The glass seems full, but perhaps dangerously so. Markets are buoyant, but not by fundamentals. Economic conditions are weakening, risks are rising, and valuations offer little room for disappointment. Investors are betting heavily on Fed support, geopolitical stability, and continued consumer resilience, none of which are guaranteed.

The size and scope of the tariffs are much larger than those imposed during President Trump’s first term and pose serious risk to economic and financial stability. This will keep companies and consumers frozen, waiting for clarity before spending. The odds of a US recession or a painful stagflationary environment is 99.9%. If they are lifted in the next few days, it is closer to 75%.

In our view, the developments over the past two months have greatly increased the likelihood of a recession, which could begin with a negative print as early as this quarter. The challenge is a swift reversal of these policies would drastically alter this outlook. President Trump has historically used the stock market as his report card. The question is whether he changes his tune if the selloff accelerates from here.  

2024 was a strong year for markets. 2025 will be a year of different as the changing of the guards occurs and President Trump implements his policies. While the economy remains on somewhat stable footing, a lot of risks remain, and the country’s fiscal position can quickly get us into trouble. We do not think any of these risks are accounted for in equity or credit market valuations today, which has kept us defensively positioned.

We would describe the current environment as strange and bifurcated, marked by significant disparities in the health and strength of consumers, companies, sectors, and countries. Despite considerable uncertainty, the market has continued to reach new highs. In this letter, we will explore the components of the Gross Domestic Product (GDP) equation, the upcoming election, government debt, and market trends.

• Central Banks face complex decisions regarding inflation, economic growth, and financial stability in the post-pandemic economic landscape.

• Government spending has significantly contributed to GDP and employment growth but has also led to a high U.S. budget deficit.

• The convergence of slowing demographic growth, deglobalization, and massive debt accumulation may further slow future potential GDP growth.

• The forty-year era of falling bond yields has likely ended, signaling a shift in the economic landscape with higher interest rates and increased borrowing costs.

• The market is expensive, even when removing the impact of the largest capitalization names from the benchmark.