Ketu Desai
By Ketu Desai
Since the pandemic, the primary driver of markets has been fiscal policy. This is a departure from the Great Financial Crisis before the pandemic, when low rates and quantitative easing drove markets. More than $5 trillion was added to the economy, and this money continues to circulate post-pandemic. DOGE, budget cuts, a smaller government, and tariffs would have all served to reduce this fiscal stimulus.
Most of these policies have since been reversed, allowing the market to recover. DOGE cuts may be somewhere in the billions, from the $1-$2 trillion expected a few months ago. Tariffs have been delayed or reduced. The administration has pivoted from reducing the GDP ratio to expanding our way out of it. The Treasury Secretary said, “…if we change the growth trajectory of the country, of the economy, then we will stabilize our finances and grow our way out of this.”
The “Big Beautiful Bill” is the centerpiece of this. The deficit already is tracking ahead of last year and the Bill, as currently proposed, will add another $2.75 trillion to the deficit according to the Wall Street Journal. The Bill is expected to boost GDP to 5.2%, according to the Council of Economic Advisers. While this estimate may be aggressive, the Bill is meant to be immediately stimulative to the economy through tax cuts and incentives. While many are positioned to expect a recession, the passing of this Bill will lead to an economic reacceleration. Look no further than the steepening yield curve and industrials hitting an all-time high to notice the market sniffing this out.
The key to growing out of a high deficit to GDP ratio is that inflation and yields don’t spike. This strategy aims to keep short-end rates and oil prices low and allow the Treasury to continue issuing there. This will keep interest expense from exploding higher. The Fed will likely be on hold throughout the summer and if the Bill passes, it will remain on hold for the remainer of the year. The administration will appoint a new Fed Chair next year, perhaps with a change in mandate.
Oil prices are down 15% this year so far. This is not by accident as a key part of the Trump administration’s agenda is to increase domestic production by 3mm bpd. This is an ambitious strategy by means of taking other options through geopolitics to influence Saudis/Russians/OPEC+ to boost oil output in return for lifting Russian sanctions, military support for OPEC nations, and pursuing an Iran deal. An added bonus is that these oil revenues will be recycled into US Treasuries.
It’s not only important to know what is driving such fiscal policy markets, but also who is driving them. Retail and corporate buybacks are clearly in charge of the markets right now. There is $15 billion in fresh capital each day, with retail and buybacks as two-thirds of that. Retail’s market share is now more than a third of market activity. This is an all-time high, significantly above the long-term average of 12%.
Buybacks will total just above $1 trillion this year, another all-time record. We’ve already seen major new buyback announcements from Apple, Visa, Alphabet, Meta, Wells Fargo, Uber, GM, AMD, and URI. The intersection of fiscal policy and these technical drivers will show leadership through certain tech stocks, crypto, financials and industrials. These higher beta areas carry more risk, and given the macro & fiscal backdrop, traditional hedges to lower beta such as long duration Treasuries won’t be very effective.
In many previous rallies, investors could hide in defensive sectors such as healthcare and staples. Currently, these sectors haven’t participated, underperforming leading sectors by nearly 15% in the past month. It’s not just the lack of hedges that makes certain investors uncomfortable, but the high valuation they will have to pay.
The S&P is no longer dominated by highly cyclical, boom & bust, low margin, highly levered manufacturing, energy, and industrial companies. It is instead dominated by highly stable cash flow, high margin, lowly levered, high shareholder return, highly innovative, less cyclical tech companies. A record number of S&P companies have higher than 25% margins, less than lx leverage, greater than 10% growth, and higher than 20% return on invested capital. These are premium businesses that command multiple premiums. The speed and the nature of this rally could make many investors uncomfortable, who will then need to step out of their comfort zone to participate.
Looking forward, the market will need to focus on the latest from Washington and emerging economic data.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
