Are we seeing an abrupt change in our bullish stance for 2025? Yes, somewhat. Let us explain.
Our position has been to expect a higher market by year-end with increased volatility, all against a backdrop of higher global liquidity and lower interest rates. To fact-check:
Global liquidity is indeed rising, led by a significant decline in the USD
The USD has fallen 2.5% during a 3-day consecutive period
Over the last decade, the USD has declined by more than 2.5% over a consecutive 3-day period only four times
The USD (DXY) reached a high of 108 against a basket of global currencies, but now trades at 103 and appears headed toward 96 or lower
While the US traditionally favors a strong dollar, an excessively strong dollar creates numerous global and domestic challenges. China and emerging markets welcome a dollar decline with China in particular able to issue new liquidity to support their flagging real estate market and consumer spending. At home, a strong dollar can trigger economic slowdowns in the US—which is precisely what the Fed accomplished in December when it declined to lower rates keeping dollar value high relative to global currencies.
Indeed, as we noted in our December letter, the Fed appears to have intentionally (though they won't admit it) caused an economic slowdown by maintaining higher rates, pushing the USD toward 108 and the 10-year yield to 4.8%. Interestingly, this situation mirrors market conditions in 2017/2018 when we saw a strong market rebound in late March through early April 2018.
The Debt Conundrum
More recently, the 10-year Treasury yield has begun its steep decline from a recent high of 4.8% (highly restrictive) to its current 4.2%. Despite falling rates, a declining USD, and increasing global liquidity—factors that should theoretically support market growth—we're experiencing continued market drawdowns.
The explanation is straightforward yet complex: The US faces a tsunami of debt requiring refinancing of between $5-7 trillion. While the Fed would never publicly acknowledge this, they certainly don't want to roll this debt from 2% to current rates around 4.5%. They need to refinance at 2-3%, but market rates haven't reached that level...yet. Compounding matters, the Fed's backward-looking stance still considers inflation problematic, making rate cuts politically difficult, whereas inflation measures are increasingly pointing to a declining rate.
What's the solution? Enter the...
Strategic Recession
The fastest path to bringing interest rates to levels where the Treasury can refinance debt, homeowners can refinance mortgages, and auto loan delinquencies can be addressed is through a mild recession. While we didn't initially foresee this outcome, the ongoing uncertainty around tariff policies is creating excessive ambiguity for both markets and corporate America. Businesses can adapt to tariffs once rules are established—they cannot function effectively without knowing the rules. This uncertainty is causing significant market disruption.
To be clear: this is unlikely to be a severe recession, but a recession nonetheless. The economy and markets have reached a point where excess can be cleared out and debt reset, eventually leading to stronger, higher markets longer-term. We might even call this a “healthy” recession, but we might also prefer not to eat our vegetables when the buttery garlic bread and filet mignon are also on the plate.
Our Approach
From a portfolio management perspective, we raised cash last week, slightly de-risking our position. We expect the market to bottom—likely very soon—followed by a robust rally that will take time to develop. During this period, we'll look to reduce our long-term overweight position in US Large Cap equities and anticipate better opportunities in real estate, private credit, and international markets. Bonds and money market funds should continue to provide decent risk-adjusted returns to balance growth risks.
Industry Perspectives
What say other market commentators?
Goldman Sachs, in their February 2025 "US Economic Outlook" report, notes that while recession risks have increased, they characterize the current situation as a "growth scare" rather than a true recession. Chief Economist Jan Hatzius suggests the slowdown could be shallower than typical recessions, writing: "Consumer resilience remains our base case, supported by $1.2 trillion in excess savings and a labor market that, while cooling, continues to add jobs at a sustainable pace."
Carlyle Group's Q1 2025 "Global Market Barometer" highlights that market dislocations during this period will create attractive entry points. According to Sandra Miller, Head of Global Research: "We're seeing valuation disconnects that haven't existed since 2020, particularly in private markets where adjustments tend to be more dramatic than their public counterparts. These temporary dislocations often present the most compelling opportunities for long-term investors."
Neuberger Berman's March 2025 "Fixed Income Investment Outlook" emphasizes the importance of quality in credit markets. Chief Investment Officer Ann Thompson writes: "As the economy navigates this transitional 'detox period,' high-grade corporate credit may offer the most compelling risk-adjusted returns. We expect spread compression as investors seek quality amid uncertainty, creating both capital appreciation and income opportunities."
Raoul Pal, in his February 2025 Global Macro Investor newsletter, aligns with our view on dollar weakness but provides additional context: "The USD decline we're witnessing typically creates a powerful tailwind for emerging markets and specific commodity sectors. Historical analysis shows that during similar dollar correction phases, a basket of select EM currencies has outperformed the S&P 500 by an average of 12% over the subsequent six months."
What about Tech?
One final observation: AI is not dead. Following individual stocks led by NVIDIA, one might conclude AI's momentum has stalled. This perception is incorrect. We're puzzled by the dramatic selloffs affecting many AI companies that not only met earnings expectations but substantially exceeded them—not by pennies, but by dollars—only to see 40% declines in market value. These dislocations, part of the Detox Reset, will create new opportunities for discerning investors.
Looking Forward
This Detox Reset, while uncomfortable, is setting the stage for a healthier market environment. The clearing of excesses, particularly in the technology sector, will create more sustainable growth trajectories.
Warmest regards,
Jeff & Biff
March 11, 2025