Above the Noise: Putting pessimism in perspective

Linus Van Pelt: "Life is difficult, isn't it, Charlie Brown?"
Charlie Brown: "Yes, it is, but I've developed a new philosophy. I only dread one day at a time."

Our favorite blockhead may dread each day as it comes, but there’s a quiet optimism in him. He never stops trying to kick that football or to fly that kite. I can relate. This is one of those moments when I dread each day, unsure of what the next news cycle or round of messages will bring. And yet, I, too, wrestle with pessimism.

Author Mustafa Suleyman recently introduced the concept of the pessimism aversion trap, the psychological tendency to avoid engaging with negative possibilities. Don’t get me wrong, I let pessimism creep into my personal life. After all, I’m a New York Giants fan. However, my aversion to pessimism lies in how we view society’s ability to overcome challenges and build a better future. That boy has cried wolf one too many times.

Take, for example, the many doomsday predictions that never quite came to pass:

• Baby boomers were all supposed to retire and crash the housing and stock markets
• We were going to run out of oil
• US was on the brink of defaulting on its debt
• A COVID-19 vaccine would take a decade
• 2022 was declared the start of a new era of stagflation
• Every office building in the country was supposedly destined to sit empty. Rest assured that my commute to the office is currently as awful as it has ever been!

Suleyman might argue that falling into the pessimism aversion trap could lead to dangerous complacency. I’m mindful of that. Still, I can’t help but contextualize the issues currently weighing on investors. Here are two examples:

• War: The most recent Israel-Hamas war began on October 7, 2023. Since then, the S&P 500 Index has advanced by more than 40%.¹
• Trade war: In 2019, the year between the start of the US-China trade war and the 2020 trade deal, the S&P 500 Index rose 31.5%.²

As Charlie Brown also said, “Learn from yesterday, live for today, look to tomorrow, rest this afternoon.”

It may be confirmation bias, but…

…the market doesn’t believe that a recession is coming. Since the beginning of the year, US high yield corporate bonds have outperformed the S&P 500 Index.³ High yield bond spreads have tightened by more than  150 basis points since April 8, when spreads peaked.⁴ Also, this year, the S&P 500 Industrials sector has significantly outpaced the broader index.⁵

Recession? The market seems to think otherwise.

Since you asked (part 1)

Q: What impact could the war between Israel and Iran have on the financial markets?

A: Geopolitical conflicts and wars often trigger immediate volatility in financial markets, but investors should take a step back and ask two key questions: Does this event meaningfully alter the growth outlook for the world’s largest economies? Does it change expectations for how major central banks will respond? If the answer to both is no, then even tragic and unsettling events are unlikely to derail broader market cycles.

The thinking would only shift if something were to occur that changed the calculus. For example, a closure of the Strait of Hormuz, a vital route for global energy flows bordered to the north by Iran, could significantly disrupt oil and natural gas markets and weigh on global economic growth. However, such a scenario doesn’t appear imminent. It's also worth noting that the US is currently producing 13.4 million barrels of oil per day, a record level that provides a significant buffer against external shocks.⁶

Since you asked (part 2)

Q: Why are tariffs not yet showing up in the inflation data?

A: Imports into the US surged in the first quarter as businesses rushed to stockpile goods ahead of new tariffs.⁷ Since then, imports have declined sharply. As we move through the summer and into the fall, the impact of these tariffs is expected to appear more clearly in inflation data. If anything, the greater concern for the stock market may be if tariffs fail to show up in inflation data. This would imply that businesses are absorbing the costs, potentially hurting corporate profitability.

The encouraging longer-term view is that bond market expectations for long-term inflation remain stable, suggesting that tariffs may cause a short-term price shock rather than sustained inflation.⁸

It was said

“I would like to get this guy to lower interest rates because if he doesn’t, we have to pay.”

– President Donald Trump

I apologize for returning to this topic, but the independence of the US Federal Reserve (Fed) remains a critical safeguard against significantly higher interest rates on government debt. While lowering rates in response to a weakening labor market is a legitimate policy response, doing so to placate the executive branch is a far more troubling prospect. A historical example worth noting is the trajectory of US interest rates following President Nixon’s politicization of the Arthur Burns-led Fed, an episode that highlights the dangers of compromising central bank autonomy.

Currently, the average maturity of US debt is approximately six years.⁹ Treasury yields, particularly in the intermediate to long end of the curve, tend to reflect the broader strength of the US economy. Historically, a sharp decline in these yields has often signaled a recession, an outcome that would likely further strain the US fiscal position.

A different tune

Recent dollar weakness has prompted the usual chorus proclaiming the end of US exceptionalism.¹⁰I choose to frame it differently. A pullback from lofty levels offers a tailwind for US multinationals and opens the door for capital to explore opportunities beyond American borders.

Everyone has a podcast

David Nadel joined our Greater Possibilities podcast to discuss investing in international small- and mid-sized (SMID) businesses. Here are some takeaways:

• Reversal of long-term trends: Recent international equity strength is attributed to a reversal of the 15-year trend favoring US stocks, driven by a weakening dollar and shifting global growth dynamics.¹¹
• Valuation gap and opportunity: International SMID stocks (small- and mid-cap) are significantly undervalued compared to US counterparts, trading at a 40–50% discount on the forward price-to-earnings ratio, offering compelling upside potential.¹²
• Rate cuts and resilience: International SMID companies may be better positioned to benefit from global rate cuts, especially in regions not facing potential US-style inflation pressures. High quality, long-duration assets in these markets potentially stand to gain.
• Under allocation and misperception: US investors are under allocated to international SMID (<1%) compared to international large caps and US SMID, largely due to risk perceptions that David says are misplaced.¹³

On the road again

My travel has (mercifully) slowed. ‘Tis not the season for investment conferences. I’ll instead take a moment to congratulate the class of 2025. Wishing you all the best as you set out on the road ahead!