Dear Clients,
The selloff we experienced earlier in the year has been replaced by a strong and sustained rally. Over the past several weeks, stocks have reached multiple new all-time highs, reminding us that markets often move in ways that inflict “pain” on the most people. This year has been no exception. Many investors allowed negative sentiment—driven largely by uncertainty surrounding President Trump’s tariff policies—to push them to the sidelines.
At Kessler Investment Group, we have consistently highlighted our view that markets tend not to respond well to uncertainty. However, periods of volatility often present the best opportunities for disciplined investors. Our decision to maintain a positive outlook on stocks during the turbulence was at times difficult to follow, but it has proven sound.
Why the Rally Has Not Surprised Us
The rally in stocks this year aligns with several important economic and policy developments we have been anticipating:
- Inflation Decline: Inflation has consistently eased since the Federal Reserve acted aggressively in 2022 to raise interest rates.
- Fed Policy Shift: As inflation cooled, we expected the Fed to eventually reverse course and begin to “normalize” rates. In September, the Fed cut rates by a quarter percent. This move to cut the Fed Funds rate adds support for risk assets like stocks.
- Tariff Uncertainty Eases: The Fed stayed on hold through the spring and summer while it assessed whether new tariff policies would reignite inflation. It ultimately determined they would not.
- Tariff Inflation Dynamics: While tariffs raise prices on many imported goods, this effect is more akin to a consumption tax than to the type of inflation tied to supply or demand shocks. The result is a one-time increase in prices—not an ongoing inflationary spiral.
- Growth Implications: Counterintuitively, tariffs can even slow economic growth, which may further ease inflationary pressures.
- Further Easing Expected: With inflation softening and the labor market weakening, we expect the Fed to continue cutting rates—likely two more times this year—with the Fed Funds rate potentially reaching around 3.5% over the next year or so. When the Fed is in an easing cycle, the resulting liquidity tends to boost the prices of risk assets like stocks.
Why This Is Not Smoot–Hawley
Some commentators have compared today’s trade policies to the Smoot–Hawley Tariff Act of 1930, which many blame for worsening the Great Depression. We disagree with that comparison. Smoot–Hawley was enacted alongside a collapse of the banking system and a sharp contraction in the money supply, which led to runaway deflation. Today’s environment is the opposite: the banking system is stable, the Fed is easing, and monetary conditions remain accommodating.
Artificial Intelligence: A Structural Growth Force
A major factor behind this year’s market gains has been the expansion of Artificial Intelligence (AI). The so-called “hyper-scalers”—Microsoft, Meta, Amazon, and Google—have committed enormous capital toward AI development and infrastructure. Their spending has created a rising tide for a wide range of technology companies, driving earnings growth and fueling market gains.
We continue to believe the AI expansion will persist for years to come and that we are not in a bubble, as some suggest. The skeptics who dismiss AI’s transformative impact today will likely be proven as wrong as those who downplayed the internet’s potential in the early 1990s.
AI’s influence will extend to every industry and every sector of the economy. It will change how businesses operate, how relationships are maintained, and how careers are defined. It will also drive an industrial expansion rivaling the original Industrial Revolution—particularly in power generation, where the U.S. will need to rebuild and expand its electric grid to meet surging energy demands. Some experts estimate that within five years, AI alone could require as much energy as the entire nation currently produces.
The next generation of mega-cap companies are being born in this environment. Our responsibility to our clients is to invest prudently—capturing the growth while protecting capital. To that end, before any new stock is added to our strategies, we insist that the company has embraced AI as an integral part of its business model.
While there will be periods when stock prices run ahead of fundamentals, we expect the current bull market to continue for several years. Ultimately, we recognize the bull market will end—likely due to the convergence of multiple factors—but not before further significant growth from current levels.
Government Shutdown: A Familiar Distraction
The current government shutdown, while disruptive in the headlines, is having little real effect on markets. History shows that political gridlock often benefits businesses by preventing hasty policy changes. We expect this shutdown to end soon, with minimal lasting impact.
Gold’s Rally: Context Matters
The recent rally in gold has also drawn investor attention. Prices have reached new all-time highs, surpassing even the inflation-adjusted peak from 1980. While such moves can be captivating, it’s important to maintain perspective.
Gold prices historically move in fits and starts, often tracking inflation over long periods. A useful rule of thumb from early in my career captures this:
“A hundred years ago, you could sell an ounce of gold and buy a nice new suit. Today, you can do the same.”
That observation frames gold’s long-term behavior: it tends to preserve purchasing power rather than create real wealth.
We see the current rally as driven by a few temporary factors:
- Recent Inflation Spike: Gold often rises with inflation, as we saw in both 1980 and 2022.
- Tariff and Currency Diversification: In the wake of new tariffs, some foreign investors and central banks are reducing exposure to the U.S. dollar and turning to gold as an alternative reserve asset.
- Crypto Correlation: The surge in cryptocurrencies like Bitcoin has also drawn attention to alternative stores of value, including gold.
Ultimately, while gold remains a legitimate store of value, we do not view the current rally as sustainable. Inflation is declining, tariff fears are receding, and gold generates neither profits, dividends, nor earnings.
A Pause That Refreshes
Finally, the selloff on Friday followed the 32nd time this year the S&P 500 Index has reached a new all-time high. The decline was a sharp one, trimming about 2.7% from the recent peak. Much of the blame was directed at President Trump’s comments suggesting renewed trade tensions with China.
We are skeptical that this latest salvo will completely derail trade negotiations between the U.S. and China. If history is any guide, this could be another example of the President’s negotiating style—stepping away from the table to extract a final concession or two before sealing a deal. Time will tell which way it goes.
In the meantime, the market appears ready for a pause that refreshes—our euphemism for a period of higher volatility and a potential pullback of 5–8% in the near term. We have been expecting such a decline since August and have been holding an above-average cash position in our managed accounts. We intend to use any short-term weakness as an opportunity to invest in stocks we have been watching closely.
We believe the rally will likely resume as we move closer to November and could continue into next year.
In Closing
The past year has been a powerful reminder that markets can reverse direction swiftly, often when sentiment is darkest. Our disciplined approach—anchored in long-term opportunity rather than short-term emotions, served our clients well.
As we look ahead, we remain optimistic about the prospects for equities, particularly those companies embracing innovation and technological transformation. We thank you for your continued confidence and the opportunity to manage your investments.
Sincerely,
Kessler Investment Group
All information in this presentation is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic performance data is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. Certain statements contained within are forward looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Please consult your adviser for further information.
Opinions shared in this presentation are not intended to provide specific advice and should not be construed as recommendations for any individual. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.