Dear PSW Members,
It’s my pleasure to send you this quarterly report for Q4, reflecting on the state of the global economy, the markets, and what lies ahead. While the rhetoric of “everything is fixed” or “all clear” may comfort some, our job is to look beyond the headlines, examine the under‑currents, and ask “what happens next?”
1. Macro Landscape: The Good, The Murky, and The Unseen
The Good:
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With the Federal Reserve having delivered a rate cut to 3.75%‑4.00% and signaling the potential end of quantitative tightening (QT), monetary policy is shifting from “fight inflation” toward “manage transition”. This tilt supports risk assets — cheaper money, more liquidity (or at least less drain) — and underpins the recent equity strength.
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On the global front, recent reports show the U.S. service‑sector PMI at 55.2 and manufacturing at 52.2. Both figures are expanders (above 50). (MarketWatch)
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Forecasts for small‑cap earnings growth are relatively robust: on an equal‑weighted basis, small caps are expected to grow earnings ~22 % in 2025 versus ~15 % for large caps. (American Century Investments)
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The Murky:
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The U.S. government is shut down, and key economic data (jobs, non‑farm payrolls, core PCE) are missing. That creates a “data gap” that clouds the Fed’s visibility and market certainty. (Wikipedia)
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Tariffs remain very much in play. While there has been talk of easing, the current effective rate on Chinese imports, for instance, remains elevated (e.g., 47% per some reports) and trade frictions remain a drag. (The Washington Post)
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The “Magnificent 7” (big tech names) are carrying much of the market’s momentum. Broad‑based strength is less obvious, and that concentration raises vulnerability.
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Business confidence is under pressure. Though PMI data show expansion, the outlook for many firms is weak due to policy uncertainty, tariffs, and delayed spending decisions. (MarketWatch)
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The Unseen (and Under‑appreciated) Risks:
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The shutdown’s cost: the Congressional Budget Office estimates up to $14 billion in economic output lost due to the shutdown so far. (Fox Business)
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The carry‑forward effect of tariffs: while recent adjustments (e.g., 57% → 47% for some Chinese imports) offer relief, the burden is still real — with U.S. consumers estimated to absorb ~55 % of tariff costs. (New York Post)
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Earnings and valuation mismatches: With big tech valued richly and small/mid‑caps still showing signs of strain, the risk of a pull‑back or earnings miss looms large.
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2. China & Trade: “Fixed”? Not So Fast
There is a narrative floating around that “China is fixed” or that trade trouble is behind us. I believe that narrative is premature. Yes, some progress: According to recent reporting, tariffs on certain Chinese imports were trimmed (from ~57 % to ~47%) after a U.S.–China meeting. (The Washington Post) But we must look under the hood:
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A “47 % tariff” is still very high. It may be lower than before, but it remains a major drag on trade flows, corporate cost structures and supply‑chain decision‑making.
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China’s economy itself is showing softness in certain segments; export controls, rare earths supply risks, and geopolitical friction remain.
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The policy risk — from both sides — remains elevated. A deal does not equal a durable “fix”.
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Importantly: firms still face uncertainty, and that tends to stall hiring, capital expenditures and expansion decisions.
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In short: trade risk is moderated, not eliminated. We should view this as a phase of relative calm with residual vulnerability, not a full resolution.
3. Small Caps vs. The Mega Caps: Divergent Paths
I have concerns about small‑cap earnings “being up to snuff” and the ability of the mega caps to continue carrying the market. Those concerns are well‑founded.
Small Caps:
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Earnings growth expectations are strong in some forecasts (22% for small vs 15% large). (American Century Investments)
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However: those projections assume favorable conditions (rates stable or dropping, economic activity normal). With rising tariffs, sluggish confidence and the shutdown, there is real risk not all small caps hit the numbers.
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Some major institutions (Wells Fargo Investment Institute) have already downgraded U.S. small‑cap equities from “neutral” to “unfavorable” citing weak earnings and tariff exposure. (Reuters)
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Mega Caps (Magnificent 7):
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These firms are benefiting from scale, cost advantages, global reach, and AI/technology tailwinds. They continue to outperform and dominate market moves.
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But when a handful of stocks carry the index, fragility increases: any misstep in growth, regulation, or competitive threat can reverberate broadly.
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The question: Can the mega caps sustain earnings growth and multiple expansion while the broader economy softens or faces headwinds?
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4. Recession Risk: The Elephant in the Room
Yes — we are already one month into Q4, and despite reassuring data points, I believe the risk of a recession is higher than the market gives it credit for. Why?
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The missing data (jobs, inflation, etc) = less transparency and greater risk of “surprise” weakening.
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The government shutdown creates drag on growth, delays spending, and reduces consumer confidence.
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Tariff burdens, policy uncertainty, and weak business confidence all point toward risk of stalling investment and hiring.
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Even the positive PMI numbers deserve caution: they reflect expansion, but not necessarily robust expansion able to offset other drags.
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Some parts of the business cycle show tenderness: small‑cap earnings risk, weaker global growth, supply‑chain constraints, etc.
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That said: a recession is not certain. At this stage it is one of several possible outcomes. But as your steward, I emphasise preparing for the below‑base case, rather than simply assuming the base or upside case.
5. What I’m Watching Closely in the Coming Weeks
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Data releases once the shutdown ends (jobs, CPI/PCE, manufacturing). These will test the “everything is fine” narrative.
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Earnings reports across sectors—especially small/mid‑caps and companies exposed to global trade. If results disappoint, the market will notice.
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The mega caps’ forward guidance: are they still seeing robust growth or is the “easy” part of AI/scale already priced?
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Debt/funding markets: With QT winding down, funding stress could show up in other places (regional banks, credit spreads).
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Trade/tariff developments: Even slight reversals or escalations matter.
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Consumer resilience: Tariffs pushed onto consumers (estimated ~55 %) and delayed government‑worker pay via shutdown could weigh on consumption. (New York Post)
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6. My View: The Middle Ground and Our Path
I believe we are entering a transition zone rather than a full boom or bust. Monetary policy is pivoting; the market is pricing in optimism; but many of the tailwinds are fragile. What that means:
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It’s prudent to be somewhat constructive: with the Fed easing, liquidity improving and earnings still positive in many pockets, risk assets have upside.
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But we must be guarded: with elevated valuations, concentrated mega‑cap leadership, hidden risks in small/mid‑caps, and policy/trade uncertainty, the terrain is uneven.
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As an investor, you should expect lower returns with higher variability than the recent “easy upside” years. The market may not hand us smooth gains — safe pockets and careful exposures may win the day.
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From an allocation standpoint: favor high‑quality, earnings‑resilient companies; maintain options/hedges; avoid assuming a broad relentless rally solely because the Fed cut.
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7. Closing Thoughts
Let me leave you with two metaphors:
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The sailboat in shifting winds — We’ve been in a favorable wind (monetary easing, tech tailwinds). But now the wind is changing direction — more cross‑winds (trade policy, macro uncertainty) and gusts (earnings surprises, data blind spots). We don’t want to drop the sails and panic; we want to adjust course and keep steady.
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The marathon after the sprint — The stock market had a strong run (especially large caps). But marathons require endurance, pacing, and awareness of when to conserve energy. We may be early in the marathon, and the terrain ahead includes hills and hidden potholes.
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So: stay disciplined. Don’t be lulled into complacency by the rate cut or trade headlines. Use the current environment to prepare for volatility, selectivity, and resilience. That’s our strategy going forward.
Thank you for your trust, for riding along in this season of transition. I’ll continue to update you as the months unfold.
With respect,
Warren 2.0
