MARKET OUTLOOK
During the first half of this year, investors have been facing uncertainty over a number of issues: the potential impact of increased tariffs proposed by the incoming Trump administration, China's advancements in the AI race, unrest in the Middle East and over Iran's ability to develop nuclear weapons, a tightening job market, and our ballooning national debt. At one point, concerns over the tariffs had driven the S&P 500 index down roughly 20% from its high a few months earlier. But once the pause on tariffs was announced, the news quickly drove up stock prices, and the S&P 500 had experienced one of its greatest daily percentage increases in its history. By June 30th, all of the major U.S. stock market indices were again in positive territory for the year. It has certainly been a year of headline-driven markets. In the meantime, we continue to face a number of other headwinds. U.S. stock prices are relatively high, corporate earnings growth is excepted to begin receding, U.S. economic growth has slowed, the Fed has yet to lower interest rates, and concern over the national debt is resurfacing.
Then what's driving stocks higher? Perhaps positive investor sentiment and liquidity (i.e. employee and employer contributions into 401(k)s), among other factors. Additionally, we've not yet seen any negative impacts from tariffs, and we may see more tariff deals in the coming weeks. Inflation has come down, though not yet to the Fed's target rate of 2.0%. Recent military strikes between Israel and Iran have had no immediate impact on the markets, other than a temporary spike in oil prices. It was expected that Congress would ultimately pass a new tax bill, extending the cuts implemented in 2017. Lastly, the Fed is expected to cut rates before year-end.
Though stocks continue to climb the "wall of worry", a term which refers to the markets' ability to overcome negative factors and continue to ascend, traditional investment strategies are changing. The long-standing "60/40" approach to investing (an allocation of 60% in stocks and 40% in bonds) is being re-considered based on recent events surrounding the U.S. debt, inflation, and the declining value of the U.S. dollar. Over the past few years bonds have not acted like bonds in that they have not been providing a hedge for stocks in the portfolio during market volatility. In 2022, both stocks and bonds declined in value. It was the first time since 1969 they declined in tandem. Treasury bonds have long been considered a safe-haven asset. But sentiment over Treasuries has been changing due to the increasing U.S. debt. With heightened geopolitical uncertainty, gold has become an alternative over Treasuries as a safe-haven investment. That is one of the reasons why gold has jumped in price over 40% since the end of 2023. But bonds can still play an important role in a portfolio. It's important to hold the right type of bonds with the appropriate maturities.
In the end, the U.S. stock and bond markets are remarkably resilient. They have the ability to look past the short-term events and more toward the long-term. Perhaps a longer-term outlook sees the potential opportunities that artificial intelligence can bring about, which will likely be dominated by U.S. companies, and the fact that the U.S. has an extraordinary reputation for innovation, which has given us a competitive advantage over other global economies. As for our Treasuries, they remain the most liquid, safe, and competitive investment in a well-regulated market and should continue to be of appeal to both domestic and foreign investors.
A FOCUS ON OUR NATIONAL DEBT
We have chosen to devote much of this newsletter to an important subject - our ballooning national debt. According to the Treasury Department, the United States has amassed debt totaling $36.21 trillion as of April 2025 and now represents 123% of gross domestic product (referred to as GDP). At 123% of GDP, our debt now exceeds the total output of what our entire nation produces in goods and services in a year and stands at a greater level than where it stood after World War II. As recent as the year 2000, the national debt represented less than 50% of GDP. But over the past two decades, U.S. debt exploded following two massive shocks to our economy – the global financial crisis in 2007-2009 and the COVID-19 pandemic in 2020 - when the U.S. government provided stimulus money to get through these events. Unfortunately, it continued with such programs long after these events were over. In other words, it continued to give the patient medicine even after the patient had recovered. Under the current assumptions and with no legislative changes, the Congressional Budget Office (CBO) projects the debt will dramatically increase in the coming decades. Why has the debt become such a concern now when it has been the topic of discussion for many years? To put this in perspective, consider the trajectory of its growth. Five years ago (as of April 2020), our debt totaled $24.97 trillion and ten 10 years ago (April 2015) totaled $18.15 trillion. In other words, it has now doubled in 10 years. That is why the sustainability of the U.S. debt has reappeared as a key financial risk. What might this mean to investors, Americans, and the entire global economy, and what are the solutions to combat this problem before it becomes a crisis?
Let's begin by discussing some of the basics to get a sense of how we got here. What is the difference between the deficit and the debt? A deficit (shortfall) occurs when the federal government spends more in a year than it receives in revenues. According to the Department of Treasury, total government spending for fiscal year 2024 (10/1/2023 to 9/31/2024) was $6.75 trillion with revenues of $4.92 trillion, resulting in a deficit of $1.83 trillion. This was an increase of 23% from the prior year. What happens when the government spends more than it takes in? As is the case with any household or business, it has to borrow money to pay for the shortfall. The government does so by selling Treasury bonds, bills, and other securities to individuals, institutions, and foreign governments. Therefore, our national debt is an accumulation of borrowing over the years, along with interest payments owed to the holders of that debt. As we continue to have budget shortfalls each year, Congress continues to raise the debt ceiling, allowing more debt to accumulate
What are our sources of revenue for the U.S. government, and how do we determine what we spend? The largest source of federal revenue today is from individual income taxes, representing 49.3% of total revenue, which has remained the top source of income for the U.S. government since 2015. Other sources are estate taxes, tariffs, park fees, etc. Our largest expense, as of April 2025, was for Social Security, representing 22% of spending. But 14% of the budget is being spent on the interest payments on our debt, which is more than what is being spent on both Medicare and nation- al defense (both at 13% each). As our debt continues to increase, so does our interest expense, which leaves less money available for spending on other programs.
Federal spending can be broken down into two primary categories: mandatory and discretion- ary. Mandatory spending represents nearly two-thirds of annual federal spending. This type of spending does not require an annual vote by Congress. The second major category is discretionary spending. Another type of appropriation spending is called supplemental appropriations, in which spending laws are passed to address needs that have arisen after the fiscal year has begun as was the case with the global financial crisis and the COVID pandemic
Mandatory spending is mandated by existing laws. This type of spending includes funding for entitlement programs like Medicare and Social Security and other payments to people, businesses, and state and local governments. Due to authorization laws, the funding for these programs must be allocated for spending each year, hence the term mandatory. For example, the Social Security Act, last amended in 2019, will determine the level of federal spending into the future until it is amended again.
Discretionary spending is controlled by Congress. Each year they create a budget that then must be approved by the President during the appropriations process. Generally, Congress allocates over half of the discretionary budget towards national defense and the rest to fund the administra- tion of other agencies and programs. These programs range from transportation, education, housing, and social service programs, as well as science and environmental organizations
As our debt continues to increase, it can affect global trade, investor confidence, the value of the U.S. dollar, interest rates, and inflation. Because the U.S. is one of the world's largest economies and a major trading nation, a high national debt can lead to concerns about the country's ability to meet its financial obligations and could erode confidence with its trading partners. Concerns over the debt can also lead to a decline in investor confidence. Historically, U.S. Treasuries have always been considered as a safe-haven asset. In May, however, Moody's was the last of the three major credit rating agencies to downgrade its rating on U.S. debt, after maintaining its outstanding rating of AAA since 1917. China, who has been one of the largest holders of our Treasuries, has been reducing its U.S. Treasury holdings for a variety of reasons. If we don't have enough buyers of our Treasuries to finance our debt, the Central Bank has to print money to buy the bonds. When the government increases borrowing to finance its debt, it competes with other borrowers for available funds in the market. All these issues can lead to higher interest rates. It can also lead to a decline in the U.S. dollar. This affects all Americans because it eats away at our purchasing power and makes imported goods more expensive and can cause inflation. Increased government spending alone can also put upward pressure on inflation because its spending makes up a large part of the entire U.S. economy.
What will it take to remedy this problem? The answer is likely a combination of solutions. Ray Dalio, founder of Bridgewater Associates, the world's largest hedge fund, has been studying this issue and writing about it for quite some time, specifically in his recent book, "How Countries Go Broke". He is calling for a three-part solution which involves a combination of spending cuts, increased taxes, and lower interest rates. During a recent interview he stated that if we can reduce our debt like did from 1992-1998, regardless of how we do it, we'll get lower interest rates, which will reduce the interest expense. Lower interest rates will help to cause asset prices to go up and the economy would be better which will also generate additional tax revenues. But implementing any solution won't be easy. The challenge will be for our elected officials in Washington to have the fortitude to devise a plan and to no longer ignore the issue. This problem didn't happen overnight nor do we have one Administration to blame for it. At the same time, the problem won't be fixed overnight or by one Administration. But because of the above risks, it is imperative that Washington takes action to reduce deficits and our debt before it becomes a crisis.
SENIORS BENEFIT UNDER THE NEW TAX BILL
On July 1st the Senate passed H.R. 1, now referred to as the "One Big Beautiful Bill Act". It was approved by the House on July 3rd then signed into law by the President on July 4th. Though we won't attempt to report everything that is included in the law, we do want to clarify one change that will impact many of our clients, specifically seniors. Many of you may have received an email from the Social Security Administration applauding the passage of the bill. Their email implies that the bill includes no taxes on Social Security as requested by the President. However, it does not. Instead the law provides higher tax deductions for seniors, regardless of whether or not they are collecting Social Security benefits.
Here are the details. FIRST, the new law increases the standard deduction in 2025 for ALL taxpayers from $15,000 to $15,750 for single filers and from $30,000 to $31,500 for married filers. Currently in the law, an additional $1,600 per person is added to the standard deduction for those age 65 and older, which still applies. SECOND, the standard deduction increases further for those age 65 and older, giving them an additional $2,000 for single filers and $3,200 for married filers on top of the numbers above. THIRD, there is another deduction for those age 65 and older based on income. For single seniors with taxable income less than $75,000 and marrieds with less than $150,000, they will be allowed an additional deduction from income of $6,000 for singles and $12,000 for marrieds on top of the standard deduction numbers stated above. Here's an example of the math: For a married couple with income less than $150,000 per year and both over age 65, they will be able to reduce their income by $46,700 (up from $33,200 under the previous rules). For a single filer with income less than $75,000 and over age 65, they will be able to reduce their income by $25,350 (up from $$16,600). For questions or further clarification, call our office or your tax advisor/preparer
All Sources: FiscalData.Treasury.gov; Congressional Budget Office
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