Tailwinds and Headwinds, or Post-Election Letter #3

By: Larry Eppolito, MBA, CFP®

Greetings!

As a reminder, while economics and finance are often politicized, I try to write in economic and financial terms – not political terms. Also, since everything is open to interpretation, please remember, my words mean exactly what I want them to mean, no more no less (Lewis Carroll). So, please feel free to call me for clarification.

The following represents my economic and financial beliefs.

In my last letter, my main point was the U.S. economy is like a massive battleship, and the various “economic winds” struggle to significantly alter its course.

I also wrote:

• Much of what we read about the economy is open to interpretation.
• The media and many politicians have a habit of reducing complicated issues to simple easy-to-understand sound bites.
• The media often attributes economic outcomes to specific causes, presented as factual truths – though they may only represent a small part of the story.
• Some economic policies that are beneficial in the short-term can have negative long-term effects.

Who, or What Truly “Controls” the Economy?

Market Forces Are Powerful

While the President plays a significant role in shaping policy and setting priorities, the broader economic landscape is driven by a number of interconnected forces. Among these, market forces are the most influential.

Market forces include:

• Consumer spending,
• Business investment and innovation,
• Credit availability,
• Commodity prices (which are cyclical in nature),
• Interest rates,
• Global economic trends.

Government Policies

The government often attempts to influence market forces through policy changes to achieve desired economic outcomes. However, these policies are frequently diluted to some extent by the power of market forces.

The Following Are Largely Responsible for Government Policies:

• The Federal Reserve Bank (The Fed), which largely controls the money supply via its monetary policies,
• While the President proposes many policies, Congress disposes of them through legislation,
• Congress primarily controls the budget (“Congress holds the purse strings”),
• The Executive Branch (The President) can sometimes act without Congress, such as when imposing tariffs.

The Executive Branch, generally:

• Proposes and advocates for new laws and policies.
• Ensures federal laws are implemented and upheld.
• Issues Executive Orders – directives to federal agencies to manage operations.
• Nominates federal officials, including Cabinet members, federal judges, and ambassadors (subject to Senate confirmation).
• Approves or vetoes legislation passed by Congress (Congress can vote to override vetoes).

Checks and Balances

It's also important to remember the United States has a system of checks and balances. When power in Congress is divided between parties, these checks and balances tend to be more pronounced, and vice versa.

Tailwinds and Headwinds

So, how do we know which policies tend to help or hinder economic growth? I’ve found it helpful to explain economic policies in terms of tailwinds and headwinds.

The Jet Stream

Imagine a roundtrip flight east from California to Boston. Did you know the flight east is shorter by about an hour? Although the effects vary, this is due to the natural west to east jet stream, which acts as a tailwind. Flying west to California from Boston often takes about an hour longer, as the jet stream acts as a headwind.

Tailwinds to Economic Growth Include:

1. Fiscal policy: Lower taxes (Congress),
2. Fiscal policy: Increased government spending (Congress),
3. Monetary policy: Lower interest rates (The Federal Reserve Bank and market forces),
4. Deregulation: Reduced business regulation (Congress/The Executive Branch),
5. Trade policy: Lower tariffs may reduce the prices we pay (Congress/The Executive Branch).

Headwinds are simply the opposite of these factors.

Trade-offs

Tailwinds may come with trade-offs. For example, lower taxes and increased government spending can lead to higher budget deficits, and all growth-boosting measures may act as an upward force on inflation (hopefully to be offset by other forces).

Similarly, deregulation can encourage abuse and excesses, while excessive regulation can act as a significant headwind to growth. It’s all about finding balance!

The Economy is Not Always Sensitive to These Forces!

Interestingly, during periods of strong economic growth, traditional headwinds may seem less impactful. During these times, I’ve heard pundits proclaim certain headwinds are actually tailwinds – an inaccurate view that overlooks how growth can mask the effects of restrictive policies! Conversely, during periods of very weak economic growth, even tailwind policies may seem to be ineffective, as the economy either limps along, or falters.

Trump’s Potential Policies

Some of President-elect Trump’s notable campaign promises include:

• Slashing the corporate tax rate to 15%,
• Reducing business regulation,
• Cutting government spending – on government – substantially,
• Putting new tariffs on China between 60% to 100%,
• Putting across-the-board 20% tariffs on most other countries.

It remains to be seen the extent to which these policies will be enacted.

Potential Tailwinds to Growth Include:

1. Lower taxes,
2. Reduced business regulation.

Potential Headwinds to Growth Include:

1. Lower government spending (on government),
2. Higher tariffs,
3. The potential for higher inflationary pressures (resulting in higher interest rates).

It’s still early to know the extent of any policy changes. But the questions include:

1. Can the economic tailwind from lower taxes overcome the reduction in tax revenues, or will it lead to a sharp rise in the deficit?
2. To what extent will higher tariffs on imports be implemented?
   • Will higher tariffs slow growth too much, leading to an economic slowdown?
   • To what extent will higher tariffs lead to higher prices?
3. Will the tailwind policies overcome any headwinds and fuel inflation again – or vice versa?
   • Will the Federal Reserve Bank reverse course and raise “their interest rate” to offset any increase in inflationary pressures?
   • Note: The Fed controls short-term rates. Longer term rates are usually affected more by market forces.
4. Will the balance of tailwinds and headwinds create "Goldilocks" growth (not too hot, not too cold) similar to the post-2008 period (disregarding the COVID-19 interruption)?

Over the last few years, I have had many of you ask me about the potential for a recession. The media has been looking for one for the last 2 1/2 years, or so!

Markets Tend to Move Ahead of Any News. This is What Confounds People!

The economy has been very strong for many reasons. There is still no recession in sight. However, keep in mind, recessions are usually a surprise. Although past performance does not guarantee future results, markets tend to decline ahead of recessions – before the “bad economic weather” arrives. Markets tend to bottom “in the midst of the malaise” and begin to trend upward in the face of deteriorating news, as they look ahead to better “economic weather” many months down the road.

Pre-Planning Via Asset Allocation

We discuss the potential for recession in nearly every meeting. We pre-plan, such that we can better endure downturns due to our stock to bond balance. I believe the long-run odds are stacked against those who try to dance around market cycles. We discuss this in nearly every meeting – and we’ll continue to do so.

In summary, I believe:

1. Much of what we read about the economy is open to interpretation.
2. The media often simplifies complex issues into easy-to-understand sound bites.
3. The media often attributes economic outcomes to specific causes, as if factually true.
4. It's difficult to trace today’s economy to any single person or policy.
5. Some economic policies that are beneficial in the short-term can have negative long-term effects.
6. Economics is a highly complex subject, yet voters are expected to “be”
7. Economic growth or recession often occurs regardless of who occupies the Oval Office.
8. The economy resembles a massive “battleship” that no single person is truly “steering.”
9. The various market forces are powerful drivers of economic outcomes.
10. Government policies also shape the economy, but the President’s control is less than often portrayed.
11. Tailwinds promote economic growth, while headwinds hinder it.
12. The economy can grow despite headwinds or falter despite tailwinds.

The Crux of the Issue

The crux of the issue is, “To what extent will tailwinds overcome the headwinds?”

I’ll have more to write as the picture clears.

Best wishes,

Larry

November 26, 2024

Securities offered through Raymond James Financial Services, Inc., member FINRA / SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Eppolito Financial Strategies is not a registered broker/dealer and is independent of Raymond James Financial Services.

Raymond James Financial Services does not accept orders and/or instructions regarding your account by e-mail, voice mail, fax or any alternate method. Transactional details do not supersede normal trade confirmations or statements. E-mail sent through the Internet is not secure or confidential. Raymond James Financial Services reserves the right to monitor all e-mail.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

Important Disclosures

Any opinions are those of Larry Eppolito and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change. This information is not intended as a solicitation or recommendation of any kind. Investments mentioned may not be suitable for all investors. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Diversification and asset allocation do not ensure a profit or protect against a loss.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.

Stocks offer long-term growth potential but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations and the potential loss of principal.

Investing in fixed income securities (bonds) involves certain risks such as market risk, if sold prior to maturity, and credit risk, especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond prices fluctuate inversely to changes in interest rates. In other words, if interest rates rise, after your purchase, you may receive less than your purchase price should you liquidate early. Bonds provide a fixed rate of return if held to maturity.

Sources:

• Raymond James Washington Policy Weekly Wrap, Ed Mills, Alex Anderson
• Raymond James Weekly Investment Strategy
• Raymond James Weekly Institutional Equity Strategy
• Raymond James Weekly Economic Release
• Raymond James Daily Morning Brew
• The Wall Street Journal
• CNBC Professional
• Bloomberg News
• Financial Advisor Magazine
• New York Times
• The Boston Globe

Other Important disclosures

Any information provided in this e-mail has been prepared from sources believed to be reliable but is not guaranteed by Raymond James Financial Services and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for informational purposes only and does not constitute a recommendation. Raymond James Financial Services and its employees may own options, rights or warrants to purchase any of the securities mentioned in e-mail. This e-mail is intended only for the person or entity to which it is addressed and may contain confidential and/or privileged material. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information by persons or entities other than the intended recipient is prohibited. If you received this message in error, please contact the sender immediately and delete the material from your computer.

Opt-out

If you wish to opt-out of my group letters, please respond to this email or call me.