May 2025 Market Update

Due to technical difficulties experienced last week which resulted in this update being a week late, this update covers the month of May and the first week of June. Please enjoy.

Economic policy has become incredibly volatile and uncertain over the past month. Between the start and pause of tariffs, the fight in congress over the extension of Trump era tax cuts (The One, Big, Beautiful Bill), and now Elon Musk promoting to “kill the bill”, it is becoming clearer that the only thing certain is government dysfunction.

As government dysfunction grows the deficit also continues to grow, and so does interest expense as a percentage of total economic output. This function is crowding out small businesses and individuals via higher interest rates and forcing the underling economy to slow. For the month of May, the US ISM services index fell into contraction territory with new orders falling to the lowest level since December 2022, while prices continue to rise to new highs. The May US ISM manufacturing index also remained in contraction territory at 48.5 and reached its lowest level since November 2024. The economy is weakening.

In January, the Trump administration communicated to America that to right the ship and begin the process of turning the American economy around it would have to endure short term pain for long term gain. In April, the pain began, but after a sharp twenty percent drop in the S&P 500, the Trump administration quickly transitioned to a plan b. It is unlikely any modern President could stand by as the stock market falls twenty percent or more and continue to gather support in congress to pass the President’s agenda. The stock market is much more intertwined into the economy than it was back in 1980, when Reagan allowed Volker to raise interest rates to eighteen percent, squeezing the inflation out of the economy while enduring a recession. If that occurred now, congress would quickly turn its back on the current administration as rising and falling assets prices is one of the most powerful positive and negative reinforcement mechanisms in behavioral economics.  

Trump tweets "Buy Stocks" April 7th, market bottoms.

Since 1980, corporate equities held as a percentage of financial assets have climbed from 10-15% to 40-45%. In many ways congressional spending and record deficits now hold Americans retirement and 401k values invested in the stock market as a hostage. If the deficit were to ever shrink and congress balance the budget, the stock market would likely suffer greatly, and if the stock market suffers then the majority of working and retired Americans could see their net worth, retirement funds, 401k balances, and home equity values decline substantially, leading to a major change in economic consumption patterns. For these reasons, many believe government will never do the right thing and instead of addressing and fixing Americas financial problems, continue kicking the can down the road, slowly going bankrupt, leaving the issue for future generations to deal with. It is a spineless policy choice and one that will not result in a better future for Americas children.

The One, Big, Beautiful Bill republicans now hope to pass supports a higher deficit than many republicans agree with and plans to run the economy “hot," meaning high growth policies designed to outpace the rise in debt. But the data shows that while the bill pushes the deficit higher, it is fiscal tightening relative to current policy. A fact the market may still need to acknowledge.

If the economy is run hot on deficit spending, it is very unlikely that interest rates will come down on their own, without widespread economic weakness. This has been fine for big businesses and the large cap stock market, which have been less impacted by high interest rates. The S&P 500 large and mega cap stocks continue to be bought in lieu of the Russell 2000 small cap stocks. These policies benefit large companies at the expense of small businesses and individuals and may end up backfiring on the administration. Interest rates remaining elevated because the economy is being run hot via deficit spending may cause high interest rates to cure high interest rates. In other words, this policy may cause the economy to overheat and actually produce deflation instead of growth. The combination of high interest rates, Ai disrupting full employment, unaffordable housing, and immigration policy may lead to a lower growth economy accompanied by lower interest rates and employment.

The large cap S&P 500 has outperformed the small cap Russell 2000 by 100% over the last five years. Demonstrating the economic policy which rewards large and mega cap corporations at the expense of small business.

For the reasons mentioned above, Elon Musk is now saying to “kill the bill." Consequently, if the bill does not pass and the deficit is cut in a big way, American workers and retirees could see their current asset values drop significantly. Current Treasury Secretary, Scott Bessent has been quoted saying, "This is the single most important issue of the day. This is pass/fail. If we do not renew and extend these tax cuts we will be facing an economic calamity, and as always with financial instability, that falls on the middle and working class. " At current stock market valuations, market participants who do not have the time horizon nor the financial ability to endure a large decline in asset values may want to consider 4-5% yielding t-bill’s and treasury bonds as an alternative to the stock market.

If America finally begins to make good financial decisions, market participants will want to be positioned so that they’re able to benefit from that, and if America decides to try and kick the can down the road in hopes of keeping economic growth and asset values propped up by continually devaluing working Americans wages via deficit spending, and it fails because growth declines, market participants will want to be on the right side of that turn in economic and financial history.

Since 2000, the deficit as percent of GDP was +2% with real GDP approximately 4%. Fast forward to 2025 and deficit as percent of GDP is -6% with real GDP approximately 2%. This is a failed policy.

Our recommendation is to position portfolios to endure a recession, in a defensive manor, risk off and in cash, T-bills, money market funds, short to mid-term 1-10 year U.S. treasury bonds and 10-30 year U.S. treasury bonds at positive carry, 10-year minus 2-year yield curve re-steepening, 10-year minus 3-month yield curve re-steepening, Short USDJPY from 153, and select low duration U.S. equities.

Getting paid to wait for growth assets to be priced at discounts, while being positioned to benefit from bond price appreciation as interest rates decline from downward economic pressure, continues to be a profitable and rewarding strategy. We remain patient and focused on managing risk through 2025.

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