In the short term, the forecasts we find most credible call for a continuation of the present into the future. If things are going a certain way, simply predict they will continue to do so. Such predictions are not really a forecast. They are extrapolating the present into the future. We believe real forecasting starts with what is known as environmental analysis. From there, threats and opportunities are identified and analyzed. Then, some probability is assessed for each course of action, so that the range of outcomes can be weighed.
At present, we are dealing with an investment environment unlike any seen. Politicians of both parties make no pretense that they will try to curtail the federal deficit. Indeed, most cannot even quote the rate the government is spending in excess of what it takes in. For fiscal year 2025 ending September 30, the figure is estimated to be $1.7 trillion. The actual computations have been delayed by the government shutdown. Total federal government indebtedness comes to $39 trillion. Interest alone comes to $1 trillion a year.
So long as the US government can come up with investors, foreign or domestic, to finance the deficits, the party rolls on. There are signs that this might be changing. For starters, the tariffs unveiled on April 2 of this year have alienated the countries and foreign investors who were once the biggest buyers of US debt. Charging a fee to export your goods to the US does not seem like a smart way to keep people financing one’s lifestyle.
On the other side of the ledger, there are the demands for building out the infrastructure to develop Artificial Intelligence (AI) estimates which range into trillions of dollars in itself, to say nothing of the energy needed to power the server farms. In another era, such private sector demands were believed to be subject to “crowding out” by the demands of the public sector. It was assumed that US Treasury securities would be funded before any corporation, leaving companies to pay an even higher cost for funds. Such funds would be for either new projects or refunding maturing loans with new money. Either way, the cost of money goes up. As the government rolls over debt to new bonds, the coupon rate for the debt is often three to four times what was paid previously.
How Washington reacts to this is the source of much speculation. In the end, the bond market does not care. In the 1980s the “bond vigilantes” refused to buy debt unless it was priced with an interest rate high enough to provide an estimated return after inflation for the life of the bond. That may come to be at a very high rate. Stocks will also be adversely affected by higher interest rates. As interest rates rise for debt, the so-called “risk free rate” also rises. So long as the interest rate is more than inflation, it provides competition for stocks in that it is a return that comes without the risk of being in equities.
And what are those risks? First, rather murky data from the government shutdown is painting a picture of few layoffs but also few hirings. The result is a rising tide of unemployment back to the level of Covid as young people in particular have difficulty finding work. AI is being portrayed as a job destroyer. There is some debate whether AI will not eliminate jobs or produce them. At this point it is an unknown. Currently, AI is aimed more at services than goods. Even in this context, it seems better at eliminating white-collar employment than blue collar. Blue collar jobs such as construction, health care, farm work, landscaping and the like were more the providence of immigrants, most of whom have been shown the door by the current administration. While removing “The worst of the worst” makes for a catchy political jingle, the reality is that over 90 percent of those removed have no criminal record even after counting as criminals those who have had traffic violations or library fines. Some of those deported in fact have been US veterans. Not the best way to show appreciation for serving a country of choice.
The next year will also be about elections. As there will be no presidential race, the issues will be sometimes more local but also a referendum on the incumbents. An unprecedented effort to redraw some state districts without a census can be seen for what it is: desperation. Efforts to flood the economy with cheap money will probably backfire in the form of higher inflation and interest rates, possibly triggering a stock market correction. A decision to hand over Ukrainian land to Putin by the US will be seen as an abdication by a democratic country for the hope of better relations with a dictator. It will not stop there.
The Economy
Economic activity continues to decelerate. Many of those who hold investment assets are doing well, while those who do not tend to come under increasing financial pressure. The latest source of concern is the health care premiums paid by those who have to finance the cost for the first time.With the government no longer helping to pay the premiums, some families of modest means will see increases far beyond the 20 percent paid by most who have always paid the going rate. At the other end of the scale, people of means are still spending enough to keep the economy in balance. This will probably continue for so long as the stock market keeps going up.
Inflation
Of all government data to come out of the shutdown, inflation numbers are the most suspect. It was not lost on anyone that the President fired the head of the Bureau of Labor Statistics after he received an inflation report he did not like. Shooting the messenger has never been a winning strategy. The sense is that inflation is running far above the government’s quoted rate of 3 or so percent. The lack of credible data makes speculation more rampant. Price escalation will probably continue, especially as inflation is more focused on services and less on goods. At one time cheap imports helped to offset service price increases and hold inflation in check. Thanks to tariffs, no more. We expect inflation rates to exceed 4 and perhaps even reach 5 percent in 2026. Any deflationary impact from AI is likely years away.
Interest Rates
The year to come may be the first time since the late 1970s that the US loses control of its interest rates. If a buyer’s strike impacts bond yields, the government will have to spend increasing amounts of money on interest. The comparison of the US to Argentina will then become more real.
The Stock Market
Given their lofty valuations, stocks may feel some gravitational pull to revert back to their longterm levels. At present, the Standard and Poors 500 Index, as quoted in the Wall Street Journal December 23,2025, is over 25 times earnings. Historically, the average P/E (price- to- earnings) ratio over the past 20 years is 16.While a quick reversal to this level is not forecast, the difference is enough to give one pause.
Fortunately, one does not have to buy the entire stock market. There are several stocks selling at valuations less than half the market average. While most are out of favor, they offend deliver stronger earnings and reliable dividends compared to today’s high-flyers. Also, perceptions change. What is a cheap stock today can come back with earnings and appreciation. More favored stocks may experience a change of perception as well, only it can be a decline in valuation to the level of the averages if not less.
An obvious question is what would it take to cause a market decline? Speculation is very rampant, especially in the area of cryptocurrency. Recent fair-weather leaders like technology seem to have had their sails trimmed. Using leverage strategies with electronic traded funds (ETF) is, in our opinion, the equivalent to a child playing with matches. Declines are usually caused by unforeseen events. That comes with the territory. The concern is when the market will come back. Corrections can last for a while. Better to know what you own rather than to trust an index to represent your interests.
Warren M. Barnett, CFA
December 23, 2025
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