3-3-3” target, aiming to achieve 3% economic growth, a reduction in the deficit to 3% by 2028, and an increase in daily oil production by 3 million barrels.

Paul Atkins, SEC Chairman – Atkins is anticipated to steer the SEC towards a more deregulatory approach, reversing many of prior SEC Chair Gensler’s inconsistent policies. Atkins has a strong pro-Bitcoin & cryptocurrency stance, advocating for a clear regulatory framework for digital assets. He has criticized Gensler’s aggressive enforcement actions against crypto firms and has emphasized the need for tailored rules that address the unique challenges of this sector.

Bitcoin Predictions

Galaxy Digital Asset Management controls $4.9 billion in digital assets and recently shared their 2025 predictions for Bitcoin and digital assets:

Bitcoin will cross $150k in the first half of 2025 and test or best $185k in the 4^th
The U.S. spot Bitcoin ETFs will collectively cross $250 billion in AUM in 2025.
Bitcoin will again be among the top performers on a risk-adjusted basis among global assets in 2025. The following is a chart for 2024 through December 20^th

At least one top wealth management platform will announce a 2% or higher recommended Bitcoin allocation.
Five Nasdaq 100 companies and five nation states will announce they have added Bitcoin to their balance sheets or sovereign wealth funds.
More than half the top 20 publicly traded Bitcoin miners by market cap will announce transitions to or enter partnerships with hyperscalers, AI, or high-performance computing firms. Hut 8 (NASDAQ: HUT), a small allocation in the most risk-tolerant Servant client models, has already made strategic announcements in this area.
The world’s top four custody banks will custody of digital assets in 2025. The Office of the Comptroller of the Currency (OCC) will create a pathway for national banks to custody digital assets, leading the world’s top four custody banks to offer digital asset services: BNY, State Street, JPMorgan Chase, and Citi.
The U.S. government will not purchase Bitcoin in 2025, but it will create a stockpile using coins it already holds, and there will be some movement within the departments and agencies to examine an expanded Bitcoin reserve policy.

If only a portion of Galaxy’s explosive Bitcoin predictions come to fruition, 2025 will be a good year for holders. We wish you a Merry Christmas and Happy Holidays. May you find time to relax, recharge, and celebrate the joy of the season with your friends and family.

As is our custom, we’ll be making an annual charitable contribution to Mercy Home for Boys & Girls. We’re looking forward to seeing you in the New Year.

Trump Era 2.0, Donald’s Version

Written November 27, 2024 by Ailie Carlene Elmore

The stage is set, the self-tanner is more orange than ever, and the star of the show has arrived. Donald Trump was elected the 47th President of the United States on November 5, 2024, winning both the popular vote and the Electoral College. Largely fueled by Rural America, President Trump’s victory sent shock waves worldwide, impacting both voters and financial markets. The equity and crypto markets seemingly embarked on a love story with the president-elect, as his potentially business-friendly tax policies and the most pro-crypto treasury stance propelled these asset classes to immediate gains. However, not all asset classes were enchanted by Trump’s victory. Concerns over the president-elect’s plans to Make America Healthy Again and potential healthcare reforms have caused Big Pharma and the healthcare sector to tumble, leaving many wondering, “Is it over now?”

It is a fool’s errand to try and predict what the next four years will hold, but we can make some forecasts about financial markets and sector performance based on Trump’s policy statements before, during, and after the election. Before diving into those projections, however, we must first revisit the president-elect’s first term in office as a prequel.. Are you ready for it?

The First Era

Donald Trump served as the 45th President of the United States from 2017 to 2021, defeating Democratic nominee Hillary Clinton in a historic election. Trump was the first president without prior experience in public office or the military, bringing a unique background in corporate America and reality television to the role. Comparing the red and blue maps of the United States from 2016 to today reveals a strikingly similar picture, with the notable exception of the swing state of Nevada. Shifts in the Electoral College reflect changes in population, as many Americans have moved away from traditionally blue states like California, New York, and Illinois to traditionally red states such as Montana, Texas, and Florida.

Source: AP Poll

Diving into the key events of Trump’s first administration, there are a few notable policy shifts that are likely to set the stage for the direction of his next term. Perhaps, his most significant fiscal policy shift, the Tax Cuts & Jobs Act of 2017 lowered individual and corporate tax rates across the board that the Biden administration has largely left untouched. The act increased the standard deduction from $6,350 to $12,000, raised the child tax credit by $1,000, reduced corporate tax rates from a range of 15%–39% to a flat 15%, and introduced the Opportunity Zone program.

Source: CNBC

While these policies reduced the tax burden for many Americans, some of President Trump’s other policy decisions were generally viewed as less favorable for the environment. Known for his critical stance on international climate agreements, Trump withdrew the United States from the Paris Agreement on Climate Change. At the same time, he expanded domestic oil and natural gas production in U.S. waters and near public lands while encouraging private investment in traditional energy resources.

Frustrated by large trade imbalances with China and Chinese infringement of U.S. intellectual property rights, Trump initiated a trade war with one of America’s largest trading partners. He imposed significant tariffs on Chinese goods, costing American households an average of $625 annually and increasing tax collections by $200 to $300 per household. Notably, his successor, Joe Biden, maintained most of these tariffs, with the exception of a few policies related to the EU and Japan.

One of the biggest casualties of these tariffs was American agriculture. A U.S. Department of Agriculture study found that retaliatory tariffs led to a $27 billion decline in U.S. agricultural exports between mid-2018, when the tariffs were introduced, and the end of 2019. The federal government provided $23 billion to U.S. farmers through the Market Facilitation Program to mitigate the impact on flat commodity markets and low export volume.

**Who was The Man?**

It is not uncommon for the incoming president to be compared to the outgoing one. So, as we compare Donald Trump with Joe Biden, we might be asking who was our fearless leader and our alpha type? Looking at the numbers behind each administration, we see a varied picture. While inflation was certainly higher under Biden, Trump added more to the federal debt level than the outgoing President. Both presidencies were impacted by the effects of the COVID-19 pandemic and despite varied economic conditions GDP growth was similar under both administrations. The S&P 500 saw greater gains under the former business executive, Donald Trump, and more recently the S&P 500 has rewarded investors by returning 18% since his re-election. While there historically isn’t a strong correlation between the political party in office and the performance of the stock market, Trump’s tax plans for corporate America have created an early indicator of what might be to come in the next 4 years.

	Trump	Biden
GDP Growth	2.3%	2.2%
Inflation	1.9%	5.4%
Average Unemployment Rate	5.04%	4.11%
S&P 500 Return	16.3%	12.6%
Increase in Federal Debt Level	39%	29%
Average Gas Price	$2.57	$3.60

Era 2.0

But on Wednesday, after the election was called, we saw it Begin Again. President Trump’s second term is likely to be a bigger show with lots of friendship bracelets exchanged this time around. There are several key aspects to Trump’s Policy 2.0 plans that financial markets will likely be paying close attention to. Below is a summary of his many and varied fiscal policy intentions floated during his election campaign:

Lower corporate income tax from 21% to 20%
Lower corporate income tax rate to 15% for those who make their products in the U.S.
Increase child tax credit to $5,000
Exempt Social Security benefits from taxation
Exempt tip income & overtime pay from taxation
Create a deduction for auto loan interest
Create a tax credit for family caregiver
Eliminate green energy subsidies from Inflation Reduction Act
Tax large private university endowments @ 1.4%
Impose universal baseline tariffs on US imports of 10% to 20% and/or reciprocal tariffs
Impose a 60% tariff on all US imports from China

Both Donald Trump’s and Kamala Harris’s plans were likely to add to the federal deficit with Vice President Harris’s plan likely adding $3.95 trillion to the federal deficit and President-elect Trump’s plans adding $7.75 trillion. It will be interesting to watch the possible impact of Trump’s new Department of Government Efficiency (DOGE) led by billionaire technologists Elon Musk and Vivek Ramaswamy. The pair aim to cut at least $500 billion in annual spending, but there are lingering questions about how DOGE recommendations to control federal spending will be implemented and sustained.

Perhaps one of the most widely discussed policy proposals of this past election has been Trump’s position on tariffs. Economists estimate that if the tariffs are raised to his proposed level, it will add 0.9% to the rate of inflation with increased costs being passed on to consumers. The tariffs are also expected to cost U.S. Farmers somewhere between $0.9 – $1.4 billion. However, many believe Trump’s tariff plans are just a negotiating tactic part of a broader geopolitical and economic plan. For example, Trump recently announced that he will immediately slap 25% tariffs on all goods imported from Canada and Mexico until the shared borders are secured to prevent illegal drugs and immigration into the United States.

In last month’s article, we discussed some of the likely stock market winners and losers under a Trump regime. Those “winners” have experienced large equity gains in associated companies over the past few weeks. Elon Musk’s Tesla has experienced a 40% increase since Trump’s victory and Bitcoin has soared to almost $100,000 causing sparks to fly across financial markets. Nuclear energy, banks, and defense and weapons companies have also shown gains in recent weeks.

In the end, we know all too well that “nothing safe is worth the drive.” As we embark on Trump Era 2.0- Donald’s Version, the world waits with bated breath, balancing hopes for economic prosperity with concerns over inflation, global relations, and deep state countermeasures. His proposed fiscal policies, the bold strokes of a self-proclaimed disruptor, could “paint the town blue,” but at what cost? Some industries are singing their “Love Story” with large market gains, while others brace themselves, wondering if perhaps “we are never ever getting back together” with normalcy.

As we analyze the past to forecast the future, let’s remember that every stage of history is unpredictable. We’re all just “dancing with our hands tied,” hoping to weather the storm. Whether you’re cheering or jeering, this Trump Era 2.0 promises to be remembered “all too well.” It will either unite us or drive us further apart. As Abraham Lincoln declared, “A house divided against itself cannot stand… I do not expect the Union to be dissolved. I do not expect the house to fall, but I do expect it will cease to be divided. It will become all one thing or all the other.”

Polymarket Predictions and Policy Perturbations

Written November 4, 2024 by John Heneghan

With less than 30 days remaining before the 2024 Presidential and other elections on November 5th, investors’ eyes are focused on the electoral outcomes and the potential market impacts.

The Presidential race remains very tight between Vice President, Kamela Harris, and former President, Donald Trump. It appears that the path to the White House will hinge on just seven key swing states: Nevada, Arizona, Michigan, North Carolina, Wisconsin, Georgia, and critically important Pennsylvania with its 19 electoral votes. Current trends and polls suggest the path to 270 electoral votes will be difficult for either candidate without securing Pennsylvania. Perhaps we now know why it’s called the Keystone State.

We begin by introducing subscribers to Polymarket for an alternative perspective on the electoral college and what we the people are collectively thinking. Polymarket is the world’s largest prediction market. It provides registered traders the opportunity to profit from their beliefs and insights by betting on the outcome of future events across various topics such as politics, sports, and pop culture. Polymarkets reflect accurate, unbiased, real-time probabilities for significant global events. Note, however, Polymarket is unavailable to U.S. residents of the United States because it has not obtained appropriate license(s) from the Commodity Futures Trading Commission.

According to Polymarket, research shows prediction markets are often more accurate than polls or pundits. Polymarket traders aggregate news, polls, and expert opinions, making informed trades with the expectation of profit. Traders’ economic incentives ensure market prices adjust to reflect “true” odds. Polymarkets always seek the truth (Latin: “semper veritas”). According to Polymarket, this makes prediction markets one of the best sources of real-time event probabilities.

So, without further ado, we present the Polymarket U.S. Presidential election market predictions as of 8:30 am on Thursday, October 10, 2024, below:

Source: Polymarket https://polymarket.com/event/presidential-election-winner-2024?tid=1728566107442

Note that there is $1.6 billion of volume on this particular polymarket. The market rules provide “This market will resolve to “Yes” if Donald J. Trump wins the 2024 US Presidential Election. Otherwise, this market will resolve to “No.” The resolution source for this market is the Associated Press, Fox News, and NBC. This market will resolve once all three sources call the race for the same candidate. If all three sources haven’t called the race for the same candidate by the inauguration date (January 20, 2025) this market will resolve based on who is inaugurated.”

Let’s now look at the potential market perturbation each candidate’s policies may have on equity markets. In the long run, there is little evidence suggesting that the political party elected has a directional influence on broad markets. U.S. Bank investment strategists examined market data over the past 75 years and concluded that financial market performance in the medium to long term is minimally impacted by election outcomes. The big drivers of financial market performance remain inflation indicators and broad economic trends.

In the short run, however, specific sectors can benefit based on who is in office and their policies in place. Once again we find that Goldman Sachs is doing “God’s work” and has developed proprietary equity portfolio baskets for each candidate with a Democratic victory basket and a Republican victory basket. Given their proprietary nature, the equity basket securities are not broadly available publicly, but various market participants have provided a general overview of sector preferences and hypothetical stock picks that might be influenced by the policies favored by each party. Please note that we are simply citing conjecture with the foregoing individual stock and ETFs cited. We have conducted limited research and these securities absolutely do not represent recommendations:

Democratic Victory Basket:

Renewable Energy: Solar, wind, and other green technology companies, like First Solar Inc (ticker: FSLR) or iShares Global Clean Energy ETF (ticker: ICLN), due to anticipated continued emphasis on environmental regulations and the funding of “community-based climate projects.”
Healthcare: Companies that might benefit from healthcare reform or expansion, like those involved in Medicaid programs, such as a large managed care organizations (MCOs) like Elevance Health (ticker: ELV) or iShares U.S. Healthcare Providers ETF (ticker: IHF), or health technology leaders, like Boston Scientific (ticker: BSX) or iShares U.S. Medical Devices ETF (ticker: IHI).
Technology: While tech is often considered bipartisan, Democrats might push for more tech regulation on “misinformation or disinformation” while at the same time supporting innovation in certain tech subsectors, especially those linked with green tech or social platforms with obedient, progressive companies, like Meta Platforms, Inc. (ticker: META).
Consumer Discretionary: Companies that might benefit from policies aimed at increasing minimum wages or enhancing consumer protections. This basket might potentially include companies like Target (ticker: TGT) or other companies with strong ESG (Environmental, Social, and Governance) practices such as those represented in the iShares ESG Aware MSCI USA ETF (ticker: ESGU). ESGU represents a potential Democratic trifecta basket in and of itself with 34% allocation to technology, 16% to consumer businesses, and 12% to healthcare.
Education: Companies related to education technology or services, like Coursera, Inc. (ticker: COUR) might also see benefits due to potential increases in educational spending.
Infrastructure with a focus on Sustainability: Companies that work on modern infrastructure, including smart cities, electric vehicle infrastructure, etc. Such companies may be found in the First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index ETF (ticker: GRID)

Republican Victory Basket:

Financials: Banks and financial institutions often benefit from deregulation, which tends to be a Republican policy initiative. Companies like JPMorgan Chase & Co (ticker: JPM) or The Financial Select Sector SPDR Fund (ticker: XLF) could be included.
Energy: Traditional energy and fossil fuel sectors, like oil and gas companies, might be favored due to lower emphasis on environmental regulations with a “drill baby drill” mindset. Think of companies like ExxonMobil Corporation (ticker: XOM) and The Energy Select Sector SPDR Fund (ticker: XLE).
Defense: Although the world was mostly a peaceful place under the 45^thS. President, increased defense spending has historically been associated with Republican administrations. Lockheed Martin (ticker: LMT) or Invesco Aerospace & Defense ETF (ticker: PPA) could be examples. (Personally, I would fade the defense sector as an area of potential focus under Elon’s Government Efficiency Commission since it has the greatest potential for taxpayer savings.)
Industrials and Materials: With policies often focusing on infrastructure or domestic production, companies in these sectors might benefit. Freeport-McMoRan Inc. (ticker: FCX) or SPDR S&P North American Natural Resources ETF (ticker: NANR) may be included.
Pharmaceuticals: Less focus on regulating drug prices could be seen as positive for big pharma. Consider companies like Eli Lilly and Company (ticker: LLY) and The Health Care Select Sector SPDR Fund (ticker: XLV). (Personally, I think of this sector as an area of risk given Robert Kennedy, Jr. grand alliance with Trump and his focus on Making America Healthy Again.)
Bitcoin/Crypto: Trump is expected to lay out “a plan to ensure the United States will be the crypto capital of the planet.” Consider Fidelity Wise Origin Bitcoin Fund (ticker: FBTC) and Fidelity Crypto Industry and Digital Payments ETF (ticker: FDIG) which includes Coinbase Global, Inc. (ticker: COIN) and several bitcoin miners.

Please note that Goldman Sachs also offered proprietary short baskets for each party, but we have only summarized Goldman’s longs.

Whether or not you accept the “veritas” of Polymarket, you may be interested in another good exchange of real-time event probabilities with the handicapping being done by capital market investors. The graphic below presents the relative performance of Goldman’s Victory Baskets through October 9, 2024:

Source: Zero Hedge https://x.com/zerohedge/status/1844168635000160748

As the chart above depicts, markets are constantly re-handicapping probabilistic outcomes. There is still plenty of race left in this two-horse contest as we come around the bend into the home stretch. Voter turnout will be critically important, particularly turnout among young voters. This cohort has typically left political decisions more in the reins of their elders and has historically demonstrated lower participation rates. Since 1988, voter turnout amongst those aged 18 to 29 years has averaged 42%, compared to 56% for those aged 30 to 44, 66% for those aged 45 to 59 years, and a 69% voter turnout for those 60 years and older. As the pundits are wont to say, veritas is stranger than fiction. We’ll all just have to see what happens.

“This is the chief thing: be not perturbed, for all things are

according to the nature of the universal.”

~ Marcus Aurelius

Fed Sends Mixed Messages

Written September 29, 2024 by John Heneghan

On September 18th, the Federal Reserve cut interest rates by 50 basis points, marking the beginning of a new rate-cutting cycle. Historically, such a large initial rate cut has typically been reserved for times of economic crisis. Updated economic projections provided by the Fed, referred to as the “dot plots”, indicate that the Fed now anticipates a higher ending 2024 unemployment rate (4.4% vs. 4.1%), higher GDP growth (2.0% vs. 1.4%), lower inflation as measured by the Personal Consumption Expenditure (PCE) index (2.3% vs. 2.4%), and a reduced 2024 year-end Federal Funds rate (4.4% vs. 4.6%) compared to its December 2023 forecasts. These updated forecasts hardly suggest any economic downturn or crisis is around the corner. Both the bond market and the Fed expect an additional 50 basis points in cuts by year-end, implying a 25 basis-point reduction at each of the two remaining Federal Open Market Committee (FOMC) meetings this year.

The Fed’s 50 basis-point cut lacks clear justification based on currently available economic data. Core and headline inflation continue to exceed the Fed’s 2% target, and base effects and housing dynamics suggest that core inflation could remain sticky. Further, on September 26^th, the U.S. Bureau of Economic Analysis reported that U.S. GDP grew at an annual rate of 3.0% for the second quarter of 2024. This final 2Q24 GDP figure was revised upward from the initial estimates and reflects healthy economic growth, driven by strong consumer spending, an upturn in private inventory investment, and business investments. Additionally, financial conditions are at their lowest since May 2022, and jobless claims continue to fall. Initial jobless claims in the U.S. fell to 218,000 for the week ended September 21, lower than analyst estimates of 223,000 to 225,000. The latest jobless claims represent a four-month low, indicating a stronger labor market than some analysts and perhaps the Fed anticipated. In addition, the latest Bank of America Fund Manager Survey shows that over 50% of respondents do not foresee a U.S. recession within the next 18 months, i.e.. the consensus expectation remains for a soft landing.

The Fed’s decision to cut interest rates by 50 basis points last week has sent mixed messages to the markets. The ensemble of market reactions suggests the Fed has ignited risk-on behavior.:

Stock Market: Initially, there was a muted or even negative reaction in the stock market. This might seem counterintuitive because rate cuts are typically viewed as positive for stocks due to lower borrowing costs which can stimulate growth. However, the immediate dip could be attributed to investor concerns that the larger-than-expected cut might indicate the Fed’s worries about underlying economic weaknesses, particularly concerning the labor market. However, following the initial confusion, there has been a meaningfully positive reaction with stocks rallying sharply as market consensus moves toward the assessment that the Fed does not have any inside information on data portending broad economic weakness.
Bond Market: The bond market showed a significant and immediate reaction with the 10-year Treasury yield spiking to 3.78% on September 26th from 3.64% the day before the Fed’s rate cut. The bond market seems to be repricing for higher expected inflation and/or stronger economic growth in the longer term post the Fed’s cut.
Gold: Gold spiked to an all-time high on September 26th by topping $2,700 per ounce for the first time in history. This signals both the possibility of a Fed dovish policy mistake and safe haven buying in response to the escalation of the wars in Ukraine and the Middle East.
Bitcoin: Likewise, bitcoin, or digital gold, has popped above $65,000 and is up almost 4% on the 26th. For market technicians, the $65,000 price per bitcoin represents a key technical level with many analysts suggesting that a breakthrough of this level may signal the beginning of another epic run. Today’s price appreciation may signal the start of a run to Bitcoin’s all-time high, previously set in November 2021 at approximately $69,000. Pop zing!
Energy Markets:
1. Oil: Oil prices have shown limited volatility as of late. Brent crude has been range-bound around $75 per barrel. There’s some underlying sentiment of a bear market in oil, with some hopes pinned on-demand increases or external stimuli like actions from China to boost prices. Escalation of the Middle East war between Israel and Iran’s Hezbollah proxy in Lebanon could drive increased risk premiums into oil prices.
2. Natural Gas: Natural gas experienced a significant jump, with futures up over 8% recently, possibly due to the aforementioned geopolitical tensions in the Middle East or expectations of increased demand from electricity producers looking for energy resources to satisfy the growing demand for Artificial Intelligence computing capacity.
3. Uranium: Uranium has seen quite dramatic swings in prices in 2024. The spot price of uranium has decreased by (11.6%) since the beginning of 2024, reaching around $80 per pound as of late September, after hitting a 16-year high earlier in the year due to increased demand and tight supply. Despite this year-to-date decrease, uranium has been the best-performing energy commodity year-over-year, despite its decline from a peak of $106 in February 2024. The supply-demand imbalances in uranium are long-term in nature as it takes around a decade to bring new supply online. As we’ve outlined previously, there is strong interest in uranium due to its role in nuclear power production, especially with global pushes towards decarbonization and the “greening” of nuclear energy. Uranium prices and Sprott Uranium Miners ETF (URNM) have been raging as of late. URNM is up about 13% since the last FOMC meeting.

X Grok AI rendering of Three Mile Island nuclear plant

Last week, BlackRock, Global Infrastructure Partners, Microsoft, and MGX announced an AI partnership that could invest up to $100 billion in U.S. energy infrastructure and data centers. Additionally, Constellation Energy signed its largest-ever power purchase agreement with Microsoft, adding 835 megawatts of carbon-free, nuclear energy to the grid. Microsoft’s long-term offtake commitment catalyzed the restart of the decommissioned Three Mile Island nuclear plant in Pennsylvania, with key permits still required. The deal is projected to contribute $16 billion to Pennsylvania’s GDP and generate over $3 billion in taxes.

Prince fans will remember an analogous Fed policy instance that occurred in 1999. At the December 21, 1999, FOMC meeting, the Fed kept interest rates unchanged, citing uncertainties around the century date change across the nation’s information processing systems. Nearly a year later, in January 2001, the Fed began cutting rates, starting with a 50 basis-point reduction due to weakening production, declining consumer confidence, tightening financial conditions, and high energy prices. At that time, jobless claims and headline inflation were higher than today. Core inflation and manufacturing activity were lower. The price-to-earnings (P/E) ratio of the S&P 500 was 30.1x, compared to 27.5x today. However, the technology sector’s price-to-sales ratio is currently over 30% higher than it was during the peak of the 2000 Tech Bubble. The top 10 companies in the S&P 500 now make up 34% of this large-cap index, compared to 25% at the height of the Tech Bubble.

Servant Financial’s market commentary and portfolio recommendations for this 1999-like party atmosphere are as follows. S&P 500 valuations appear rich using metrics like the Shiller P/E ratio. Further, yield-to-earnings comparison (the inverse of the P/E ratio versus bond yields) suggests U.S. stocks are less attractively priced relative to bonds than at any time since the 1990s and are reminiscent of conditions before the dot-com bubble. For now, looser financial conditions introduced by the Fed (characterized by lower interest rates, higher liquidity, and easier credit) may end up keeping the ‘party’ going for some time, but no one knows for sure. We will continue to keep a watchful eye on the adults (10-year Treasury yield and gold) and the underage, yet savvy teenager (bitcoin) for messages and clues that things are getting out of hand and it’s time to leave the party. We’ll also keep an eye on inflation rates, shifts in Fed policy guidance, or significant geopolitical events that could also serve as catalysts for a change in market dynamics.

In light of these economic uncertainties, we believe it’s prudent for investors to continue to maintain globally diversified portfolios. Globally diversified portfolios are comprised of traditional investments in stocks and bonds but importantly also include diversifying assets like gold, silver, shares in gold miners, bitcoin, and real assets such as uranium and farmland. These assets offer a hedge against inflation, and currency fluctuations, and provide portfolio stability during periods of market volatility.

Little Ditty About Gold

Written August 26, 2024August 31, 2024 by John Heneghan

In the investment world, it is often said, “It is better to fail conventionally than to succeed unconventionally.” Investors’ attitudes have been shaped over the last four decades to believe that the best portfolio strategy is to simply invest in a traditional benchmark 60/40 stock-bond portfolio. The Wall Street mantra to buy “stocks for the long run,” balanced with an allocation to government and corporate bonds for their stability and safety of income reigns in investment advisory circles. As we noted in last October’s “Got Gold?”, modern investment portfolios have generally been constructed with gold absent from the asset allocation, despite gold’s long history of portfolio diversification benefits and as a hedge against inflation and geopolitical risks. For example, around 71% of U.S. advisors have less than 1% exposure to gold. And only 2% of U.S. advisors had between 5% and 10% of gold exposure in portfolios, with none having an exposure exceeding 10%, according to Bank of America Global Research.

Luminary investor Peter Lynch, portfolio manager of the highly successful Fidelity Magellan Fund and writer of “One Up On Wall Street: How To Use What You Already Know To Make Money In The Market” takes a decidedly balanced approach to investing. He often condensed his commonsense approach to “Never invest in anything you can’t illustrate with a crayon.” He further advised that if you cannot summarize your investment thesis in a concise two-minute elevator speech (or convey your thesis through a short song or ditty), then you should simply move on.

Crayon Illustration

Our fanciful, fictional “crayon illustration” this month begins by time traveling back to the 1980s to a tune about “Two American kids growin’ up in the heartland.” A rural upbringing with its Tastee-Freez pop culture instilled in our young lovers a great appreciation for scarce assets like gold, farmland, and true love. In fact, the singer-songwriter in our tale was a co-founder of the Farm Aid concert fundraiser in Champaign, Illinois in 1985 along with Willie Nelson. Of course, we’re talking about John Cougar Mellencamp and his little ditty about Jack and Diane. Let’s imagine that our young Jack and Diane developed an unconventional investment plan back in 1982 after their “little ditty” got some AM/FM radio airtime.

These “two American kids growing up the heartland” just “doin’ the best they can” did some napkin illustrations while eating their $1.50 chili dogs. Today, a gourmet chili dog costs $5.19 at Portillo’s, or 3.5 times the price of a chili dog in 1982. Jack and Diane took a portion of the royalties from their certified gold single (1 million in unit sales) and decided to invest it in a scarce asset with stable, enduring value across time and cultures.

“Jackie sits back, collects his thoughts for the moment. Scratches his head and does his best {Peter Lynch}. “Well then, there Diane, we oughta {just buy some gold.} “Diane says, Baby, you ain’t missin’ a thing.”

Jack has been thinking about his awesome good fortune of a number one single and so they buy a single gold bar at the average price of gold in 1982 of $447 an ounce for a total investment of $179,000. Our hopelessly romantic young lovers bury that gold bar behind their favorite “shady tree” on the generational family farm for safekeeping.

Today, that gold bar birthed from true love and a solid gold single about rural life in America is now worth a cool One Million Dollars! Gold’s spot price just surpassed $2,500 per troy ounce on August 16th, an all-time high. With gold bars typically weighing in at about 400 ounces, that makes Jack and Diane’s gold bar worth around $1 million, or 5.6 times its cost.

Source: Trading Economics

Got Gold Reflections

In our October 2023 gold report, we cited commentary from former Credit Suisse economist Zoltan Pozsar that appears to be quite prescient with the benefit of 10 months of hindsight:

Commenting further on the commodities allocation Pozsar echoed the words of Ray Dalio on “gold, inflation and growth”:

“Within that commodities basket, I think gold is going to have a very special meaning, simply because gold is coming back on the margin as a reserve asset and as a settlement medium for interstate capital flows. I think cash and commodities is a very good mix. I think you can also put, very prominently, some commodity-based equities into that portfolio and also some defensive stocks. Both of these will be value stocks, which are going to benefit from this environment. This is because growth stocks have owned the last decade and value stocks are going to own this decade. I think that’s a pretty healthy mix, but I would be very careful about broad equity exposure, and I would be very careful of growth stocks.”

Year-to-date through the week ended August 16^th, gold has indeed been shining with total returns of 19.4%, leading all major asset classes except Bitcoin. It’s been a safe haven’s dream, outperforming many traditional stock indices. VanEck Gold Miners ETF (GDX) and iShares Silver Trust (SLV) have also been showing some luster while playing some catch-up to gold over recent years with total returns of 27.7% and 23.8%, respectively, over the same period.

Bitcoin (digital gold) continues to be this decade’s top hit with total returns of 40.7% year-to-date. If gold is the old reliable of the 1980s, Bitcoin’s been the wild, unpredictable teenager of this era.

The midstream energy asset class nosed out U.S. large caps (S&P 500) with a total return of 17.6% compared to 17.5% for the S&P 500 over this period. The Magnificent Seven technology stocks, particularly Nvidia, have been responsible for a substantial majority of the S&P 500 year-to-date gains, with Nvidia alone skyrocketing by 162.2%.

With the Federal Reserve expected to embark on a rate-cutting cycle at its next meeting in September, ongoing wars in Ukraine and the Middle East, and Presidential candidates floating inflationary policy trial balloons like price controls (“inflation’s absolute best friend for life”), hiking and lowering of corporate income tax rates, tariffs on imports, taxing of unrealized capital gains, forgiveness of student loan debt, and free healthcare for all, Pozsar’s statement on inflation from that Got Gold? The article is also looking like a 24-karat prediction:

“Two percent inflation and going back to the old world, I don’t think it stands a snowball’s chance in hell. Low inflation is over and we’re not going back.”

Forward Positioning

With continued U.S. dollar purchasing power erosion due to inflation, gold continues to serve as a store of value, outperforming bonds over the past five decades as illustrated by our protagonists Jack and Diane. Gold has returned 7.9% annualized over the past 50 years, outperforming U.S. intermediate-term bond returns of 7.0%. Gold has also been one of the top-performing assets since the peak of the Tech Bubble in March 2000 with an annualized return of 9.2%, outperforming U.S. large-cap stocks’ total return of 7.8%.

Exhibiting low correlations with major asset classes and a positive correlation with inflation, gold can serve as a strategic portfolio diversifier. Demand from U.S. investors is starting to increase, while strong demand from central banks and geopolitical and financial risks have helped drive gold to all-time highs in 2024. While there are risks, current fiscal policies, geopolitical tensions, central bank dynamics, and expected easing in monetary policy could bode well for gold returns in the coming years.

Potential risks to gold include higher real interest rates and the emergence of Bitcoin as a potential mainstream alternative. Since 2016, Bitcoin has outperformed gold, although gold has outperformed very recently. The growing interest in Bitcoin among investors, particularly younger generations, may be cannibalizing gold demand. Servant Financial advocates a blended approach that includes physical gold, Bitcoin/digital assets, and gold miners as we seek to hedge portfolios for the inevitable erosion of purchasing power resulting from inflationary monetary policy.

Record gold prices and signs of cost stabilization have led to notable margin improvements for gold miners. Gold miner production has reaccelerated, with large miners seeing improvements in cash flow as capex has leveled out since the start of the year. Stock performance of the miners has also been improving, with gold stocks outperforming U.S. large-cap stocks in 2024. Given record gold prices, we see the potential for further production improvements at attractive margins. Servant Financial plans to maintain existing client portfolio exposures to gold miners but intends to trim positions if the current balanced sentiment on gold miners moves toward excessive bullishness.

Let’s close this golden ditty about Jack and Diane with a karaoke sing-along, “Oh, let it rock, let it roll. Hold some gold to save your souls. Holding on to sixteen as long as you can. Changes come around real soon, make us women and men.”

Inflation Conundrum: How to Protect Your Portfolio

Written July 16, 2024August 29, 2024 by John Heneghan

Stock Market and Inflation Trends

Stock indexes have continued their bull run in July ahead of the much-anticipated June Consumer Price Index (CPI) report. On July 10th, the S&P 500 and the Nasdaq Composite both closed at record highs, marking their seventh consecutive session of gains in July. The Dow Jones Industrial Average ended just shy of its own record close. Through July 10th, the S&P 500 was up 3% for the month, while the tech-heavy Nasdaq surged 4.9%, and the Dow added 1.4%

The continuation of risk-on attitudes were encouraged by Fed Chairman Powell’s July 9th comments in Congressional testimony before the Senate Banking Committee. Powell expressed caution about cutting interest rates, stating that the data does not yet support full confidence in the inflation path needed for a rate cut. He emphasized the need for more positive economic indicators to boost his confidence on the future path of inflation. Powell also warned that maintaining high interest rates for too long could negatively impact economic growth. On the other hand, he commented that prematurely easing monetary policy or easing too much could harm the Fed’s progress in taming inflation.

The Federal Reserve remains focused on achieving its 2% inflation target and is closely monitoring labor market conditions, which have shown recent signs of cooling but remain relatively robust. If you recall, May CPI came in much cooler than expected, which went a long way in restoring Wall Street’s faith that expected Federal Reserve rate cuts would happen in 2024.

The June Consumer Price Index (CPI) was reported on the morning of July 11^th,and it did not disappoint. CPI for all items decreased by (0.1%) in June 2024, which was below expectations of a 0.1% increase. This is the first negative month-over-month inflation print since May 2020. Year-over-year headline inflation for June of 3.0% now sits at a 12-month low. Core CPI, which removes more volatile energy and food prices, increased 3.3% from a year ago.

In response to the June CPI print, bond traders have increased the odds of a Fed rate cut by September 2024 to 83% from 67% odds before the deflationary June CPI inflation print. Exactly one year ago, the Fed stopped raising interest rates. Despite market and Fed expectations for at least one interest rate cut this year, U.S. inflation remains 100 basis points above the Fed’s 2% inflation mandate.

The next inflation update is the June PCE Prices Index on July 26, which is Fed’s favored inflation indicator. Additionally, there are two more CPI prints and one more PCE Price read due out before the Fed’s next meeting in September.

Bull vs. Bear

Bullish and bearish investors immediately began battling it out after the June CPI print as to whether inflation has been tamed by the Federal Reserve or not. Mastering of inflation is generally considered bullish for both bond and stock markets. Alternatively, the starting of a Fed easing cycle without putting a lid on inflation is considered bearish to both markets. The worst-case economic scenario is stagflation where we experience slowing economic growth, but inflationary pressures remain.

Risk capital began making its bets on July 11^th right away as capital made meaningful rotations by asset classes, equity market capitalization and sector, and geography.

Here is a heat map for the trading day for popular, domestic Exchange Traded Funds (ETFs):

Bond ETFs (AGG, +0.5%, LQD +0.5%, JNK +0.4%) as expected all responded positively to the deflationary CPI print. While the top-performing major equity benchmark was interest rate-sensitive small caps (IWM, +3.7%) on the day. Capital-hungry small caps have substantially lagged the S&P 500 (SPY, -0.9%) on a year-to-date basis by over 10%. The technology-heavy NASDAQ (QQQ, -2.2%) was the worst performer on the day along with the S&P 500 Technology sector (XLK, -2.5%) as investors booked profits and/or took some chips off the Magnificent 7 table. Interest rate-sensitive sectors within the S&P 500 had meaningful bounces with Real Estate (XLRE, +2.7%) and Utilities (XLU, +1.8%) the top performers.

It’s also worth noting that traditional inflation hedges like precious and industrial metals also did well with gold (GLD, +1.7%) and S&P Materials sector (XLB, +1.4%). The U.S. Dollar Index (DX-Y.NYB, -0.6%) traded lower against a basket of the other global fiat currencies. Fidelity Wise Origin Bitcoin Fund (FBTC, +0.1%) was flat, but China (FXI, 2.2%) was the top-performing international market on the day as the dollar weakness acts as a for sale sign on Chinese goods on international markets.

Relative to the S&P 500 decline on the day, noteworthy contributors to Servant Financial client models were Farmland Partners (FPI, +3.2%), gold miners (GDX, +2.8%), Sprott Physical Gold and Silver Trust (CEF, +2.0%), silver (SLV, 1.9%), high quality value-oriented large caps (DSTL +1.6%, BRK.B +1.2%, MOAT +1.1%) and uranium (URNM, 1.3%).

Protecting Your Portfolio

Inflation has remained stubbornly above 3% and well above the Federal Reserve’s official 2% policy target for more than three years. Over this period, the traditional 60%/40% (equities/fixed income) portfolio has struggled and may no longer be an appropriate default investment approach going forward.

The risks of continued persistent inflation above the Fed’s target inflation of 2% are considerable. The Federal Reserve is expected to begin an easing cycle at a time when the fiscal situation remains nothing short of precarious. As witnessed in the recent Presidential debate and in the discourse that followed, there is a complete lack of fiscal restraint being expressed by political leaders on either side of the aisle. The Congressional Budget Office recently estimated that the fiscal budget deficit was estimated at $1.9 trillion, or 7% of U.S. GDP, for the year ended June 30, 2024. The last time the deficit was this high as a percentage of GDP was during World War II.

Just to cite one conundrum reflecting Washington’s inability to responsibly govern, the Federation for American Immigration Reform testified before the House Budget Committee that American taxpayers pay $151 billion annually due to illegal immigration. The CBO estimated 2024 deficit of $1.9 trillion apparently does not fully account for the cost of illegal immigration at the state and local level or include discretionary costs and long-term entitlement costs associated with illegal immigration.

The prospects for a traditional 60/40 portfolio in a future resplendent with high and sustained inflation are worrying, particularly if inflation is like that experienced in the 1970s and early ‘80s stagflationary period. Servant Financial believes broadly diversified portfolios require a healthy allocation to inflation-protected assets like gold and precious metals, bitcoin (“digital gold”), real estate, high-quality large-cap equities, energy, and raw materials to weather any potential economic disturbances ahead. Specifically, Servant Core portfolio allocations to Real Assets, Infrastructure (energy), and Digital Assets range from approximately 9% for the most conservative client risk profiles to 25% for the most aggressive risk profiles. We also run a bespoke “best ideas” portfolio that has substantially all its assets invested in Real Assets, Infrastructure, and Digital Assets.

We close this article with a wise quote from another period of war, irresponsible governance, and economic injustice for the working class and poor in our nation.

“In this unfolding conundrum of life and history, there is such a thing as being too late. Procrastination is still the thief of time. Life often leaves us standing bare, naked, and dejected with a lost opportunity. The tide in the affairs of men does not remain at flood — it ebbs. We may cry out desperately for time to pause in her passage, but time is adamant to every plea and rushes on. Over the bleached bones and jumbled residues of numerous civilizations are written the pathetic words, “Too late.””

~ Martin Luther King, Jr., Beyond Vietnam — A Time to Break Silence

Delivered 4 April 1967, Riverside Church, New York City