Happy New Year! Another year in the history books...

Before we discuss our thoughts on the New Year, some observations on 2025: The world economy stayed stronger than most expected. Inflation eased but not to the extent that many had predicted. Inflation continues to be sticky at 2.75%-3.00% in the United States. Inflation is also stubbornly high in Japan and other industrial countries. Short-term interest rates fell; however, long-term rates remain in the 4.125% area. Stock prices continued to be extremely volatile. By year-end, returns were positive by approximately 15% depending on the exposure to Artificial Intelligence (AI) tech stocks. Our portfolios in 2025 performed comparably well with approximately 33% in stocks and the balance in much safer income investments.

For the new year we are cautious. Almost every prediction is for a stronger economy, higher corporate earnings, lower interest rates and higher stock prices. The consensus is rarely correct. We agree that the world economy should remain in growth mode. However, we believe inflation will stay in this 3% area. This should keep the United States’ 10-year interest rate at current levels or higher. This rate determines mortgage rates, car loan rates and others. The Federal Reserve Bank will lower the short-term interest rate several times in 2026 as they control this interest rate. The markets control the longer-term interest rate and as stated we expect this rate to move slightly higher. Stock valuations are historically high based upon their multiple earnings, cash flows, book value, etc. By 2026 year-end, we expect more modest gains in stocks and much more volatility, especially in the high-flying Artificial Intelligence (AI) technology sector.

We appreciate your continued trust and confidence. Best wishes for a healthy and prosperous 2026.

Predictions for a slowdown in the world economy continue to appear to be premature. This may go down as the most predicted recession in history. We are not denying the possibility, we believe IF it comes, it is a late 2023 or 2024 event. How severe a recession is also open for serious debate. We are in the mild camp. Employment continues to be strong. Wage gains are becoming common place. Yes, high tech companies over hired in the boom. With the cost of money being almost free, they expanded into business areas they knew little about. The result of this is layoffs and terminations of employees. However, this “bad sign” for the economy seems to be unique to the high-tech area. Other industries continue to hire employees. The labor shortage is a long way from over. With more people working and earning more money it is a “good sign” for the economy.

On the inflation front there is no doubt inflation, for now, has slowed. But slowing inflation is not, solved inflation. A drop from 9% to 6% inflation is hardly anything to celebrate. The Federal Reserve target rate is 2%. We expect the Fed to continue to raise interest rates and keep them higher for longer. Some of the progress on inflation comes from a strong U.S. dollar. This makes buying on the international market cheaper. Recently, as talk accelerates about interest rates in the U.S. topping, the dollar has weakened. This can reverse the progress made on inflation. It becomes a classic catch-22 problem. Raise rates inflations slows. Lower rates inflation returns. This is the basis of our higher for longer prediction. The best outlook for inflation is the fact the growth of M2 money supply has slowed dramatically. The Fed is no longer printing money. We hope they maintain this discipline but must acknowledge political pressure could sway them. .

Investment markets, in our opinion, are moving towards being a little too bullish. Participants seem to believe inflation, interest rates, the economy, corporate earnings, the budget deficit, Russia, China, the crypto meltdown, the liquidity crunch is select areas, are all going to work out without any major problems. It is a leap of faith. We are most concerned about corporate profits. Past earnings were inflated by cheap money. It allowed firms to make acquisitions to grow profits. Re-financing billions in debt at lower and lower interest rates certainly helped. The environment now is completely different. Labor costs are surging. Cost of materials are higher. Cost of insurance, transportation etc. are all higher. It's difficult to see any growth of corporate profits. With higher interest rates calling for lower multiples on flat profits, we remain in the cautious camp towards stocks. The current bond market is fascinating. Investors are convinced inflation is coming down and thus interest rates will follow. They expect interest rates to go back to 1.5% on the short end and 2.75% on the long end. We completely disagree with this. Many pundits are calling for investors to buy 20- and 30-year bonds to lock in the rate at the 4% level. We are convinced this is exactly what an investor should not do right now. That area of the bond market produced 25% plus losses in 2022. .

We are bullish on gold. Relative to the destruction in value of paper currencies, gold is not expensive. We are NOT perpetual gold bugs. We only purchased gold stocks two years ago. For now, they are paying excellent cash dividends and generating good free cash flow. .

We are bullish on steel stocks, particularly CLF. There is much discipline in this area and the stocks are selling as if a horrible recession is already here. We like the fertilizer stocks. Prices of potash and phosphate are down. This appears to be fully reflected in the stock prices. .

After earnings season is over in the next 4/5 weeks, we will re-evaluate on thoughts. Bank stocks are intriguing. They are also selling in some cases as if the recession is here and they will be writing off millions in bad loans. They also benefit from higher interest rates. As mentioned, many are looking for lower interest rates. We disagree with this narrative and will monitor the bank stocks for increasing cash dividends and potential stock buybacks.

Recent news leads some investors to believe the economy is already in recession. Couple this with the misinterpreted news that inflation is now under control, and you have the foundation for a rally in both stock and bond prices. We are enjoying the rally but doubt it will last. The economy is not in recession. Unemployment is at all-time low, average hourly earnings are higher and retail sales are resilient. This is hardly the figures of a recession. Inventory adjustments at businesses are historically volatile. This past quarter showed business reluctant to pay higher prices for inventory. This can only last for a certain length of time. Ultimately inventories must be rebuilt or go out of business. Inflation figures no question, showed improvement. A drop from 9.5% to 8% is an improvement. The thoughts of many analysts that inflation is quickly dropping back to the Fed’s 2% target rate is folly. Inflation is stubborn. Housing costs are yet to fully work their way through the figures. Rents are strong and going higher. Mortgage rates are high. Prices of homes, off their highs, are holding up. Housing represents approximately 33% of the inflation calculations. The cost of labor is in the early stages of increasing. With unemployment low and the labor force not increasing, it is unlikely the cost of labor will fall. In fact, it will continue to increase. Don’t be fooled by last month’s report. More workers at lower paying jobs held down the average cost. Energy prices fell last month from the release of millions of barrels of oil from the government strategic petroleum reserve. The fall in price distorted the inflation figures. The release will end by October. Energy prices will then go back to trading upon supply and demand dynamics. In our opinion, the most important ingredient of future inflation is reducing the growth and size of the money supply. The Fed is not addressing this issue. They believe inflation can be reduced to their 2% target by simply raising interest rates. We doubt this. This supports our outlook for inflation to stay stubbornly at the 5% to 6% level for another 24 months until the Fed drains liquidity (printed money) from the banking system.

Financial stocks were battered during the recent market downturn. They have since recovered somewhat. We believe the outlook for bank stocks is bright. They are a beneficiary of higher interest rates. They are also a major benefactor of technology. Their costs of acquiring deposits are much lower. With reasonable loan demand their net interest rate margins will expand nicely. Their charge offs for bad loans are negligible. Consumer debt, credit scores and ability to pay debt is at a high. With our outlook for a strong economy and continued wage growth, this element of banking will remain positive.

The bond market rally is muted. Yields are slightly lower. We urge investors to stay with short (18 months and less) durations. Yields in this area are at yield curve highs. In our opinion the risk of extending maturities outweighs the potential reward.

We remain bullish on commodity prices. Recent price pullbacks are just that, pullbacks. We see gold prices and agriculture prices returning to recent highs.

The current debate on Wall Street centers on the potential for a recession. Many pundits are claiming we are already in a recession. Many more are predicting a severe recession before year end. Holding this belief enforces their thinking that inflation is going to fall back to a 2% level. With inflation this low, the thinking proceeds, interest rates are not going higher and will begin falling by year end. In a two-word response we describe this logic as “highly doubtful”. Wall Street is not Main Street. There is no question Wall Street is in a recession. Perhaps a severe recession. Markets are sharply lower. Bonuses are down, investment banking fees are non-existent. Assets under management are falling. Summer Rentals in the Hamptons are off sharply. The prognosticators working in this environment tend to assume their personal experiences must be what is going on all over the country. The New York media often follows this crowd. Current reporting on the economy is tilted.

Facts on the economy show employment is strong. Job creation is strong. Wages are moving higher. There is pent up demand for autos, travel, computer chips and services. Recent durable goods orders show strength across the board. The June ISM services index showed growth in all 18 categories. Manufacturing indexes recently released are showing growth. These are not the signs of a recession.

The outlook for inflation to fall back to the 2% level is based upon the mistaken Keynesian theory of a recession lowering commodity prices. It fails to address the recent 43% growth in the M-2 money supply. This money printing is the root cause of inflation. Until the Federal Reserve Bank removes much the excess reserves created over the last 24 months, we doubt inflation will make an exit.

Interest rates are a function of inflation. To deal with higher inflation the Fed must drain reserves. If inflation stays elevated, the Fed will be forced to “raise” interest rates higher than current expectations. We strongly disagree with any theory the Fed will be “lowering” interest rates by year end, or early next year. Keynesian belief that 2.25% interest rates will discourage 8.5% inflation is suspect. Labor inflation and housing inflation are beginning to work their way into the CPI. We don’t see this changing anytime soon.

The bond market follows interest rates. Higher rates, lower bond prices. The first half of 2022 is the worst bond market performance in over a hundred years. This is with interest rates at only 3% on a ten-year government bond. A move higher in the rate will continue the bond market rout. Better to keep fixed income maturities short to avoid further pain and suffering.

Our outlook for a strong economy doesn’t flow through to a good stock market. History shows several diversions between the two. Higher costs of doing business will hamper corporate profits. Businesses face higher labor costs, higher transportation costs, higher energy costs and especially higher costs of capital. We are cognizant of the profit benefit over the last ten years of companies re-financing debt at lower and lower levels. Stocks sell at a multiple of earnings and cash flows. Flat to lower earnings with higher interest rates leads us to believe prices stock prices will continue to fall.

While our current (and past 18 month) outlook for stock and bond prices is bearish, we see excellent buying opportunities occurring later this year, or early next year, when prices are lower. Wall Street will overcompensate to the downside when their predictions of recession etc. fail to materialize.

Markets are much changed since our last letter. There are many issues behind the moves. The main issues are inflation, the Russian invasion of the Ukraine, falling covid cases, the outlook for interest rates and the outlook for the world economy.

Covid cases are falling sharply in most of the world. Many countries are slowly dropping travel restrictions while simultaneously re-opening their economy to pre-covid levels. We expect this trend to continue and result in strong economic growth around the world. While inflation is a threat to this increased consumer spending, we believe recent geopolitical events will increase this trend. Consumers are showing a propensity to spend. They lived through the threat of covid. Now they are confronted with a dictator in Russia potentially destroying world peace. Both events are creating a reason for consumers to examine their “bucket list” with the goal of crossing off a few entries. This may be travel, buying a new vehicle or a new house, adding a pool or extension to their existing house, buying different clothes, attending sporting events etc. A recent survey of Europeans revealed many people saying they always wanted to visit the United States. They now pledge they are going to do the same. Good for the U.S. economy.

The Russian invasion of the Ukraine is tragic in the suffering and deaths it will cause before it is over. The economic results are not as certain. A world-wide recession that some predict is not a certainty. Higher prices for certain commodities are more of a guarantee. While difficult to deal with the prices, it is not a precursor to ruining the world economy. We hope that a negotiated end to the invasion can come soon.

Before the invasion, inflation was moving significantly higher. This was sure to bring about an increase in interest rates in the U.S. and elsewhere. There is nothing that changes our opinion about inflation. If anything, the war will cause inflation to be even higher than pre-war. Interest rates will need to go higher than previous expectations. Central Bankers including our Federal Reserve may go much slower in raising interest rates due to concerns about the Russia/Ukraine tragedy. This will only assure that inflation and interest rates are headed higher.

We expect bond prices to trade much lower between now and year end regardless of what happens overseas. Only keeping durations as short as possible will prevent fixed income losses. The stock market will trend lower over the year marked by intermediate periods of rallies, only to later make new lows. Buying the dips will not work. Commodity stocks are performing well and will be a small area of the stock market that will perform. Commodity prices from beans, corn, wheat, oil, natural gas, copper, gold etc. will be volatile, but are not going back down to levels of a few years ago. The Nasdaq YTD is down 17%, the S&P is down 11.4%. Energy stocks are, on average, up 35%. Global metals and mining are up 11%. Commodity related stocks are, on average, up 20%.

Our managed portfolios are showing slight gains YTD. Our positions for the last 18 months have avoided high flying Nasdaq issues with little investment merit, while concentrating on good cash flow generating companies with positive exposure to inflation.

We view a strong world economy. However, we believe the best investment approach is one of selection and caution.

The first quarter economic data of 2021 continues to point towards a major economic recovery around the world. By design, your portfolio is invested in many issues tied directly to the recovering economy. Last year saw investors go overboard on high-tech glamour issues - companies making little if any money and generating no positive cash flow. This year the markets are rewarding investments in companies with real profits, cash flow and dividends. We continue to like bank stocks, energy, gold mining, fertilizer, and pharmaceutical issues among others.

This year, interest rates and inflation are also on their way back up. Most fixed income investments are down sharply for 2021. The negative returns are close to double digits depending upon duration. We believe bonds will continue to be a “bubble” market in 2021. Traditional fixed income investments have the potential to drop by as much as 15% to 20% by year end. You may notice your fixed income holdings are almost all “floating rate” issues avoiding this risk. We also have large money market balances at quarter end. This is not a permanent home but more of a safe port in the storm.

Higher inflation and runaway government spending are currently our biggest worries. We are monitoring the same and will act when necessary.

A special thank you for your understanding of the past year. The pandemic brought unprecedented downward moves in economic growth and, for a while, investment prices. Interest rates also plunged to 0%. We managed portfolios throughout the last twelve months with discipline while also taking advantage of markets underpricing value stocks. This approach is the reason your portfolio(s) have fully recovered and are now at “new high-water marks”.

Prices for stocks and some bonds are now attractive. The sell off in banks, energy, airlines and basic industries such as chemicals is overdone. Markets are as “illiquid” as any time in history. Price movements are now driven by loans to hedge funds and others being called by banks. It becomes forced selling.

This started with many, us included, underestimating the ability of the world public to panic over the corona virus. The damage to the world economy is real. The damage is also self-inflicted. We believe in the next 4/6 weeks the panic will end and we will slowly return to business as usual. This return to normal has incurred in China and South Korea. This tells us the world recession will probably be shallow and short-lived.

We are waiting, trying to determine when the “forced selling” and panic selling is over, or close to over. At that time, we will be increasing our equity positions from approximately 35% to 50/55%. Dividend yields far exceed yields on bonds. The Fed will most likely keep rates at the current unprecedented low levels even after the crisis is over. Stock dividend yields are attractive.

There are some that believe the panic over the virus will continue for the balance of 2020 and well into 2021. We disagree. They see the world going into a severe recession or near depression. We disagree. The world dealt successfully with Asian flu, Hong Kong flu, swine flu and others. It will handle the Corona virus.

President Smoot (AKA Trump), tweeted this morning that the problem is not the trade war with China and others. His contention is that the FED is keeping interest rates too high. They need to lower them immediately and aggressively is his advice.

This is absurd. The ten-year U.S. Treasury is 1.70%. The cost of money is NOT keeping people from buying cars and homes. The ability to borrow money at all time low interest rates is NOT keeping corporations from borrowing to expand plant and equipment. For both business and consumers, loans are readily available at historical low interest rates. Does the President believe if the cost of loans was just lower, it would create a major spending boom by business and consumers?

The problem is indeed tariffs. This is a major cost increase that discourages both Chinese citizens from buying and U.S. citizens from buying. It destroys business confidence on both sides. It stops business activity. The U.S. and China represent approximately 45% of the world economy. The other 55% are beginning to see sales to both China and the U.S. slow.

Hopefully the President’s comments are just political posturing. It worries us that he may actually believe what he tweeted this morning.

10 Reasons Why Terril & Co. Is Reducing Your Portfolio’s Exposure To Stocks And Long Duration Bonds

In no particular order …

1. The market doesn’t seem to care that the budget deficit is now running at more than $1 trillion per year, an all-time high. Pundits say the deficit doesn’t matter anymore. We disagree.
2. Cover stories in mainstream business media proclaim the “death” of inflation. It is buried forever, the experts say. Again, we disagree.
3. Investors seem to trust that no matter the real world shocks dealt to the international economy and investment markets, central bankers will simply cut interest rates and save them from losses. We believe that could be a very costly assumption.
4. In 25% of the industrialized world, the interest rate on newly issued debt is negative. Yes, banks are PAYING the buyer to warehouse their money. This is not normal. This is the type of extreme condition often seen at market tops.
   Markets seem complacently certain that interest rates worldwide will remain at current or lower levels forever. We remember the days when an interest rate of 5% was considered low.
5. Investors are taking on more risk every day in an attempt to boost returns. Abandoning risk guidelines to chase momentum stocks is commonplace – and is seldom a smart long-term investment strategy.
6. A larger than once imaginable segment of current presidential contenders are extolling the merits of socialism. Amazingly, they are finding a following.
7. The IPO market is again red-hot with offerings of companies that have little, if any, chance of ever generating positive cash flows. Enamored with rosy sales growth projections and swelling customer counts, IPO investors are ignoring seriously flawed business models that cannot generate profits.
8. Bitcoin and other cyber currencies continue to have a following even as the sector deals with scandal after scandal. The notion that central banks will stand by idly and lose control of their currencies is ridiculous. A core function of government is to control the means of financial exchange and the creation of same.
9. Market volatility is unprecedented. Liquidity is poor in major moves up and down – a sign that many of today’s investors are short-term speculators, not long term holders.
10. Computer algorithms rule today’s trading floor. Typically, algorithms base buy-sell decisions on price momentum, not investment fundamentals.

Investment markets in late 2018 decided it was likely that the world economy was approaching a recession. The prevailing thought was that banks would end up with billions in bad loans and interest rates would return to zero. We didn’t agree with this reasoning in December, and we continue to be skeptical of it today. Consumers in the U.S. and most other industrialized countries are in their best financial position in 50 years. Central bankers around the world continue to provide ample liquidity and are acting to keep interest rates at historic lows. The movement toward more economic freedom and away from socialism is alive and continuing to progress, albeit slowly.

We believe the world economy will continue to grow in 2019. It may be at a slower pace than in 2018, but it will be growth nonetheless. Also, interest rates are likely to rise slightly in the coming year.

The stock market developed a love affair with growth stocks about 6 or 7 years ago. Buy growth at any price was the mantra. We believe this love affair is now on the rocks (witness Apple, Netflix and Tesla). We see value stocks – the laggards of the last 6 years – beginning to get some affection. Steady earnings, increasing dividends, stock buy-backs and good balance sheets do matter. A dominant position in an industry also helps. Last year, banks, energy, pharmaceuticals, basic materials and computer chips were laggards. While the fundamentals of these businesses were good, their stock prices were down. This dichotomy will change in 2019.

The political atmosphere stinks. Partisanship is worse than ever. After nearly one month, the U.S. government remains shut down. Brexit issues overhang Britain. China’s trade dispute with the U.S., Canada and Europe remains front and center. Budget deficits are obscene. It is easy to get depressed.

However, political events like the above are not likely to cause a major world recession. We continue to believe in the economic potency of creative entrepreneurs, the world citizens that produce and trade with each other. Their determination to create a better life for themselves tends to overcome the incompetence of their governments.

We remain constructively positive on the outlook for the world economy and investment markets.

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