The Objective Advisor

In December 2023, Vladimir Putin declared that the 2024 BRICS Summit, hosted by Russia, would be focused on establishing a “fair world order” based on shared principles. At the core of Putin’s goals for stronger BRICS economic integration is a longstanding and overriding objective to provide a viable alternative to the West’s global hegemony in nearly all facets of political, military, economic, financial, and security affairs.

Challenging Western Dominance

Creating a common currency designed to curtail — and displace – the dominance of the U.S. dollar as the world’s reserve currency has been a central theme when the BRICS Summit was formalized in 2009 with initial founding membership of Brazil, Russia, India, and China. Today, the dollar remains the commanding currency in global transactions, involved in an overwhelming number of exchanges, although a growing number of dealings involve the euro.

Putin has recently called for BRICS to establish a “safer and harmonious world” with a goal towards creating its own parliament.

Today, BRICS as an intergovernmental organization is comprised of Russia, China, India, Brazil, South Africa, Egypt, Ethiopia, Iran and United Arab Emirates. Saudi Arabia, due to join formally in January 2024, has not yet declared its official membership, while rumors persist that North Korea is seeking affiliation. Argentina was also invited to join, although newly elected President Javier Milei has made it clear the nation will not be joining in the near-term.

With the first presidential debate behind us, it’s safe to say election season is in full swing. While last week’s debate was light on economic policies, the future of tax policy (along with potential efforts to arrest elevated federal deficits) could have broad implications for the municipal (muni) market — some good, some not so good. With the Tax Cuts and Jobs Act (TCJA) set to sunset in 2025, the election will go a long way in determining the future of tax policy in the U.S. And for muni securities and their unique tax-exemption characteristics, the election will go a long way in determining future demand for the asset class. But with the Federal Reserve (Fed) embarking on a rate cutting cycle likely starting this week, the next few months could be the last “best time” to buy munis, regardless of changes to tax policy.

Spending > Income = Deficits

While there are still several months until the election is decided, the expectation is that regardless of who ultimately becomes our 47th president, the biggest loser could be the fiscal deficit. Per the Congressional Budget Office (CBO), the U.S. government is expected to run sizable deficits over the next decade — to the tune of 5% – 7% of gross domestic product (GDP) each year. According to the CBO, the deficit increases significantly in relation to GDP over the next 30 years, reaching 8.5% of GDP in 2054. That growth results from rising interest costs and large and sustained primary deficits. CBO deficit projections assume the personal tax cuts within the TCJA will expire at the end of 2025, so deficits are likely to be even higher assuming either Kamala Harris or Donald Trump will extend most, if not all, of the tax cuts. If tax cuts are fully extended, budget deficits are expected to be in the 7%–8% range of GDP over the next decade. Deficits will remain elevated regardless of who is in the White House in 2025, even without new spending or tax cuts due to higher spending on Medicare and Social Security plus the (growing) interest expense on the (growing) debt pile.

Of course, last week’s headliner was Jerome Powell and the Federal Reserve (Fed) cutting rates by a half percent on Wednesday, September 18, the first time since the COVID-19 pandemic broke out in 2020. The Fed “pause” ended at 423 days and now stands as the second-longest on record, while the 26% gain for the S&P 500 during the pause (7/27/23–9/18/24) ranks first. Here we share some thoughts on the Fed’s move last week and some potential market implications of not only Fed policy but also fiscal policy post-election.

It's Not How You Drive, It’s How You Arrive

Golfers may appreciate this mantra as representing the importance of the final putt that goes in the hole as being the most important thing, more so than a well-struck first shot off the tee. We think this analogy works for the Fed here. While the 0.25% vs. 0.50% debate was all the rage, what matters most is how much Powell and company cut for the entire cycle and how lower rates affect the economy. Whether the cycle starts with a quarter or half-point cut isn’t as important given the Fed will almost certainly have to cut much more than that this cycle. (For those who appreciate NASCAR more than golf, call it a pit stop on the way to the more important finish line.)

We don’t know how much the Fed will end up cutting, but if they are able to engineer a soft landing — and last week’s rally sure suggests the market thinks that’s what we’ll get — then perhaps they end up stopping before they get to 3% (the upper bound now sits at 5%, down from 5.5%). The Fed and most analysts think the neutral rate is around 3%, or potentially a bit higher. Either way, based on the 1995 experience, that sets up a favorable environment for stock investors. After the initial cut in July 1995, the S&P 500 rallied 18.7% over the next 12 months.

The bar for third quarter earnings is low, with analysts currently expecting only about a 3% increase in S&P 500 earnings per share (EPS). That low bar and a supportive economic environment points to potential upside. However, stocks may already be pricing in solid results, with the S&P 500 up more than 7% since the third quarter began on July 1. Here we preview earnings season and discuss some of the key drivers of earnings growth in the year ahead.

Quick Numbers Check

The S&P 500 consensus earnings growth number of 3% for the third quarter is not something to write home about, especially after double-digit earnings growth in the second quarter. The soft number is partly due to a tougher comparison. In Q2 2024, earnings had an easier comparison with a 3.3% drop in earnings in the prior-year quarter (Q2 2023 vs. Q2 2022). For the third quarter now being reported, the comparison gets tougher as earnings growth in Q3 2023 was over 5% (vs. Q2 2022).

The biggest drags on earnings this quarter are likely to come from the energy and industrials sectors, while the biggest contributions are expected to be from technology, communication services, and financials. The largest, technology-oriented companies — the so-called Magnificent Seven (Mag 7) — will again drive a big chunk of overall earnings growth even as their growth has slowed (more on that below).

A significant new bill was just signed into law, locking in the 2017 tax cuts and introducing new deductions across its 900+ pages. While a few new tax breaks could fatten your refund next spring, there are also some belt-tightening measures for federal healthcare, food-aid, and student loan programs that could impact millions—so don’t tune out.

What does this mean for you? In the short term, your paycheck probably won’t shrink, and you might notice a little extra thanks to extended tax rates. But with cuts to some benefits programs, it’s more important than ever to contribute to a safety net, so keep growing your emergency fund and investing for your future. With steady money habits, you’re less vulnerable to policy swings—Congress might cast the votes, but you steer your own financial direction.

I’ve included helpful explainers and news updates below. If you have any questions, let’s talk. The world keeps changing, but remember, you’re not navigating it alone and your financial future remains firmly in your hands.

Thank you,
Paul Celentano