2025: CAUTIOUS OPTIMISM WITH SOME UNUSUAL UNCERTAINTY
 

For years, we have been guided by the direction of corporate earnings (especially those of the companies we invest in) and real-estate cash flows, in conjunction with the level and direction of interest rates.   The values of companies and real estate are primarily measured by two factors: earnings/cash flows and the impact of changes in interest rates.  This could not have been more evident over the past three years.  During this period, we experienced the benefits of declining interest rates coupled with rising earnings, and the challenges of significant interest rate increases as the Federal Reserve worked to control inflation.  This heightened inflation emerged from two main sources: the economic aftermath of the COVID-19 pandemic and excessive federal spending, which not only fueled inflationary pressures but also contributed to mounting national debt.  Chart 1 shows inflation, S&P 500^® index earnings growth (or decline), and the federal funds rate over the past ten years:
 

Financial markets experienced noteworthy volatility in 2022, marked by multiple increases in short-term interest rates (four 75-basis-point increases, two 50-basis-point increases, and one 25-basis-point increase).  This led to a dramatic decline across all asset classes: the stock market plummeted, bond holders faced significant paper losses due to rising 10-year U.S. Treasury rates, and the commercial real-estate market faced liquidity challenges and office vacancies.  Adding to market turbulence was the unprovoked invasion of Ukraine by Russia.  Only a few times in recent history did both stocks and bonds decline simultaneously by more than 10%.  The volatility created an illiquid financing environment for real estate, a sector already weakened by COVID-19’s impact on attendance in offices.  However, 2023 saw a turnaround with significant gains in the stock market, especially fueled by technology-oriented growth companies and the surging interest in artificial intelligence (AI).  NVIDIA emerged as a standout performer, with its chips becoming essential for data centers and AI.   At the same time, as you can see in Chart 1, inflation gradually moved down towards the Federal Reserve’s 2% target, though not quite reaching it.  This year was also marked by geopolitical turmoil, including the Hamas attack on Israel leading to more than a thousand deaths, barbarism not seen since al Qaeda, and over 200 hostages forcefully taken into Gaza, where some live and many perished.  Now we as investors were digesting two regional wars as Hezbollah and the Houthis joined in attacking Israel with daily missiles and drones.  The U.S. provided military support to both Ukraine and Israel, boosting domestic defense spending and benefiting defense sector stocks throughout 2023 and 2024.

As 2024 began, corporate earnings continued their upward trajectory as shown in Chart 1, while 10-year U.S. Treasury rates increased late in the year.  Departing from recent history, however, equity markets faltered in December.  The stock market rally was dominated by the Magnificent Seven – Amazon.com, Tesla, Microsoft, Alphabet, Apple, Meta Platforms, and NVIDIA.  In an almost unprecedented manner, these seven stocks make up 33% of the S&P 500^® Index and were responsible for 54% of this past year’s stock market gain.  This concentration led to the S&P 500^® Index (market-cap weighted) price-earnings ratio of 21.6x on 2025 projected earnings compared to the S&P 500^® Equal Weighted Index price-earnings ratio at a more modest 16.4x.  Of course, the projected 2025 earnings growth for the Magnificent Seven is 18%, while the other 493 companies are projected to grow 11%.  Herein lies the dilemma for investors:  does one continue overweighting those companies whose stocks increased between 13% and 171% or begin to broaden one’s portfolio to reflect the cheaper valuation for the majority of companies in the S&P 500^® Index?  Meanwhile, mid-cap, small-cap and international indices underperformed the S&P 500^® Equal Weighted Index.  Perhaps at some point mid-cap and small-cap will have their day (and we do include them in our most diversified strategy).  The international indices have trailed domestic indices cumulatively since 2008, influencing our decision to maintain minimal international exposure in some of our strategies, while still adhering to diversification requirements.

So, market despair in 2022 for basically all investors; happiness in 2023 as we rebounded from the ugliness of higher interest rates and inflation, while coping with two worsening wars and even Russia threatening a nuclear attack; and, once again in 2024, growth stocks continuing to dramatically outpace value stocks.  However, interest rates for the 10-year U.S. Treasury rose again to 4.6% by year-end reflecting a more cautious Federal Reserve seeking to attain its elusive goal of 2% inflation.  In our opinion, this negatively impacted equity markets at the end of the year, but there was still happiness as the equity markets mostly recovered the losses of 2022.  Bitcoin surged along with gold to new highs reflecting, in our opinion, the growing national debt and inflation concerns as well as domestic political uncertainty (more on that shortly).

Entering 2025, investors face a complex landscape: projected corporate earnings growth of 14.6%; inflation seemingly hovering between 2.5% and 3% (again, not quite at the Fed’s goal of 2%); the 10-year U.S. Treasury yield at 4.6%; ongoing conflicts in Ukraine and the Middle East, including a hostage situation going on its second year; and a new sheriff in Washington, D.C., President-elect Trump.  Market valuations have become more attractive following the year-end volatility.

The recent U.S. election resulted in Republican control of the House, Senate, and Presidency.  The new administration’s agenda includes ending wars, reducing inflation, stimulating economic growth, cutting taxes, implementing immigration reform, reducing crime, and curtailing government waste.  We as investors need to handicap President-elect Trump’s ability to accomplish any of the above, and try to determine how this impacts the different investments that we make, but always through the lens of long-term investing.  However, the Republicans hold one of the smallest House majorities in history, with extreme factions in both parties potentially impeding progress.  This political dynamic could affect the extension of Trump’s 2017 Tax Cuts and Jobs Act, which has significant estate and income tax provisions sunsetting at yearend.  Additionally, any expectations of a “peace dividend” boosting price-earnings ratios through globalization have diminished amid the ongoing global conflicts.

Our Investment Strategy View for 2025 

The past three years remind us that investment markets respond primarily to three factors:  earnings growth (or decline), inflation levels, and Federal Reserve policy in pursuit of its dual mandate of low inflation and full employment.  Recent trends in gold and bitcoin prices suggest growing concerns about national debt and inflation.  FLI does not currently recommend either asset class to clients.  Here is why we remain cautiously optimistic while acknowledging certain concerns:

1. Corporate Earnings Growth

Analysts project corporate earnings growth of 14.6%.  We believe the Information Technology sector and select other companies will continue to lead this growth.  President-elect Trump’s pro-business agenda, including tax and regulatory reforms, could support this growth – though implementation remains uncertain given political realities.  While we believe current growth projections are ambitious, overall market valuations remain reasonable.

2. Inflation Dynamics

Inflation persists between 2.5% and 3%.  It remains to be seen if President-elect Trump’s tariff policies will put upward pressure on inflation.  Also, the President-elect has strongly suggested he will reduce inflation through an aggressive energy drilling agenda, as well as reduced regulations.  Yet the impact remains uncertain given current robust domestic oil and gas production levels and the typical lag time for new production. 

3. Federal Reserve Policy

The Federal Reserve is rightly data-dependent.  Employment is still quite strong with unemployment hovering around 4%.  Achieving the Fed’s 2% inflation target without triggering a recession presents a challenge, and that has tempered the Fed’s appetite for reducing short-term rates over the next year, as seen in its most recent dot plot released in December.  We do not anticipate a recession in 2025 unless there is some exogenous shock to the economy as suggested by Fed Chair Powell at the December meeting.

4. Credit Market Health

Current high-yield bond spreads compared to U.S. Treasuries remain narrow, suggesting minimal stress in the economy. 

5. Consumer Strength

Consumer spending, representing nearly 70% of U.S. economic activity, is reasonably strong as wage gains outpace inflation, housing values appreciate, and wealth increases from stock market gains.  We expect these factors to continue supporting consumer spending.

6. AI Innovation Impact

The widespread adoption of artificial intelligence across industries and consumers promises enhanced productivity and innovation.  This trend drives substantial corporate investment, particularly in geographically dispersed data centers.

Investment Implications

The factors above support our cautiously optimistic outlook.  Projected earnings growth should more than mitigate any potential degradation of price-earnings multiples, leading to modest equity gains in 2025; however, not all companies will be treated alike.

That is why we strongly encourage our two-pronged investment approach:

· Growth-oriented strategies focusing on large-cap companies with above-average earnings growth.

· Financially strong dividend growers that are typically somewhat dominant in their industries.

The expected 7%+ growth in annual dividends for our Dividend Growth strategy offers valuable protection, particularly if inflation remains between 2.5% and 3%, or even moves somewhat higher.  This strategic combination should help insulate our clients from potential surprises in inflation while the rate on the 10-year U.S. Treasury remains in the 4% to 5% range.

For many clients, it is prudent to have some exposure to fixed income where after-tax rates for medium-term maturities should deliver a slight gain above inflation.  Thus, a fixed income allocation serves as a buffer against market volatility.  We do not anticipate a repeat of 2022’s aggressive Federal Reserve actions that caused significant losses for bond holders.

Our uncertainty comes from the concern that while the new administration’s policies could enhance the business environment, they might also fuel higher inflation.  Higher inflation would, in our opinion, force the Federal Reserve to maintain or even increase short-term rates rather than implement expected reductions.  Additionally, we hope the two regional wars do not become greater global conflicts, noting President-elect Trump’s campaign promise to resolve both conflicts and secure the release of hostages, including American citizens.

Looking ahead to 2025, we see potential for investor gains based on several factors:

· Interest rates remaining within a stable range, reflecting controlled inflation;

· Improving corporate earnings;

· Possible de-escalation of global hostilities in Ukraine and the Middle East along with the release of the remaining hostages;

· Pragmatic immigration policy implementation;

· Extension/modification of the income and estate tax provisions of Trump’s signature legislation, the 2017 Tax Cuts and Jobs Act.  A modification of the SALT deduction cap would benefit many of our clients significantly.

As investors, we need a diversified asset allocation plan that achieves one’s long-term investment goals, despite the current uncertainty.  We expect considerable market volatility driven by domestic political developments and their potential impact on inflation and tax policy.  In addition, unpredictable geopolitical strife, including possible cyberattacks and terrorism, adds another layer of uncertainty and volatility.  In our opinion, as stated earlier, one’s plan should consist of modest fixed-income exposure, strategic investment in growth companies, and dividend-growing companies as well as select real estate and alternative strategies, where appropriate.

Of course, careful tax planning is essential, particularly given accumulated unrealized capital gains.  We encourage all clients to engage with our wealth management team for tax optimization strategies and to schedule regular reviews with our investment professionals to fine tune asset allocations where appropriate. 

On behalf of the entire FLI team, we trust these insights will prove valuable as we navigate the year ahead.  More importantly, we wish you and your families a healthy, happy, and prosperous new year.  We remain dedicated to serving your investment and wealth management needs! 

Wishing you a healthy, happy, and prosperous New Year!

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

DISCLAIMER

The views expressed herein are those of Robert D. Rosenthal or First Long Island Investors, LLC (“FLI”), are for informational purposes, and are based on facts, assumptions, and understandings as of January 15, 2025 (the “Publication Date”).  This information is subject to change at any time based on market and other conditions.  This communication is not an offer to sell any securities or a solicitation of an offer to purchase or sell any security and should not be construed as such.  References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.  Nothing herein should be construed as a recommendation to purchase any particular security.  The companies and securities described herein may not be held in every (or any) FLI strategy at any given time.  Investment returns will fluctuate over time, and past performance is not a guarantee of future results.

This communication may not be reproduced, distributed, or transmitted, in whole or in part, by any means, without written permission from FLI.

All performance data presented throughout this communication is net of fees, expenses, and incentive allocations through or as of December 31, 2024, as the case may be, unless otherwise noted.  Past performance of FLI and its affiliates, including any strategies or funds mentioned herein, is not indicative of future results.  Any forecasts included in this communication are based on the reasonable beliefs of Mr. Rosenthal or FLI as of the Publication Date and are not a guarantee of future performance.  This communication may contain forward-looking statements, including observations about markets and industry and regulatory trends.  Forward-looking statements may be identified by, among other things, the use of words such as “expects,” “anticipates,” “believes,” or “estimates,” or the negatives of these terms, and similar expressions.  Forward-looking statements reflect the views of the author as of the Publication Date with respect to possible future events.  Actual results may differ materially. 

FLI believes the information contained herein to be reliable as of the Publication Date but does not warrant its accuracy or completeness.  This communication is subject to modification, change, or supplement without prior notice to you.  Some of the data presented in and relied upon in this document are based upon data and information provided by unaffiliated third-parties and is subject to change without notice.

NO ASSURANCE CAN BE MADE THAT PROFITS WILL BE ACHIEVED OR THAT SUBSTANTIAL LOSSES WILL NOT BE INCURRED.

Copyright © 2025 by First Long Island Investors, LLC.  All rights reserved.

First Long Island Investors, LLC was honored to host Dr. Meena Bose, Chair of Presidential Studies at Hofstra University, at the Garden City Hotel on October 30^th for our semi-annual Thought Leadership Breakfast.  Dr. Bose is the author of “Shaping and Signaling Presidential Policy: The National Security Decision Making of Eisenhower and Kennedy”, and the editor of several volumes in presidential studies. 

The discussion, which focused on the 2024 U.S. presidential election, began with Dr. Bose providing context surrounding the current political climate of the United States.  She discussed how the country is more divided than ever and faces a multitude of challenges, making the 2024 election highly consequential.  Dr. Bose noted that it is not just the presidential election that will impact America; the House and Senate elections will also shape the future of our country.  The composition of these two legislative branches will be crucial in determining policy moving forward.

Dr. Bose drew parallels to the 2016 election and compared former President Trump’s positions then and now.  Although former President Trump was considered an underdog in both the 2016 and 2020 elections, Dr. Bose emphasized that the 2016 race offered a more apt comparison for 2024 due to the significant impact the COVID-19 pandemic had on the 2020 election. 

At the time of the 2016 election, various factors seemed to point to Hillary Clinton’s victory, including national polls, the candidates perceived political leadership qualities, party support, fundraising success, and overall public opinion.  However, Dr. Bose pointed out that a crucial shift in voter support within Democratic-leaning states like Pennsylvania, Michigan, and Wisconsin was not adequately recognized.  This oversight contributed to Trump’s ultimate victory in 2016, despite Clinton’s favorability by many metrics.  

Looking ahead to the 2024 election, Dr. Bose underscored that the outcome will hinge on the performance of the swing states: Arizona, Georgia, Michigan, Nevada, North Carolina, Pennsylvania, and Wisconsin.  The deciding factor for voters in these battleground states, she suggested, will be the issues they prioritize most – namely the economy, immigration, foreign policy, and reproductive rights.

Dr. Bose pointed out that former President Trump seems to be performing better in polls compared to his previous campaigns against Clinton and Biden, despite being behind nationally in those races.  Dr. Bose referenced two methods for predicting the election winner that historically have had very high success rates.  The first method is Nate Silver’s data-driven approach, which at the time pointed to former President Trump having a slight edge over Vice President Harris.  The second method was created by Allan Lichtman, who has correctly predicted nine of the last ten presidential elections using his “13 keys” system.  This approach focuses on the political landscape and the incumbent party’s performance rather than on polling or other conventional metrics. According to Lichtman’s model, the candidate who wins the majority of the thirteen keys is likely to prevail in the election.  Lichtman’s method predicted Vice President Harris as the winner.  The voters have since spoken, and we now know the outcome of the election.  Hopefully, the country can come together and work towards a brighter future.

September 30, 2024

“Our portfolio doesn’t depend on our being right about the twists and turns of the economy.  It depends on our understanding the prospects for our companies and what is discounted in their share prices.”  

Bill Miller

Our investment strategies delivered positive returns in the third quarter, with all of our Security, Defensive, and Traditional Equity strategies posting gains.  Our flagship Dividend Growth strategy led the way during the quarter, advancing 10.1% net of fees and expenses.  Year-to-date, all of these strategies have generated meaningful positive returns. 

We are also seeing promising traction with our exposure to specific real estate lending investments primarily in the Lehigh Valley, Pennsylvania; Austin, Texas; and parts of Florida.  These gains have been achieved despite difficult geopolitical and domestic political environments.  

The ongoing conflict in Ukraine and escalating tensions in the Middle East continue to impact markets.  Domestically, the political climate has grown increasingly heated, with contentious Presidential, Senate, and House races between Democrats and Republicans.  The rhetoric from all levels of the federal government has intensified, with debates, a bombardment of media campaigns, and rallies targeting voters nationwide.

Despite the angst fueled by ongoing wars and domestic political drama, we believe earnings and interest rates played key roles in the gains mentioned above.  Declining inflation (Chart 1), growing gross domestic product (Chart 2), and declining short-term interest rates (Chart 3) also were, in large part, responsible for these strong results.

The previous charts illustrate what some describe as a “soft landing,” where inflation continues to ease while economic activity sustains growth with a moderate slowdown.  We do not, however, see a recession in the foreseeable future.  Also, in our opinion, declining inflation and lower interest rates contribute to stock market valuations remaining at reasonable, although not cheap, levels.  Chart 4 depicts what we believe are reasonable levels for the stock market, as represented by both the S&P 500 Index (market-cap weighted) and the S&P 500 Equal Weighted Index:

For the soft landing to occur and valuations for equities to remain at reasonable levels, corporate earnings must continue to grow.  We believe this to be the case with large-capitalization, mid-cap, and small-cap companies.  As an aside, our suggestion in the last quarterly letter that small-cap and more value-oriented strategies would rally played out in the third quarter.  International investments also demonstrated impressive signs of life.

Chart 5 reflects Wall Street consensus expectations for earnings growth of the S&P 500 Index in the coming year.  If the earnings come in as forecast, this is particularly noteworthy as it suggests that the market, as a whole, is not overvalued in our opinion:
 

Chart 5 shows consensus projections for strong earnings growth in 2025 compared to 2024.  While we anticipate earnings growth next year, we believe this projected gain is overly optimistic.  In our view, this projection will come down over time, reflecting factors such as decreased consumer demand, uncertainty from a new administration as well as continued geopolitical strife, but we still expect reasonable earnings growth next year.  This will require more scrutiny on a company-by-company basis, making it a stock picker’s market across all market capitalizations.  In our view, the performance of individual companies, driven by their specific earnings growth, will be the primary differentiator.  The rising tide probably will not lift all companies equally. 

The backdrop to cautious optimism in our Security, Defensive, and Traditional Equity strategies is a slowly growing economy, decreasing inflation, falling short-term interest rates, and the absence of an imminent recession (which we do not foresee until late 2025 or later).  We anticipate that companies delivering earnings growth in a declining interest rate environment should appreciate in line with their earnings growth.  In the case of our Dividend Growth strategy, we anticipate appreciation in line with projected dividend growth of at least 7%, which should be well above the anticipated inflation rate.  That being said, it is difficult to fully predict the impact of AI on numerous companies, including those that have less obvious ties to technology.  

The charts above support our cautious optimism, which is justified by this dynamic combination of earnings growth and a supportive environment that will benefit equities, as well as real estate.  We believe real estate will particularly benefit from a slower-growing economy accompanied by declining short-term interest rates.

A final piece of the economic growth puzzle is employment.  It is clear to us that employment has somewhat weakened this year.  While still relatively strong with an unemployment rate of 4.1%, this does reflect an increase from the recent low of 3.4% in April 2023.  There is a theory (the so-called Sahm rule), which states that when the three-month moving average of the unemployment rate rises by 0.5% or more from the lowest three-month average over the previous twelve months, the economy is entering a recession.  Although this rule was recently triggered, we, and the rule’s namesake, do not believe it necessarily applies given the current unique economic situation we are facing.  Currently, consumers continue to spend more on average, with wage gains for many outpacing inflation.  The following two charts illustrate the recent record on unemployment and consumer spending:

Considering various economic factors (including earnings, employment, inflation, and interest rates), we believe that investing for the long term is still reasonable although not inexpensive.  That said, there has been a notable rotation within the equity markets.  Value-oriented companies such as our dividend growers, rallied in the third quarter as did small-cap companies across both growth and value.  The Magnificent Seven had comparatively mixed results in the third quarter despite putting up by and large strong earnings.  We anticipate these trends might continue in the fourth quarter.  This reinforces our longstanding view that our clients should maintain diversified portfolios with exposure extending well beyond the Magnificent Seven.

The Election

One cannot avoid the vitriol of this election cycle.  It is unique in American politics to see a sitting President well into the election cycle bow out.  It appears, in our opinion, that concerns over his mental acuity and negative polling contributed to his decision.  The Vice President was anointed to replace President Biden without a primary process.  Her opponent is former President Trump who has contested the outcome of the previous election.  

The country seems equally divided, suggesting this could be a very close election.  Additionally, both the Senate and the House are contested, with the outcome of these races carrying significant implications.  The views articulated by Vice President Harris and former President Trump on tax, economic, social, and foreign policy issues are quite divergent.  The party in control of both houses, if any, will dictate the trajectory of legislation.  Otherwise they will be forced to “play” in the same sandbox. 

Several tax proposals are critical to our clients, particularly those impacting income tax and estate planning.  The changes to individual income tax rates and estate tax exemptions that were part of the Tax Cuts and Jobs Act of 2017 enacted by former President Trump are set to expire at the end of 2025, which will affect both tax and estate planning.  Clarity is needed to reduce confusion and allow taxpayers to plan for the future.  

Vice President Harris has proposed increasing taxes on certain tax payers (both corporate and individual) on income, estates, capital gains, and corporate earnings.  She has also floated the concept of tax on “unrealized capital gains.”  We view these proposals as potentially negative to long-term investors.

Former President Trump, on the other hand, has proposed a series of tax reductions.  While they sound appealing (no federal income tax on tips or social security, liberalization of the SALT deduction, and reduced corporate tax), implementing all of them could lead to large federal deficits and increase our already high national debt.  

All of these proposals are speculative and contingent on the outcomes of the Presidential, House, and Senate elections.  These elections are extremely consequential given the divergence in economic ideology.  Long-term investors should pay close attention, and we will keep you apprised. 

Adding to this complexity is the expected increase in liquidity coming from both fiscal and monetary policy in early 2025.  This could be positive for equity markets and the economy in general.  The Fed may stop its quantitative tapering, and funds in the government’s general account may be released.  We will continue to monitor these developments and their potential impact on our investment strategies.

What to do?

As stated, we delivered very good results in the third quarter, and year-to-date performance is quite solid.  We have almost made up all the loss from 2022 and then some, depending on the strategy.  Being patient and focusing on long-term investing has paid off.  Our continued guidance to maintain diversification still makes sense.  The recent outperformance by value stocks and small-cap stocks, while the Magnificent Seven have slowed, has brought happiness to a larger segment of investors.  This recent appreciation in value stocks has helped our Dividend Growth strategy, while the improvement in smaller-capitalization stocks and international strategies have helped other strategies, which have meaningful allocations to both value and smaller-caps along with allocations to more growth-oriented strategies.  

We continue to advise clients to maintain allocations to our “bookend” strategy of rapidly growing companies on one hand and dividend growing companies on the other hand, as well as exposure to small and mid-cap companies.  At the same time, our allocation to high-quality, slightly longer duration fixed income, implemented over the last year, is also appropriate for clients.  We also continue to recommend select alternative strategies where appropriate.

Given the world we live in as investors, some volatility should be expected.  The potential for a lengthy longshoreman strike at major ports in 2025 could be consequential and disruptive, following a short strike the first few days of October.  Ongoing foreign wars and the acrimony surrounding the upcoming election (where roughly 51% will be happy and 49% unhappy) could cause investor angst as we wait to see what this all means for the future.  

At FLI, our approach is to examine each investment through the lens of earnings growth, dividend growth, valuation, and for our alternative investments, economic opportunity.  This disciplined course will help us navigate any twists and turns the economy, geopolitics, and domestic politics may throw at us!  This approach has served us well for 41 years and is reflected in the opening quote. 

Of course, despite our cautious optimism, we encourage you to call upon any of the members of our investment and wealth management committees should you have questions or concerns. 

Finally, please join us at our next Thought Leadership Breakfast seminar on Wednesday, October 30th.  Our keynote speaker is Meena Bose, a renowned political science professor at Hofstra University, who will provide an insightful assessment of the 2024 U.S. Presidential election. 

Also, be on the lookout for our revamped website later this year, and please come visit us to see our newly renovated offices.

Have a great fall and holiday season,

Robert D. Rosenthal

Chairman, Chief Executive Officer and

Chief Investment Officer

The first six months of the year have resulted in reasonable gains for our clients who  adopted FLI’s philosophy of investing in different asset classes and having a prudent, customized asset allocation.  This diversification permitted our typical client to be exposed to what worked in the first half of the year, which was predominantly “growth shares.”  Many of our clients also benefitted from exposure to the disruptive technology of artificial intelligence (AI).  Specifically, once again, equity market appreciation has been biased to large-cap growth shares led by several companies (predominantly NVIDIA).  At the same time, large-cap value-oriented companies, many paying dividends, were somewhat left in the dust.  This is a pattern that began last year, which rewarded investors in the large-cap growth index as it trounced the large-cap value index.

The phenomena of a handful of super large Information Technology, Communication Services, and Consumer Discretionary companies driving markets forward resulted in a bifurcation between the S&P 500 Index (market cap weighted) versus the S&P 500 Equal Weighted Index.  

In other words, if you were exposed to NVIDIA, Microsoft, Alphabet, Eli Lilly, Meta Platforms, Amazon.com, and several others, you enjoyed significant returns for the past six months.  In particular, Microsoft, Apple, NVIDIA, and Alphabet are responsible for over 52%of the S&P 500 Index return through the first half of the year.  If you were predominantly exposed to value-type companies, those primarily paying and growing dividends, which were not talking up the AI phenomenon, your returns were meager or modestly down in the second quarter.  Our discipline at FLI is to try to expose our clients to both styles through our defensive and traditional equity baskets.  Both baskets include strategies that expose our clients to both NVIDIA and other technology-oriented companies, while bookending that exposure with more traditional value-oriented companies, particularly those that grow

dividends on an annual basis and have fundamental balance sheet strength.  We typically also include a modest exposure to fixed income, which for our clients was modestly higher over the first six months but provided a reasonable rate of interest and ballast to our overall investment plans.

This approach takes into consideration numerous current factors including:

1. We do not anticipate a recession in the next twelve months.  GDP growth should be in the 2% range.
2. We expect inflation to continue to modestly and slowly abate.
3. We believe that the Federal Reserve will keep interest rates higher for longer, but do expect one interest rate reduction later this year or possibly two.
4. Geopolitical turmoil will continue and could possibly get worse.
5. Domestic political uncertainty has just increased with the first Presidential debate and President Biden deciding not to run for re-election. We could be in uncharted political waters, and we are in an important election cycle with significant economic policy consequences.
6. Earnings for the S&P 500 Index companies remain reasonably good, led by technology-oriented companies.
7. Employment remains robust with the unemployment rate around 4%.
8. Embedded inflation from the last three years remains a headwind for a portion of the U.S. population.  This is impacting consumer behavior and affecting a number of consumer-oriented companies, at least in the short term.

Given this mixed bag of economic and political factors, sticking with a long-term asset allocation that attempts to navigate these uncertain waters continues to make sense to us.  Growth shares are trading at somewhat high multiples as evidenced by the cap weighted S&P 500 Index (however nothing like growth companies in 2000).  Value companies, which drag down the S&P 500 Equal Weighted Index, seem like bargains but do not possess the growth in earnings that leading technology-oriented companies continue to demonstrate.  Dividends and annual dividend growth seem to be out of favor for now, but we expect these types of companies will contribute decent performance over the long term as they have in the past.  Small-cap companies have gone basically nowhere, either growth oriented or more value oriented (year-to-date the Russell 2000 Index is up a meager 1.7%).  This area does present an opportunity as expressed by one of our small-cap outside managers in a recent meeting.

In the commercial real estate arena, higher interest rates and distress in office buildings has led to dismal results as measured by the REIT index.  The exception probably is in real estate related to data centers, which are being gobbled up by large technology-oriented companies.  The residential real estate market has been impacted by high mortgage rates and higher home prices, resulting in a lack of supply.  (In our opinion, many do not want to give up a low mortgage rate on an existing home to move and secure a loan at a much higher rate.)  Affordability is becoming an issue for some new home buyers.

As of this writing, the uncertainty and lack of popularity of the two apparent candidates for President may present some volatility going forward.  This, coupled with two raging wars, provides for further uncertainty.  On the other hand, growing earnings and high employment while inflation slows down provides some optimism.  The ultimate impact in terms of earnings growth from the expansion of AI usage also represents a growth opportunity for corporate earnings.  As stated, however, the happiness thus far in equity markets has not broadened out and seems to favor, for the most part, the leading large technology-oriented companies.  Not the best situation for all investors.  When this will change typically depends on when we face a recession; potential tax law changes impacting economic growth favorably or unfavorably; and, of course, the actions of the Federal Reserve. 

All of our strategies in the defensive and traditional equity baskets have appreciated thus far this year.  As stated previously, those with greater exposure to large technology-oriented companies fared decisively better.  Having said that, it appears valuations favor a tilt towards more value-oriented companies.  The growth bias can continue given the unknown horizon for AI-oriented companies.  Whereas the prospective multiple on earnings for the S&P 500 Index for 2025 feels somewhat high, it should be remembered that the makeup of the S&P has changed dramatically over the past 35 years.  There are more growth-oriented, innovative, technology-oriented companies and much less smoke stack or industrial companies.  These, asset light and technology heavy companies trade at a higher price-to-earnings ratio.

We have shaved some of the big technology-oriented companies over the quarter. Most notably NVIDIA, which is still a major holding in several of our strategies as it has appreciated 150% year-to-date.  Our dividend-oriented strategy, which has modestly appreciated for the first two quarters, has seen dividend growth on average of 7.3% so far this year with 67% of the companies

thus far reporting dividend increases (the strategy was slightly negative for the second quarter).  This average dividend increase is more than twice the Personal Consumption Expenditures (PCE) inflation rate. 

The second half of the year and beyond represents some challenges, but markets typically climb a wall of worry. The election is in November, and its outcome could affect tax policy in the coming years. The two wars present potential volatility given the uncertainty of possible escalation. The direction of inflation during the balance of the year will be instrumental in the interest rate policy of the Federal Reserve. Should inflation not abate sufficiently to move the Fed to decrease short term rates, this could result in equity market disappointment.  Also, at some point both investors and the government should consider our federal debt as it approaches $35 trillion and the interest burden crowds out worthy government investment. Fiscal sanity needs to prevail going forward to stem annual deficits and our total debt.

Where does all of this leave us as investors?  As the opening quote states, we need a plan not predicated on “beating” the markets, but a sane path to growing our wealth in a compounding way.  This can only be achieved, in our opinion, by avoiding substantial losses through smart diversification, and bookending the majority of our asset allocation among growth and value-oriented equity strategies.  In addition, quality fixed income, private real estate, and some possible alternative strategies can also contribute to the prudent diversification we feel is needed to navigate uncertainty over the longer term. Of course, we customize asset allocations for each client depending on their personal circumstances and long-term goals.

Enjoy the summer and feel free to contact me or anyone on our investment and wealth management teams to assist you. 

Best regards,

Robert D. Rosenthal
Chairman, Chief Executive Officer,
and Chief Investment Officer

PS: From a historical standpoint, when the S&P 500 Index is up 12% or more in the first six months of the year, there is further happiness in the last six months of the year 79% of the time over the past 70 years!  History is only a guide.

DISCLAIMER

The views expressed herein are those of Robert D. Rosenthal or First Long Island Investors, LLC (“FLI”), are for informational purposes, and are based on facts, assumptions, and understandings as of July 25, 2024 (the “Publication Date”).  This information is subject to change at any time based on market and other conditions.  This communication is not an offer to sell any securities or a solicitation of an offer to purchase or sell any security and should not be construed as such.  References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.  Nothing herein should be construed as a recommendation to purchase any particular security.  The companies and securities described herein may not be held in every (or any) FLI strategy at any given time.  Investment returns will fluctuate over time, and past performance is not a guarantee of future results.

This communication may not be reproduced, distributed, or transmitted, in whole or in part, by any means, without written permission from FLI.

All performance data presented throughout this communication is net of fees, expenses, and incentive allocations through or as of June 30, 2024, as the case may be, unless otherwise noted.  Past performance of FLI and its affiliates, including any strategies or funds mentioned herein, is not indicative of future results.  Any forecasts included in this communication are based on the reasonable beliefs of Mr. Rosenthal or FLI as of the Publication Date and are not a guarantee of future performance.  This communication may contain forward-looking statements, including observations about markets and industry and regulatory trends.  Forward-looking statements may be identified by, among other things, the use of words such as “expects,” “anticipates,” “believes,” or “estimates,” or the negatives of these terms, and similar expressions.  Forward-looking statements reflect the views of the author as of the Publication Date with respect to possible future events.  Actual results may differ materially. 

FLI believes the information contained herein to be reliable as of the Publication Date but does not warrant its accuracy or completeness.  This communication is subject to modification, change, or supplement without prior notice to you.  Some of the data presented in and relied upon in this document are based upon data and information provided by unaffiliated third-parties and is subject to change without notice.

NO ASSURANCE CAN BE MADE THAT PROFITS WILL BE ACHIEVED OR THAT SUBSTANTIAL LOSSES WILL NOT BE INCURRED.

Copyright © 2024 by First Long Island Investors, LLC.  All rights reserved.

First Long Island Investors, LLC was honored to host Natalie Karp, Founding Partner of Karp Loshak Long Term Care Insurance Solutions Brokerage, Inc., at the Garden City Hotel on May 8^th for our semi-annual FLI Thought Leadership Breakfast. Karp Loshak, founded in 2008, serves as an independent broker affiliated with the leading Long-Term Care (LTC) Insurance carriers.  The firm is highly respected for their educational and consultative approach, which has been recognized as a resource by the Wall Street Journal and Newsday for their expertise on LTC insurance.

The conversation began with Natalie providing an overview of the current LTC landscape, emphasizing the escalating costs of care and the importance of proactively evaluating LTC insurance options.  She positioned LTC insurance as a crucial financial planning tool designed to mitigate the exorbitant expenses associated with LTC and highlighted the diverse range of LTC insurance solutions available.

Natalie noted that LTC insurance is often overlooked because people are reluctant to confront the possibility of future care needs.  However, ignoring this reality can lead to significant financial and emotional strain.  She cited the high and rising cost of care and that the typical LTC need spans three years, which makes the need for LTC insurance more critical as life expectancies continue to increase.  As a general guideline, Natalie mentioned that approximately 70% of individuals aged 70 years and older, and 80% of those reaching age 80, will require some level of LTC at some point.

FLI emphasizes the importance of considering LTC insurance for, quality of life, tax planning and estate preservation for suitable clients.  LTC insurance provides tax-free benefits, helping preserve income and assets that would otherwise be depleted by care costs.  Without LTC insurance, income reallocation or asset liquidation may trigger income taxes.  Additionally, potential payroll tax implications loom, as nearly 30% of states have proposed imposing new mandatory payroll taxes on those who do not have private LTC coverage in order to fund the LTC burden on Medicaid.  LTC premiums may be tax deductible for individuals, and corporations can benefit from tax advantages by paying premiums on behalf of employees.

The FLI Thought Leadership Breakfast series aims to provide our clients with access to industry thought leaders and experts who can provide valuable insights to help them make informed financial decisions. We were pleased to feature Natalie Karp as our guest speaker and remain committed to providing this level of expertise through future events.  If you or your family have an interest in Long-Term Care Insurance, please do not hesitate to reach out to any of us here at FLI.