We believe the U.S. economy will maintain its soft-landing in 4Q24 and into 2025 supported by two main factors. First, GDP remains strong, with the 4Q24 Atlanta GDPnow forecast up to 3.3%, a sharp increase from the October 1 estimate of 2.54%* Second, we agree with the consensus that the Fed will cut another 25 bps at its December 18th meeting, bringing the total easing for 2024 to 100 basis points. These factors should favor a continued rotation into small- and mid-cap value stocks, which we expect to outperform.
The Federal Debt and Deficit: The unspoken risk
The greatest threat to this outlook comes from the growing U.S. budget deficit and federal debt. The Congressional Budget Office projects a $1.9 trillion budget deficit for 2024, which adds to the federal debt, now exceeding $35.5 trillion. This level of debt growth is unsustainable and demands urgent action.**
To address the budget deficit, policymakers have three options:
Raise Taxes: This could slow GDP growth, creating a trade-off.
Grow GDP: Higher GDP would increase tax revenues at current tax rates but risks driving inflation.
Cut Spending: Reducing spending is difficult, given the small proportion of discretionary expenses in the federal budget.
The Trump administration plans to attack the deficit by both cutting spending and growing GDP. While we think the Elon Musk driven DOGE initiative will find early success in cutting government waste, in much the same way a first cost cutting program at a corporation finds low hanging fruit, it is highly unlikely that the ambitious $2 trillion goal will be achieved on an annual basis. That said, even smaller reductions, such as a few hundred million dollars annually are worth pursuing. Growing GDP thus will likely be the main strategy to increase revenues.
Tariffs and Cost Cuts: Can They Coexist with GDP Growth?
Trump’s tariff policies aim to stimulate domestic GDP by bringing jobs and manufacturing back to the U.S. This strategy could raise tax revenues and maintain a stronger monetary cycle within the country instead of sending dollars abroad. However, the plan risks higher inflation due to increased prices, which could slow GDP growth. Likewise, any DOGE cost savings will likely be a drain on GDP. We think these trade-offs are clear and well understood by both political parties, and we think the actual path forward will likely lie in some sort of compromise on tariff actions that are not as severe as the statements made on the campaign trail.
Counting on a Friendly Fed?
We believe the Trump administration is focused on the Fed because it would like the Fed to lower rates if Trump’s policies slow GDP growth. Said differently, Trump wants a “Fed put” to keep rates low as his policies are implemented. For now, with Powell and the Fed committed to a program of lower rates, there is likely little need to call for change at the Fed. If growth slows, we think rhetoric will heat up.
Soft-Landing Likely to Persist
We expect the soft-landing to continue through at least the first half of 2025, supported by GDP strength and the Fed’s cumulative easing. Additionally, we expect there will be early wins in tariff negotiations and DOGE cuts to spur positive headlines, while the tougher negotiations and more punitive policy actions will take longer to play out.
This environment should continue to favor small- and mid-cap value stocks, which should see rising earnings and lower borrowing costs. This group, in our view, has been overlooked by the market dating back to the first QE program in 2009, and the built-up investor neglect and relative undervaluation is palpable.
Carpe Diem!
**An Update to the Budget and Economic Outlook: 2024 to 2034 | Congressional Budget Office, Financial Audit: Bureau of the Fiscal Service's FY 2024 and FY 2023 Schedules of Federal Debt | U.S. GAO
Rewey Asset Management is a registered investment advisor in the State of New Jersey.
This material is for informational purposes only and is not a recommendation or advice. Investments and strategies mentioned are not suitable for all investors. No one can predict or project performance, and forward-looking statements are not guarantees. Past performance is not indicative of future results. Investing involves risk, including the loss of principal.
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