Happy Fourth of July! I hope you’re enjoying a long holiday weekend. That’s what I am doing, so this letter will be a little different.

But first, this is a very special Fourth of July. It is the beginning of a year-long celebration of the 250^th anniversary of signing the Declaration of Independence. And truly, we celebrate more than just the founding of the United States of America. We celebrate the creation of the most successful economic experiment in history. None of the founding fathers had read Adam Smith’s The Wealth of Nations, as it had only been written a few months earlier. No one was thinking of free market capitalism or stock markets or any of the things that have made the United States and the world wealthier than they could have possibly imagined.

It came about because of that group’s yearning to be free and independent, to make their own choices and run their own lives free from government interference. The results speak for themselves.

There will be lots of essays written over the course of this year. Many of them will be moving. But it comes down to, “we mutually pledge our lives, our fortunes and our sacred honor.” It was blood, sweat, toil and tears. And it has been a rocky, often contentious journey but if one were charting the growth of the United States, the chart would go from the lower left to the upper right. And in this semiquincentennial year, we should all think about those who did pledge their lives, fortunes and their so that we can live in such a time. I for one feel deeply grateful.

In last week’s letter I referenced Torsten Sløk’s excellent midyear outlook for Apollo Global Management. Our views are generally (though not completely) aligned, but Torsten explains it much more eloquently and with many of his always-enlightening charts. Today I’ll share some longer quotes which will, I hope, help you visualize where the economy is headed.

Let’s jump right in.

Headwinds to Growth

We’ll start with a deeper look at Torsten’s “headwinds” graphic I shared last week. I find the sailboat image quite evocative. Sailing against the wind means slower progress and an uncomfortable ride but it may be the only way to reach your port. Similarly, the economy has to face headwinds in order to move forward. Our only choice is to deal with them.

Source: Apollo

Here are some of Torsten’s comments on those points. On tariffs:

“Both small and large businesses have reported significant impacts to their bottom lines as a result of all the confusion. We can see that most clearly by the fact that the number of companies that have been reporting forward guidance has been crashing—that is a warning sign about what’s coming, as companies are no longer able to say what they are seeing going forward…

“We do not believe that the current policy turbulence is going to go away. This is not a political view; it’s just a view expressing that policy uncertainty is elevated and is likely to remain so. Such view is built on our constant consultations with market participants and corporate CEOs…

“Assuming that the June 16 tariff rates stay in effect in perpetuity—it’s hard enough to model this stuff as it is, so you have to make assumptions like this—the Lab sees GDP growth 0.6 percentage points lower through 2025 and the unemployment rate 0.3 percentage points higher by year-end.”

On trade war retaliation:

“While the reduction in standoffishness in the US-China trade talks is cause for optimism, there remains the risk of trade war retaliation in the months ahead. What shape or form that may take remains to be seen, but consider, for example, trade in prescription drugs.”

Source: Apollo

On consumer confidence:

“While the Conference Board did report an increase in consumer confidence in May after five consecutive months of decline, it continues to be challenged in the US, according to University of Michigan polling… The number of consumers worried about losing their jobs is at levels normally seen during a recession.”

Source: Apollo

John here. I circled the most recent spike in that last chart because it should be an alarm bell. Since 1980, jumps like that have always been associated with recessions (the shaded areas).

Maybe people are just more prone to worry now – but workers usually know when their jobs are in jeopardy. They sense it even if not directly told. At the very least, this says recession remains a real possibility.

On student loan repayments:

“While tariffs are obviously top-of-mind, we feel obligated to remind readers about an issue that has nothing to do with any of the above, but, purely by coincidence, is happening in the background. Nine million student loan borrowers enjoyed a moratorium after President Biden gave them the opportunity to not pay back their student loans and have it not impact their credit scores.

“As of early May, that reprieve was no longer, and a lack of student loan repayments will now impact credit scores. FICO scores could go down roughly 65 points on average, with up to 10% of US households facing a steep decline in their credit score. This could impact their ability to get new loans to finance the purchase of a car, a house, or new furniture.”

John here. This is a good example of the way policy changes always have side effects. If you think, as I do, that ending the student loan reprieve is the right move, it can still have negative short-term consequences. Suddenly reduced credit scores for a large group of consumers could also mean a sudden drop in the number of qualified home buyers, for instance.

Finally, Torsten had some observations about DOGE:

“As of this writing, DOGE has clocked just $150 billion in reductions, although estimates of his team’s precise impact have fluctuated. Additionally, the department had laid off roughly 260,000 federal government employees as of the end of May.

“Regardless of its precise impact, we see DOGE’s cost-cutting as having a negative impact on the economic outlook due to continued uncertainty with government workforce reductions.”

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The DOGE layoffs have both direct and indirect impact. Economically speaking, those 260,000 now-jobless people are only part of the story. A much larger number of federal workers are now wondering if they will be next. This affects their spending and investment behavior. As with the student loan issue, even the most necessary changes will have side effects.

Stagflation Risk

I said last week I thought “stagflation” is not the likely course unless unemployment rises considerably more than we’ve seen. Nonetheless, Torsten sees stagflation as the likely result of the president’s trade policies.

The economy’s direction will be determined largely by the way businesses respond to the new tariffs and other policies. A May survey by the Dallas Fed gives us some preliminary answers. Both manufacturing and service firms were asked what actions they are taking in response to higher tariffs. They could choose multiple answers.

Source: Apollo

A big majority (76%) of manufacturers say they are passing on at least some cost increases to customers. That’s inflationary. Some 50% say they are “absorbing cost increases internally.” That probably means some combination of layoffs and lower profit margins, which are more recessionary. Put them together and yes, stagflation is a risk. But we’re not there yet.

By the way, notice something else in this survey data. The stated goal of all these changes is to bring manufacturing and jobs that went overseas back to the US. There’s little sign this will  happen. Only 37% of manufacturers say they are looking for new domestic suppliers. Only 11% say they are relocating production to the US. That’s less than the 17% who say they want to find new foreign suppliers.

I share the goal of wanting to make the US less dependent on China. Everything I see says the tariffs aren’t going to accomplish that goal. I realize many people think otherwise. They are operating on hope, not evidence. The evidence we have says the tariffs are harming the economy while, at least so far, delivering few benefits. Tariffs are a tax on consumers. They do raise some much-needed revenue, but not enough to cut deficits all that much.

Four Scenarios

All that said, we should also recognize that tariff impact doesn’t fall across the economy equally. Some sectors feel greater pain than others. Torsten had another good graphic on that point.

Source: Apollo

He added these comments:

“What can this all mean to investment opportunities? We continue to believe that seniority in the capital structure and a sharp focus on businesses able to generate strong cash flows remain paramount.

“We also believe that sectors with less impact from tariffs and the uncertainty around the macro environment—i.e., cable/telecom, healthcare, utilities/power, and technology—are preferable to those with higher potential negative impact, such as industrials, energy, and consumer/retail (Exhibit 24).

“If, for example, one were running a long-short trading strategy around tariffs, you could argue that they would be short those sectors to the right—consumer goods makers, retailers, even energy. Energy is generally at risk because we trade a lot of energy with different countries and tariffs will be disruptive to that trade. Industrials are also at risk. Why? Because 37% of imports from China go to industrial customers—auto parts components, airplane components, washing machine components. Why is media on the right? Because digital advertising is the first thing to decline in a recession.

“Long positions in this strategy would be on the left. Tariffs don’t really play into your need for healthcare. We will still get sick. (On the other hand, medical devices will be impacted.) Regarding cable and telecom, our mobile and internet subscriptions won’t really be affected by tariffs. (Mobile phones themselves, on the other hand, will be.)”

Torsten also included this graphic summarizing the four basic scenarios. (If this looks familiar, you may be thinking of a similar Gavekal matrix I’ve shared before.)

Source: Apollo

• In the lower right “Goldilocks” scenario of low inflation and high GDP growth, stocks rise while interest rates (and inflation, too) aren’t a problem. Investing is easy in such times: Just buy the riskiest assets you can afford.
   
• “Overheating” is straightforward, too. It’s an inflationary boom in which higher interest rates start hitting marginal borrowers. The answer is to invest in higher quality credit and equities.
   
• In a “Recession” environment, stocks are falling so you avoid them. Meanwhile interest rates are falling, which helps long-term bonds you want to extend your maturities.
   
• “Stagflation” is quite different from any of those. You face both rising inflation and interest rates and weaker growth and stock prices. The best bet is to hoard cash and look for buying opportunities in distressed assets.

Now is a particularly confusing time because you can make a plausible case for all four scenarios. You can also argue plausibly against all four scenarios. Record highs in the S&P 500 are inconsistent with stagflation or recession. But falling GDP (note that Q1 was just revised lower to -0.5%) doesn’t seem compatible with overheating or Goldilocks.

For the moment, we seem to be in a heretofore unknown quadrant in which stocks rise while economic growth falls. The only explanation I have is “markets are irrational.” But they won’t stay that way forever.

You can download the full Torsten Sløk outlook here. It’s 20 pages but worth the time.

American Capitalism on Steroids

Many of you are familiar with my good friend Joe Lonsdale. He does a fabulous monthly podcast called The American Optimist where he interviews the real movers and shakers in the technology, defense and political arena. He was a cofounder of Palantir and has funded many extraordinarily successful technology and biotech/healthcare businesses. One of his real passions is extolling the virtues of capitalism and free markets in a way that makes them real to his readers and friends.

Joe has partnered with Max Meyer to bring us something new: a quarterly print magazine called Arena. It features stories on successful entrepreneurs and businesses that embody the American spirit. The actual wordsmithing and well-crafted writing is simply extraordinary. It is a large-format magazine worthy of any coffee table anywhere.

The latest magazine features an exclusive interview with Brian Schimpf called “Engineer at War.” It is about how Anduril CEO Brian Schimpf built an engineering enterprise to take on Goliath and protect the US. It is riveting and fascinating and is just one of the scores of interviews you will get with a subscription. I can’t recommend it enough.

My readers can get a 25% discount at this link. Subscribe and then wait in anticipation until you get your physical magazine in your hand. Every 90 days you’ll get another issue confirming why free markets and capitalism are the best way out of our current dilemmas.

Longevity, Fireworks and a Great Weekend

Mike Roizen just left after spending a few days with Shane and I in Dallas. We were reviewing the progress on the longevity clinic here in Dorado. Since he was here, I and some friends put a party together were 120+ people showed up to hear him make a powerful presentation on so many topics about longevity. Nearly everybody wanted a copy of the deck. My thanks to neighbor and friend Chris Del Rey for opening his home for that event.

I have always been a fan of fireworks and the 4^th of July is simply made for fireworks. So many great memories. When I had an office in the Ballpark in Arlington (the Texas Rangers) I could literally walk out of my office, lean back against the car and look up and see the fireworks directly over my head. Up close and personal. One year Shane and I got to be on top of a museum in lower Manhattan where we could watch both the New York and New Jersey fireworks. From my condo in Dallas, where I had half the floor, I had a 270° view of Dallas and the surrounding area. You could literally see 17 different fireworks going off from the balcony. Most were off in the distance, but a few were quite close.

My new adopted neighbors in Puerto Rico use any excuse to set off fireworks. They are not a spectacular, but they are everywhere. We will probably wander down to the beach and watch the fun.

And with that, I will hit the send button. You have a great week and I hope your July 4 was awesome! And don’t forget to follow me on X!

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Your still a young boy when it comes to fireworks analyst,

John Mauldin

P.S. If you like my letters, you'll love reading Over My Shoulder with serious economic analysis from my global network, at a surprisingly affordable price. Click here to learn more.

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