If something cannot last forever, it will end.
– Herb Stein; Economist
For investors in U.S. equities, November was indeed a month to be thankful for, with the S&P 500 rising 5.9% for the month and 28% year-to-date, yet even that stellar return was exceeded by the MidCap 400’s 8.8% and the SmallCap 600’s 10.9% November returns. MarketWatch headlined its story describing the month’s market action, “Dow 45,000 is just the start as the stock market looks to December’s seasonal gains,” using the image of an upward ascending rocket ship to reinforce its bullish view. Indeed, the Conference Board, in its monthly survey of consumer confidence regarding the likelihood of higher stock prices in 12 months, saw that index reaching its historical high in a series dating back to 1987. However, the party was confined to these fifty states, as the S&P indices tracking the performance of European, Latin American, and Asian stocks declined by 1.7%, 4.4%, and 4.7%, respectively. Increasingly, though, in the “forest” of global equities, it is “the tree” of U.S. equities that dominates, as the U.S. share of that index has doubled from 35% in 1995 to its current representation of 70%.
This month’s bipolar return of domestic and foreign equities likely reflects the outcome of the November 5th U.S. presidential election, with the winner of that contest having run on a platform promising the aggressive use of tariffs to address the issue of our nearly $1 trillion annual trade deficit. The real significance of discussing the employment of what is essentially a tax on U.S. imports may be its possible foreshadowing of the end of a global financial system that extends all the way back to 1971, in which the U.S. dollar has served as the global reserve currency. This system has not been without its benefits for the United States, but the cost of those benefits may have reached a price that neither this country nor the rest of the world can continue to pay.
A growing global economy requires an ever-increasing supply of money, and most of the money that is needed is, drumroll please…the U.S. dollar. The source of the supply to meet that increasing demand for dollars is the U.S. trade deficit, which leads to our importing the world’s tradable goods and the exporting of our dollars. The rest of the world cannot spend those dollars in their own countries, so those dollars owned by foreign interests are used to purchase U.S. financial assets, the supply of which is augmented by our ever-larger federal budget deficits and the increased issuance of U.S. Treasury securities. Fortunately for investors in the U.S. stock market, a portion of that inflow of foreign capital is used to purchase U.S. equities, which helps explain the value of our stock market growing at a rate five times greater than our economy over the past forty years. This trend is also reflected in foreign interests, which owned a value of U.S. dollar-denominated assets equivalent to 10% of the size of our economy in the year 2000, having seen that share rise to its current level of 80%.
As mentioned above, the current “regime” has not been without its benefits for this country and its people. U.S. corporations, which contribute significantly to our trade deficit, have experienced rising profit margins through their employment of lower-cost foreign labor. The financial services industry (a.k.a. “Wall Street”) has certainly benefited, as have U.S. geopolitical interests, as evidenced by the thirty-seven countries currently subject to some form of economic sanctions by this country. However, the negatives have grown to such a level that they now pose a rising threat to the well-being of this nation. The wealth of U.S. households has risen dramatically in the past forty years, but the inflation-adjusted income of the average U.S. household has scarcely grown. The interest on our federal debt now exceeds the size of our defense budget. The United States Navy has been forced to significantly extend the number of years needed to implement its shipbuilding programs due to the “hollowing out” of this nation’s industrial base and the resulting lack of capacity to build those ships. As the benefits of the U.S. dollar-based system are enjoyed by a shrinking share of our population, an increasing proportion of the U.S. population demanding change has grown.
The incoming administration intends to reduce this country’s trade deficit through the use of tariffs, but this is a conversation about an effect without addressing its cause. Like many discussions, this one will likely both broaden and deepen over time to focus on the cause, and as it does, it will serve as a signpost indicating that we are drawing closer to the end of a now fifty-year-old system and the onset of the creation of the one destined to succeed it. It may be global central banks’ sale of $225 billion in U.S. Treasuries and $500 billion purchase of gold in 2023, as well as its 50% rise in price over the past three years, outpacing even the S&P 500’s 39.6%, that provides indications of what that system may be.
50/50 portfolios returned 3.3% for the month, offsetting the negativity of October and leaving portfolios now up 17.35% year-to-date. Equities returned 5.1%, with the outperformance of small-cap stocks offsetting the negative returns of foreign equities, allowing that asset class to come close to, if not quite reaching, that of the S&P 500. The fixed income and “other” half returned 1.5%, aided by the mid-month reversal in interest rates, allowing fixed income to add a bit of price appreciation to their cash flow. Year-to-date, equities have returned 21.7% and fixed income and “other” 13%, so for 2024, investors are thankful for an early Christmas!
Mark H. Tekamp