March 2025 Letter

Investment Update

I am pleased to announce that we have engaged East Bay Investment Solutions as an investment strategist to supplement our existing investment resources. One of East Bay’s founding partners, Eric Stein, CFA, and I worked together at RSM from 2011 to 2017, and I’ve always respected his intelligence and approach to portfolio construction. You can now view Eric’s full bio on our website.

I’m excited about the additional expertise East Bay brings to our investment process and portfolio construction. Their insights, combined with Zack’s Research, Zack’s Investment Management, and BlackRock, reinforce our confidence that we are making smart investment decisions in our portfolio construction.  To that end, you may see some portfolio changes in the coming months as we fully integrate their expertise into any portfolio tilts we take, versus the equity and bond markets as a whole.

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Recent Market Volatility

The past few weeks of late February and early March 2025 have been marked by significant market swings, influenced by tariffs, the evolving war in Ukraine, and recession worries tied to reduced government spending. Some observers even speculate that the new Trump administration may want a market pullback, given Treasury Secretary Scott Bessent’s remarks that “Wall Street has done great” and that the economy needs “rebalancing.” While I don’t take any politician’s words at face value, there are potential incentives for the government to let some air out of the equity markets.

(It should be noted that the government is not the end all be all of asset prices and economic activity, but the government certainly does influence both things)

First, depressed asset prices can help moderate inflation. When people feel wealthier (because their stocks are up), they tend to spend more freely. Conversely, when equity values fall, it naturally reins in some of that extra consumption that plays into prices.

Second, the treasury bond market typically responds to drops in equity prices and lower-than-expected inflation. During a sell-off, nervous investors often say, “I don’t want to ride out this volatility; I’m moving into safe Treasury bonds.” The resulting demand for bonds drives bond yields lower—beneficial for a Treasury Department looking to refinance over $10 trillion of maturing debt in the coming year. Financing that debt at 3–4% instead of 5% can translate into trillions of dollars in savings over the next decade (I’ll explore this further in the next section).

It’s also plausible the administration would prefer a recession early in its term and it has historical precedent (i.e., Ronald Reagan in 1981-1982). Doing so might push interest rates down, place some blame (fairly or not) on the prior administration, and pave the way for a rebound before the next election. Given the significant debt burden accrued over the past 25 years, no administration has an enviable task ahead… which leads into my next section...

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Deficits, Debt, and DOGE

If you have followed any of my other previous writing of the last few years, you will know I am a deficit and debt hawk. I have often highlighted our increasing national debt relative to size of our economy (“GDP”).  We may never know what upper bound of government debt relative to economic output will start to cause real economic problems, but that level is closer than it used to be.  For a long time in American politics, people have cried wolf about debt to GDP and other debt factors.  Ross Perot in 1992 based his candidacy largely on this issue…and the debt at that time was 41% of GDP.  As nothing truly broke in 80s and 90s, and deficit hawks continued to cry wolf in the 2000s and 2010s without serious debt events, today we now see our debt is 130%+ compared to our nation’s GDP, and I fear too many have become desensitized to debt concerns.

When I assess today’s most pressing economic challenges, the federal debt and spending trajectory top my list. I fully recognize my bias as someone entrenched in finance, accounting, and economics, but I believe the long-term consequences of unsustainable fiscal policies are one of the most, if not THE most, concerning issue for the government to solve.  Without solving the issues, at some point the government’s ability to sustain essential programs—defense, entitlements, and even debt interest payments—will be called into question.

The reality is that excessive government borrowing puts immense strain on the whole financial system: As national debt grows, lenders demand higher interest rates to compensate for the increased risk that they will never be repaid or that inflation, via money printing, will eliminate any investment returns lenders would earn with lower interest rates. Higher borrowing costs translate to weaker corporate profits, reduced innovation, and less homeownership affordability, among other things. The global economy thrives on low interest rates and controlled inflation—conditions that are increasingly at risk as debt grows at an unsustainable rate.

History teaches us a truth in economics that government spending should not outpace tax receipts and reasonable economic growth. Historically, tax revenue tends to hover around 17%-19% of GDP, regardless of tax rates. If the economy grows at 3% annually, government spending should remain at or below 20-22% of GDP. The surge in government spending over the past five years, largely driven by COVID-related stimulus, pushed annual spending to over 25% of GDP. Those levels are unsustainable and have blown out the debt trajectory.  When spending grows faster than the economy can sustainably support, we borrow more and more from the future to pay for today. While some deficit spending — particularly for infrastructure, may be justified, in general it means taking away from a future generation.  As a new father, that thought resonates with me more than ever.

I have a deep respect for Ray Dalio’s insights. He argues that for the U.S. to achieve fiscal sustainability, the budget deficit must be reduced to 2-3% of GDP—essentially ensuring that debt growth does not outpace economic growth. This means that if the economy grows at 2-3% annually, the national debt should expand at a similar rate to remain manageable.

Currently, the numbers tell a different story. In fiscal year 2024, the U.S. deficit was approximately $1.8 trillion, equating to deficit of 6.4% of GDP—more than double the sustainable threshold. Bringing the deficit down to 2-3% of GDP would require cutting annual borrowing (the deficit) by roughly $900 billion annually.

Favorite relevant quotes:

“In democracy the populus eventually realize they can vote themselves all the money.” - Charlie Munger

“Nothing is so permanent as a temporary government program.” – Milton Friedman

As of February 2025, the U.S. national debt stands at approximately $36 trillion. Alarmingly, over $15 trillion of that debt matures in the next three years and must be refinanced at significantly higher rates than when it was first issued.

To put this in perspective: If the average interest rate on national debt rises from 2.5% to 4.5%, annual interest payments jump from $900 billion to $1.62 trillion—far outpacing any deficit reduction efforts to date.

Historically, debt-to-GDP levels this high have only been seen immediately following World War II—a moment in history where taking on significant debt was an unquestionable necessity. Looking at today’s balance sheet, can we honestly say that the debt accumulated over the past 25 years was spent as wisely?

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Note on Market Valuations & Expected Future Earnings

Lately, there has been considerable discussion in financial circles about current stock market valuations relative to historical norms. One of the most commonly cited metrics is the price-to-earnings (P/E) ratio—a measure of how much investors are willing to pay for each dollar of corporate earnings. Historically, the U.S. stock market has traded at an average P/E ratio of around 20x earnings. Today, that figure is closer to 30x earnings, raising concerns among some investors that a market correction is imminent.

While valuation metrics provide useful context, they are often poor predictors of short-term market movements. A high P/E ratio alone does not mean a downturn is imminent. However, history does suggest that elevated valuations tend to result in lower-than-average returns over the medium to long term. This is why valuation matters—it influences medium and long term return expectations, rather than dictating immediate market movements.

With the S&P 500 up 26% in 2023 and another 25% in 2024, it would be reasonable to expect more moderate returns in the coming years as earnings growth catches up to valuations. That said, market timing based solely on valuation levels has proven unreliable. Instead, we focus on disciplined, long-term investing and adjusting our financial assumptions as needed to ensure your portfolio remains aligned with your goals—whether that’s building wealth or sustaining a secure retirement.

One final note on these elevated valuations: they underscore the importance of diversification. With large-cap U.S. stocks trading at higher multiples, our portfolio resources remind us there’s a broader investment universe to consider. Smaller domestic companies and international markets often present more attractive valuations relative to their earnings, reinforcing the value of a well-diversified strategy to both manage risk and pursue long-term growth.

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The Power of Long-Term Investing

We live in a divided country, and it is easy to tie political shifts to financial outcomes, but history has shown that investing is not about who is in the White House—it’s about participating in the ongoing progress of human history, productivity, and innovation.

Over the past century, global markets endured wars, recessions, inflation crises, financial collapses, and political upheavals. Yet, long-term investors who stayed the course have been rewarded. Economies expand, industries evolve, and human ingenuity drives progress forward, regardless of political cycles.

Think about the transformative breakthroughs we’ve seen in just a few decades—technological innovation, medical advancements, artificial intelligence, and renewable energy. These shifts weren’t dictated by any single government, but by entrepreneurs, businesses, and global economic growth. This is why we diversify across sectors, regions, and asset classes—to capture long-term opportunities, rather than react to short-term uncertainty.

While headlines may give us reasons to worry, history tells us that progress and innovation continue, no matter the political environment. The best approach remains disciplined investing, a long-term perspective, and confidence in the future of global markets.

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Final Thoughts

I appreciate your trust as we navigate these complexities. My commitment remains the same: to position your portfolio wisely for the road ahead and to help you make prudent financial decisions in an ever-changing world.

As always, if you have any questions or concerns, don’t hesitate to reach out.

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