PWA 2025 Year-End Letter, Part 3: All Else Is Never Equal

I promised that in Part 3 we would drill down into the economy, and we will... But first, I need to reemphasize that while the data below deserve close attention, the sheer scale of -- and wealth concentration within -- the U.S. stock market demands that it remains a central focus of policymakers...

Among others, Gavekal Research founder Louis Vincent-Gave concurs:

"The US won't accept a 2/3rds drop in equity prices, it won't accept a 1/3rd drop in real estate; it won't because it can't. Because in the US, asset prices are the economy.  The Buffett Indicator (total US stock market capitalization) is now twice the GDP.  If stock prices go down 30% it's a disaster.  It's like for sure a recession.

The stock market is now the tail that wags the dog."

And that's despite the words of Treasury Secretary Scott Bessent back on April 9th of this year:

"For the last four decades, Wall Street has grown wealthier than ever before. And it can continue to grow and do well. But for the next four years, it’s Main Street’s turn.

It’s Main Street’s turn to hire workers. It’s Main Street’s turn to drive investment. And it’s Main Street’s turn to restore the American Dream."

Now, the problem with Mr. Bessent's well-intended rhetoric is that in a world where Wall Street has, literally for decades, been propped up by policy, as opposed to fundamental reality, should policy indeed turn its focus entirely onto the real economy -- while keeping the deficit somewhat under wraps -- Wall Street virtually has to lose.

At least that's what Wall Street itself had to say (S&P 500's reaction to Bessent's 3% deficit pledge, "Liberation Day", etc.):


Essentially, the market said "let's see if they really mean it."

Well, no, of course they didn't! They literally couldn't -- without crashing the market, that is.

Here's how his commentary unfolded during the year:

Early 2025 (sparking the red in the above chart):

• Bessent’s economic framework is widely discussed as a 3-3-3 plan with an aspirational 3% deficit target over the longer term. 

Spring–Summer 2025:

• As actual fiscal reality takes shape and deficits remain elevated (~5–6% of GDP), Bessent’s public language shifts toward economic growth as the primary path to fiscal improvement.

Mid–Late 2025:

• Messaging centers on “grow our way out”, with economic growth emphasized over strict near-term deficit goals.

And here's Wall Street's reaction to the shift in tune (now it's deficits be damned):

As we stated in part 2,

"...it remains difficult to envision a full-blown recession in an environment where the federal government is running near-record budget deficits… Typically such fiscal largesse is reserved for deep recession, not late-cycle expansion -- yet, here we are!"

So, summing up today's policymaker-conundrum:  They simply can't pop the market bubble that monetary policy has inflated over many years without doing serious damage to the overall economy... Yet, while they've richly rewarded capital, labor has taken it in the shorts (and now knows it) -- which is no longer politically-doable; so they have to somehow manufacture the best of both worlds... I.e., they have to aim fiscal policy at the real economy, while, at a minimum, keep from crashing the markets.

Hence, from our latest core portfolio narrative:

"The portfolio emphasizes real-economy exposures, broad-based global equity diversification, and a deliberate mix of inflation-resilient assets, while retaining the flexibility to strategically hedge specific positions or asset classes as conditions warrant."

Now, all of the above said, when we look to the 43 inputs to our own PWA Index (tracks overall general conditions), and see the likes of the following (red-shaded areas highlight past recessions), we absolutely must not get carried away with the they-can't-allow-a-recession/markets-can't-go-down narrative:

Consumer Confidence:

Homebuilder Sentiment and Buyers Traffic (below 50 [red line] = contraction):

Housing Starts:

Housing Permits:

Cass Freight Index (shipments):

Heavy Truck Sales:

Institute for Supply Mgmt Manufacturing Index (below 50 [red line] = contraction):

Factory Capacity Utilization:

Leading/Coincident Economic Indicators Ratio (never been this low outside of recession):

But, then again, it's not all bad... In fact, the percentage of positive inputs has been trending higher over the past few months.

Therefore, as we sit here today, our index scores just barely in the red (-2.33; the highest reading since February), with 30% of its inputs scoring positive, 33% negative and 37% neutral:

Not your robust economy-booming read for sure, but definitely not a recession-imminent signal either.

In summary:  While our own research and observations ultimately guide our hand, the economists whose work me most respect (and, thus, pay for access to) make equally cogent bull (MRB Partners) and bear (BCA) economic cases... 

As things stand presently, we find KPMG's Diane Swonk's overall assessment of go-forward probabilities most consistent with our own.

Here are the key highlights:

“Earlier rate cuts by the Federal Reserve will kick in, while expansions to tax cuts voted into law in 2025 are realized. Many will see their take-home pay rise on January 1, while refunds surge to their highest level on record during tax season. Consumers treat those as windfall gains; much will be spent.” 

“Trade and immigration policies are still evolving but uncertainty about the future has abated. That should add to the momentum due to the ongoing boom in AI and a new round of monetary and fiscal stimulus. Economic gains are expected to become more evenly distributed, at least early in the year.”

“Refunds will be issued on everything from taxes on tips to overtime pay, interest on new vehicle loans, expansions to charitable deductions, and larger tax credits for children and seniors. The deduction for state and local real estate taxes has been lifted for households earning up to $500,000 a year.

That will provide a much-needed lift for discretionary purchases. Spending on vehicles, appliances, consumer electronics, jewelry and vacations tend to benefit the most from a surge in tax refunds.

Separately, we are starting to see a shift in spending due to the proliferation of GLP-1 drugs. Spending on fast food and snacks is falling while spending on fruits and vegetables and smaller size clothing is increasing.

Spending is expected to slow as we get into the summer and fall, barring additional fiscal stimulus. Never say never in an election year.”

All the while:

“The Fed’s actions provide us with little protection against the burn of inflation.”

In a nutshell, there are -- thanks primarily to policy -- meaningful economic tailwinds that should accelerate as we move into the first half of 2026... All else equal, that backdrop is bullish for risk assets.

The thing is, all else is never equal... Economy-boosting policy, under present circumstances, runs the very real risk of reigniting inflationary forces that -- à la 2022 -- are decidedly negative for long-duration fixed income and equities (technology in particular) at today’s valuation levels.

In the end, prudent portfolio management is all about understanding, as best we can, the hand we’re dealt, and -- given present circumstances -- remaining broadly diversified, hedging dynamically where it makes sense, and painstakingly seeking out pockets of value wherever and whenever they emerge.

Oh, and of course, internally, maintaining the following perspective:

"I don't think awareness can be practiced... If you practice it, then it becomes mechanical... Like a man who plays a piano, if he practices all day long he might practice the wrong notes... Awareness implies no practice at all... It is free observation, without any distortion, without any bias, without any prejudice, without any conclusion, free observation and exposition."

--J. Krishnamurti 

"Practice" in the above context meaning the intentional training of the mind toward a predetermined ideal -- and trust me, it's every bit as difficult (although imperative) to resist when investing as it is in life.

That’s a wrap on PWA’s 2025 year-end message.

Dear clients, 

Please know that we take the responsibility you’ve entrusted to us humbly and with the utmost care... We cannot express enough how much we appreciate -- and truly enjoy -- the opportunity to know and to work with each and every one of you!

All of us here at PWA wish you and yours the absolute best in the new year!!

Link to Part 1

Link to Part 2