Market Insights Special Edition — Market Shifts Q&A

Hi, I'm Bryan Kucholtz, Head of Texas Capital's Private Bank. And with me today is Steve Orr, our Chief Investment Officer.

We understand the market uncertainty has raised concerns about the current economic climate and wanted to address some of the common questions we're hearing. So, Steve, what's happening in the world today? 

Well, actually a lot. You know, Bryan, first of all, the global economy is doing pretty well. We're in pretty good shape overall. Economists are pretty certain we're going to grow 2.8% or so this year, 2.5, 2.2% economic growth around the globe is sort of a red line, if you will, for some recessions in some places, but we're still comfortably above that. Now here at home, we're looking at downshifting from second gear to first gear, still well above recession. It's still just moving along. But we had talked about having a slowdown in the second half of the year. Let's kind of pull forward a little bit with some of this tariff noise. More worried than actual fact. We also have five wars going on around the world, and this thing called tariff trauma. 

Hey, Steve, what has caused the recent downdraft in the markets? 

Well, you know, we had this really nice two-year run from October of 2022, based on The Magnificent Seven and this artificial intelligence meme, if you will. And that just drove prices well above earnings. So we got overvalued. We were due for a little bit of a pullback or a pause if you will, and that really started towards the end of last year. And it picked up steam when the tariff conversation accelerated a little bit late February, early March. And what happened when we got the actual announcement of tariffs instead of just pricing in some tariff uncertainty, markets moved very quickly to pricing in the idea of is it a soft recession or a big recession? And now here a week or so on, even those attitudes and overreaction are moderating a bit, and we're in a process now where we're just going to grind away and let earnings come up towards prices. We still think earnings are going to grow this year as opposed to, say, March 2020, when the government shut things down and everybody thought earnings were going to zero. That's not happening now. 1998, we had a whole week where when Putin shut down the ruble and long-term credit failed, we thought, oh, earnings are going to be cut in half. And they weren't. 2008 earnings only dropped about 20%. So we still have earnings growth this year. And we still have unemployment in a very good place, 4.1%. And job growth is still continuing. So right now all this talk about recession and horrible things that tariff trauma is going to create, we really don't see it happening. It's one thing to have the media noise stir things up and get people's emotions rising to the front. But when you think with emotion, invariably bad things happen to your portfolio. Just don't need it. So stepping back, keeping a big picture in mind, we see that we're still going to have economic growth this year. It's probably going to be slower than we'd like, but when the economy continues to grow, you continue to add new jobs, and unemployment is still well below 5%, we're not concerned and we think that once we get through this period, think of it this way, this period is a whole lot like baseball season. It's our favorite time of the year. Who's going to win the World Series? Tell me in six months. Just come back and we'll talk in six months. It's the same way with all this tariff stuff. Let's talk again in six weeks and in six months the landscape is going to look very different. And we're going to have a better earnings picture in six months. And we're going to have some opportunities in the portfolio.

I love the baseball analogy, by the way. Steve, what do you think that this means for the economy? 

Well, you're hearing a lot of noise again right now about recession, stagflation, recession, stagflation. A recession, you'd see unemployment north of 5% headed towards 6%. You'd see weekly jobless claims that come out on Thursday morning jumping up to 300,000, then jumping up to 500,000. And we'd see credit spreads in the corporate bond world rising much more rapidly than they have been, just a number of factors like that, that would give us a recession checklist that, again, would put a recession time frame in the 9- to 12-month range. We're nowhere near checking off all that list right now. And what we really see for tariffs is there's going to be a little bit of adjustment here. But you're hearing talk of inflation at 6%, 7%. No, that's not going to happen. We really think inflation if all the tariffs were to take effect that have been announced, might go up as much as a quarter to three-eighths of a percent. So instead of running this year at 2.8 to 3%, maybe we finish this year at 3.6, 3.7%. Again, not a big impact. We think job creation continues and we think maybe we have a couple of quarters of flat growth, but we're going to continue to grow this year. 

Good information. Same question along those lines. How about inflation? 

Well okay. Diving a little bit more deeper into inflation like what I was talking about. We got to step back and remember inflation runs in about 15- to 20-year cycles. And back in June of 22 we hit 9%. And we came down. We bottomed two and a half ish. And we've just sort of built a base at two and a half. A lot of folks had never experienced that. Now some of us certainly had way back when. But before the Cubs won the World Series, we'll put that in context. So inflation that we found, our team went back and looked all the way to World War I, coming back forward always comes in waves. And when you have one way peak like that, 9% in June of 2022, 36 to 40 months, there's another peak. A lot of times that peak is two-thirds the size priced out. So we're thinking just without any of this tariff change, that inflation was going to rise into this year, middle of next year. We think instead of, say, hitting 4% in the middle of next year, maybe it's more like four and a quarter. So in this year, planning on three and a half, 3.75% inflation, a little bit higher than our 2.8 right now. Again, not earth shattering, not anything that's going to push us into recession. Inflation doesn't do that. But we're definitely going to be seeing all of us making some adjustments here and there.

That's really good analysis, Steve. How does this change our view on interest rates and the Fed? 

Well, the Fed says right now that they're on hold, you know, I don't see that any of this changes what's happening with the Fed and their view on rates. Their short-term rates, right now their overnight ranges from four and a quarter to 4.5%. And that's still well above posted inflation of 2.8. Now that's the consumer price index. I do tell you there's more measures of inflation than I can count. And depending on which method used, Dallas trimmed mean, Chicago's method, and Cleveland Fed method, whatever. You're going to have a range of inflation from, say, 2.8 to about 3.5% right now. So pick your number, but four and a quarter to four and a half, the Fed views themselves as being restrictive by having short-term rates over inflation. Got it. But they've come out and said very clearly they don't want to make any changes 'til they see the effects of tariffs. Well, that could be a year or more. Now the markets are a very different case here. And remember you see these odds quoted on CNBC and some of the other channels, odds of Fed making three cuts this year. Fed bond futures are a hedging tool. And markets are using those to make bets about which way the Fed might move. We don't think the Fed makes any move at the May meeting, and maybe not even 'til the July meeting at the earliest, and that would only be in the case of some really serious tariff effects, like what was announced last week. Let's say those take full effect and they do slow the economy in the second quarter, and you do see 4.8% unemployment. That's not our base case. What's going to happen? But if it would, you might see the Fed consider making an action, cutting rates one step, a quarter of a percent in the fall. We still think those odds are very low, lower than what the street is betting right now. They're comfortable focusing on inflation first. If unemployment goes up to 4.8%, 5% you might see something different. Now here's why. A lot of people don't realize that Congress pushed on the Fed back in 1977 with the Humphrey Hawkins Bill this idea that the Fed somehow is responsible for full employment, not just stable prices, but also full employment. The Fed is not in the hiring business or the firing business. So it's a tough, tough job for the Fed. But remember they're watching inflation first and then are watching unemployment second. And right now both of those are really pretty well contained given how our economy is changing from services to more knowledge-based data driven economy. So don't put a lot of stock in that, that the Fed is going to go out and make a bunch of changes to interest rates right now. 

That's really, really good analysis on those questions that the last thing I would say is taking all of that into consideration, Steve, what changes should we be considering in our portfolios? 

Well, right now, Bryan, all of our dashboard indicators are keeping us fully invested. Yeah, we have a certain level of cash in portfolios. We're very comfortable with that level. Remember we were just talking about the Fed that four and a quarter to four and a half. Most of us are making just over 4% on our cash. So if you have cash on the sidelines, it needs to stay there. This is not a buy the dip environment right now. We need to be careful and thoughtful and let the DXY drama with the tariff trauma play out. And that's going to be a few months. So we can afford to wait and just be patient. You know we're not changing our equity allocation at the moment. We're not changing our bond allocations. And we're very comfortable being invested in this environment. But if you have cash, it's okay to keep cash. 

Well, to sum up our time today, we remain skeptical that all announced tariffs will actually take effect. Between country negotiations and lawsuits here at home, the tariff landscape will be less harsh than we anticipated. Earnings will still grow this year and we should skirt recession. Interest rates are largely on hold trying to handicap how far these tariffs will go. The Fed has said they're standing pat, and we do not expect any change in the short- term rates until summer at the earliest. Steve, thank you so much for taking time today to answer these questions. We really appreciate it. 

Well, let us know how we can help you; 'til next time.