Employment, inflation, and AI: Looking back on 2025

BRIAN HESS: Yeah, I think we could get an A on that one.

JACK JANASIEWICZ: OK. There we go. I like it.

BRIAN HESS: Generally been moving in the right direction.

JACK JANASIEWICZ: I'm Jack Janasiewicz.

BRIAN HESS: I'm Brian Hess. This is Tactical Take. Hey, Jack. Welcome back.

JACK JANASIEWICZ: Back in the hot seat again. Here we go.

BRIAN HESS: Good to be here. I thought maybe this month we could start by looking back on 2025. We're reaching second half of November now, and it's been an interesting year. So I thought maybe we could recap some of the themes that we had coming into the year, or at least some of the maybe late forecasts we were making at the start.

And I think the first one, and probably the most prominent call, is that we were looking for a slowdown this year in the economy, a US slowdown. And so how would you say that played out over the course of the year? I'm curious as to check in. Do we think we got that right? Has it worked? Is it still ongoing?

JACK JANASIEWICZ: Oh, maybe we'll call that incomplete, I'm going to be generous in grading our own calls here. But I think, yeah, we had been thinking that the labor market would slow. We started to talk about that over the summertime. And it really hasn't, I guess, manifested, at least in the economic data, to the point where we could maybe say, yeah, it's really a problem now.

I mean, again, the labor market certainly is appearing soft. We see that in almost every data point that ties back to the labor market. But I think maybe the disconnect from our perspective is that we haven't really seen it filter its way through to the stock market. We're seeing the market react accordingly with the slower economic backdrop.

So again, we're still in that same camp. We continue to expect that slowing in the labor market. It's been a linear cooling. The risk is that it accelerates. But this is something we've been talking about. Maybe it's been happening a little bit slower and a little bit more elongated than we'd expected.

BRIAN HESS: Yeah, it's been a very slow slowing. The first half of the year was a slowdown. I think that's pretty clear. And then we got into the summer months, and a lot of that tariff-related uncertainty passed. And I think that maybe put a floor under growth temporarily. And then now we're in this shutdown, where we don't even for sure. We're going to talk about that shortly. But yeah, I think it was a reasonable call. It just hasn't really manifested in much weaker earnings growth.

JACK JANASIEWICZ: Right, exactly. And that's even surprised us. And I think it surprised us. And maybe you could argue that surprised the market as well, obviously. Because when I look at the results from the third quarter earnings season, the trough in earnings was around 6.5%. And we almost came in something closer to 15%--

BRIAN HESS: Yeah, way off.

JACK JANASIEWICZ: --after you adjust for Meta. So even the market, I think, was off in terms of expectations for that as well.

BRIAN HESS: All right. Second one is that we were looking for continued disinflation in the economy. We've gotten a lot of CPI prints over the course of the year. How would you say we did on that?

JACK JANASIEWICZ: Yeah, again, I think it's moving in the right direction. I would certainly say that it's not accelerating. And the things that we've been talking about for quite some time I think are still in play. And the big one is simply that there's still plenty of pent-up disinflation, deflation coming from the shelter component of the inflation basket. And that's going to continue.

I think people have been looking at the tariff side of the equation and seeing the potential for goods' prices to creep higher in here. That might be the case. But the thing we keep pointing to is that this is going to be offset by what we're seeing with that shelter and basically service cost disinflation. And that's really playing out as we thought.

BRIAN HESS: Yeah, I think we could get an A on that one.

JACK JANASIEWICZ: OK. There we go. I like it.

BRIAN HESS: Generally been moving in the right direction. And if I'm not mistaken, last month the shelter print was the weakest month-over-month print since 2021, which basically predates the big inflation spike.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: So that is good news. Third one, I think we got-- which I'm about to bring up-- fed rate cuts, I think we did pretty well on. We were consistent in our message. The Fed will be able to cut rates. And they've now delivered two cuts so far this year. We'll talk about the December meeting in a little bit. So I don't want to go too deep there right now.

And then the last one, maybe the most surprising thing, we were talking about at the start of the year how we had two 20-plus percent years for the S&P 500 in 2023 and 2024. Probably wouldn't be able to match that. And we're not up 20% year-to-date. But we were looking for more modest stock market returns. And I'd say the S&P anyway has exceeded those expectations.

JACK JANASIEWICZ: Sure. And it goes back to what we just talked about. I think that earnings story has probably been more robust than even we thought. And we were still pretty optimistic, I think, relative to a lot of other strategists and some of our competitors out there in terms of thinking what the market might deliver.

So we were optimistic. But I think even our optimism wasn't strong enough to reflect what's going on in the markets today. And that all comes back to that earnings story.

BRIAN HESS: Yeah, absolutely. It's been quite an impressive year for returns, not only in the US, but also internationally where we are above 20% in most cases. All right. Anything else from this year that surprised you that you want to add to the list?

JACK JANASIEWICZ: No, those are the major themes. We're always talking about the labor market and the economy and how that ties back to the equity market. So from that perspective, those are the big ones. And then I guess it still comes back down-- I'm sure we'll talk about this, but it's really the tech trade because that's been the dominant factor. The Mag Seven, the tech, the AI build-out-- those are the bigger themes, I think, that's still left to play here.

BRIAN HESS: So let's go there right now then, since that probably is the reason why we've had these above expectations-- or returns that exceeded our expectations. But more recently, there's been some volatility. We've seen some names roll over, others still near their highs. Let's take stock on the AI and tech theme and if you're still comfortable with that as a market leadership narrative.

JACK JANASIEWICZ: Yeah. And we've talked about this in previous podcasts. I think the–

BRIAN HESS: I think we talk about it every month. It's so dominant.

JACK JANASIEWICZ: It's a broken record, so to speak. But we have seen things change a little bit over the last couple of weeks. And just to rehash what we've been talking about, the CapEx build-out has largely been funded via free cash flow. And I think we're just trying to draw the analogies between the dot-com bust and what we're seeing today because I think that's where some of the blueprints are coming from, if you're not quite as optimistic with the AI build-out.

But that's been changing a little bit more recently. You're seeing a little bit more bond issuance coming. So a little bit of financing on the liability side of the equation as opposed to just basically paying out some of this investment from free cash flow.

And the risk there is that if you're just paying out of free cash flow, when things go bad, well, it's a bad investment. Maybe you gave up opportunity cost, but there's no balance sheet impairment from the liability side.

Now when you start introducing that borrowing side of the equation, well now, you're bringing in liabilities there. And if we end up having problems down the road, you could have balance sheet impairment, which then forces a repairment. And obviously, then things can go bad off of the back of that.

So a slight change. I'm not saying that's completely the dynamic that's shifted. But we are now starting to see issuance there. And I think that's raising some eyebrows. And so it comes back to that return on invested capital. What are these data centers? What are these investments going to pay in the longer term? And are these investments being financed from the debt side worth it?

The one thing I would say, we're not as, I think, concerned about it, certainly throwing up some yellow flags, let's say. But we always say one man's CapEx is another man's earnings. And if you listen to all the hyperscalers, they've upped their forecast for just fourth quarter CapEx spend. We all know that 2026 CapEx spend is going to be very robust as well, again on a year-on-year perspective.

So that money is still going to be spent. And we've heard from a lot of these hyperscalers that the risk is that they don't invest enough, and they fall behind, and as a result, get left behind. So I don't think that CapEx spend is about to end anytime soon. And so as a result of that, that's still going to feed through to the broader tech complex in terms of earnings from other places.

So I think that's the one thing we continue to fall back on. Yeah, maybe we see a little bit of concern about the return on capital from the hyperscalers, but they're still going to spend. And that just means there's going to be earnings for somebody else.

BRIAN HESS: So no sign of weakening momentum in terms of the appetite to invest.

JACK JANASIEWICZ: Correct.

BRIAN HESS: And that means good things probably for earnings as we move into next year.

JACK JANASIEWICZ: Sure.

BRIAN HESS: However, maybe we've moved into a new level of potential for excess by financing via debt. And that creates the risk that if the bond market were to lose its appetite for this, suddenly, that could force a break on the CapEx, which would then impair earnings.

JACK JANASIEWICZ: And this is that–

BRIAN HESS: That's the risk.

JACK JANASIEWICZ: Yeah. This is what we've been calling that narrative reset. It's no longer sort of blue sky, trees grow to the sky sort of thing. People are now starting to question a little bit. And if anything, maybe that just resets expectations that we can't continue to just have this go off into perpetuity.

There's still upside. But maybe we got to pull back a little bit on that optimism for the upside. And so that's the narrative reset we keep talking about in here.

BRIAN HESS: And it's still unchallenged in terms of other narratives. There's no other dominant factor that's threatening to overtake it from a leadership standpoint. So it is still the game in town for us to watch.

JACK JANASIEWICZ: Yeah, exactly.

BRIAN HESS: All right. Well, that's, I think, a good update and something slightly different than what we've talked about before. So thank you.

All right. Moving gears. We're done looking back on 2025. Maybe next month we can start to look ahead for 2026 and think about the themes that might be driving markets in our views next year. But for now, let's get back into the here and now.

We've just ended the government shutdown, which has been a bit of a nuisance for macro traders and analysts like ourselves having gotten all the data we'd love to analyze. And we're about to. We're going to get a lot this week. Over the next couple of weeks, we'll learn a lot about the US economy. What are you expecting to see?

JACK JANASIEWICZ: Again, we've been really relying on third and fourth tier data, which it's the best thing that we can come by. But let's still not forget that the government data is still the most robust ones out there. And so the issue going forward is going to be, are we going to have some gaps? And so something to think about.

I'm sure, from what I've heard, the September jobs print will come out. The data is there. But when you start to push forward into the October print, maybe there's going to be some holes. Because if you think about it from the establishment portion, basically, the BLS is just contacting companies, and they're reporting in the jobs gains and job losses there.

But if you go to the household survey, that's literally people at the BLS picking up the phone and calling households. And so one area you're relying on private sector data just to come back to you with the data. So we'll have that because the private sector didn't shut down. But when you talk about the BLS having to make phone calls to really do the household sector, they basically weren't working during this time. So you're going to have a hole on that.

So we're going to get some data. In some places, we won't get it. But I think the trend continues. It's a modest slowing. And we'll continue to see how that evolves over time. But this goes back to what we just talked about, reviewing the 2025 outlook.

I think you're going to continue to see that sort of slowing in the labor market. And you're seeing that from all the headlines. You're seeing companies announcing layoffs. You're seeing in some of the other data that it's certainly not seeing a robust strengthening labor market. I think–

BRIAN HESS: We've seen a lot more announcements of work layoffs, large numbers of jobs than we have. We're adding head count.

JACK JANASIEWICZ: So I think the balance of risks are probably skewed towards softer data than stronger data. How about that?

BRIAN HESS: Makes sense. And I think that dynamic between the two reports with respect to the labor market means we can get good data on number of jobs created, but the unemployment rate will probably be more ambiguous.

JACK JANASIEWICZ: Right.

BRIAN HESS: OK. All right. So we'll see what happens. It'll be an interesting couple of weeks for us on that front. And then complicating matters for the Fed is this same dynamic we were just talking about where they haven't had a lot of data to fall back on. They're flying blind to an extent. And last week, the market really started to question whether they'd be willing to cut rates again in December. Market pricing is below 50%, in terms of a cut in December.

And actually, I checked yesterday. I had market pricing below 100% for even the January meeting. So the market's not even pricing a full cut between now and the January meeting, which is a big change from a couple of months ago.

JACK JANASIEWICZ: Yeah, sure. It certainly has. And I think you're seeing that reflected in, like you were just referencing the future contracts, where if you maybe go back to the middle of October, it was 100%. And we were even pricing in a slight probability of a 50% cut for December. And to your point, now we're below 50%.

And I think you're seeing some of that being picked up in the volatility of the bond market. You can look at the move index, which looks at the 30-day implied volatility in the Treasury curve. That's started to pick back up a little bit. So repricing the Fed outlook has probably helped to create a little bit of volatility that we're seeing in the markets more recently.

Having said that, though, if I look out to, let's say, summer of next year, the market is still pricing in two cuts. So we got rid of maybe the December cut. But the market is still looking for two more cuts come summer next year.

BRIAN HESS: So just pushing it out. Yeah. There's not been a change in terms of, well, maybe the Fed's about to switch to a hawkish bias.

JACK JANASIEWICZ: I think-- and that's the key. From our perspective, it's one thing to hike. It's another thing to pause with still an easing bias and ease. And I think that's part of our financial condition.

BRIAN HESS: You're saying it's one thing to cut or not cut. But–

JACK JANASIEWICZ: Pivoting to–

BRIAN HESS: Switching to hiking is going to be very disruptive.

JACK JANASIEWICZ: Exactly.

BRIAN HESS: That would-- I mean, and speaking about the bond market. So we've been in this range. I think we've been looking 3.75 to 4 and 1/2 or tens, as are most likely range or near the bottom end of it, above 4%. So we're not all the way down there. But if the Fed doesn't cut in December, I don't think it has huge implications for our views on the bond market. Would you agree?

JACK JANASIEWICZ: Yeah, I think so. I think that's fair. And it may be, again, look at it in terms of that skew, that risk of what's more likely a slowing labor market or reselling, slowing inflation backdrop accelerating. The risk is probably still towards continued deceleration there. So maybe you're in the middle of the range, but the bias might be going back towards 4% on tens, for example.

BRIAN HESS: And we still think the Fed will resume the cutting cycle at some point next year, even if they are unable to do so in December. And a lot of this will depend on how the data comes out in the next two weeks. If we get really soft data, I mean, gosh, they probably could cut in December. And if not December, they'll definitely come in January.

JACK JANASIEWICZ: Yeah. And I think, too-- I mean, listen we've had a lot of Fed speak over the last couple of weeks. And when you start to go through the number of people that have talked about pausing for the December meeting, the list is pretty long. You've got five of them. I'll read them off. You've got Musalem, Schmid, Goolsbee, Collins, and Barr have all come out and said, we think we should be pausing in here. So that's five.

You still have three wild cards with Powell, Cook, and Jefferson. And we know the other four are going to be leaning towards cuts. Is that enough to get everybody in line to cut? It seems like a pretty high hurdle right now.

BRIAN HESS: Probably not, given the data vacuum.

JACK JANASIEWICZ: Yep.

BRIAN HESS: OK. So that'll be interesting to see how they handle the lack of a cut if it goes that way in the press conference. And maybe it'll be like a dovish hold.

JACK JANASIEWICZ: Yeah. That forward guidance is going to be very interesting. That'll be–

BRIAN HESS: Yeah, it'll put–

JACK JANASIEWICZ: --interesting when

BRIAN HESS: --Powell in the hot seat for the press conference.

JACK JANASIEWICZ: Yep.

BRIAN HESS: All right. And then lastly, we've done some more model trades since the last time we connected. I thought maybe we could touch base on them. So the biggest difference maybe is that we've moved back to an overweight equity position at the portfolios overall. Why are we leaning long stocks as we head into the last part of the year?

JACK JANASIEWICZ: Yeah. I mean, I think there's a couple of things to think about. I'm sure we're all aware of the seasonal patterns. The seasonal strength going into the end of the year is always very healthy for the markets. If we do a review of third quarter earnings, pretty strong across the board.

And I think when you look at earnings per share, estimates continue to go up and to the right. Net margin estimates for the S&P, up and to the right. Those are still pretty good things you want to see if you're going to be bullish on the markets. So I think despite some of the headlines we're seeing that are creating some volatility in the marketplace, if we step back and look at the bigger picture, it's still pretty accommodative.

And to what we just went with regard to the Fed, still financial conditions are easing. You're still looking at potential cuts going forward. We're not hiking. So I think the backdrop is still setting up to be supportive for rally into the end of the year.

This is a healthy pause I think we're seeing right now. And a lot of people are still on bubble watch. But stocks do go down in bull markets. They correct. They have a little bit of a shift under the surface. And I think that's partly what we're seeing right now-- some of the froth getting taken out of some of those overextended segments of the marketplace, whether it be some of the computing names and–

BRIAN HESS: Like quantum computing.

JACK JANASIEWICZ: Crypto. Yeah, quantum computing. Cryptos are seeing a pretty big deleveraging. So kind of get that reset out of the way, and I think we'll hopefully resume forward in here.

So again, the fundamental backdrop to me has not really deteriorated to a point where I'm concerned that all of a sudden we should be thinking about, OK, things are rolling over hard here. The backdrop still is pretty supportive.

BRIAN HESS: So the macro fundamentals are still supportive. Growth is strong and not collapsing. maybe not accelerating, but it's stable. The Fed is still with an easing bias, even if they might not cut. Inflation is contained. FX has been pretty quiet. Bond market implied vol is rising, but credit spreads are still tight.

So financial conditions are generally accommodative. And you like the seasonality trade heading into the end of the year, which is something you didn't mention. So there tends to be an upward push just as we move through the second half of November into December.

And we'll have to be mindful of the fact that once we come into the new year, one of our colleagues, Luke, pointed this out, I guess it was last week in the chat, that a lot of people are sitting on some pretty healthy capital gains. And it wouldn't be shocking to see some profit-taking once we get into a new tax year.

JACK JANASIEWICZ: Yeah, 100%. And we're on-- look, I think once we flip the calendar year, we'll reassess some of our positions. But I still think, fundamentally speaking, market's in pretty good shape. It's just maybe we get a little bit of a technical correction near-term, as some of the tax loss selling kicks in and that sort of thing.

BRIAN HESS: Understood. And one last thing before we wrap. So emerging markets, just want to touch on that because we are a 2% overweight emerging markets, one of our bigger tactical tilts. What do we like about EM equities? This is on the stock side.

JACK JANASIEWICZ: Yeah. It's the same thing right. I mean, if you expect a lot of the central banks in emerging markets to piggyback on the Fed, there's room for them to be cutting. And that's what we're seeing. In some cases, we're seeing inflation rates well below what we're seeing here in the United States.

Think about a lot of the inflation levels in Europe-- or I'm sorry, in Asia, you're below 2%. So there's room for additional easing coming out of–

BRIAN HESS: True in Europe too, for the most part.

JACK JANASIEWICZ: Yes, exactly.

BRIAN HESS: Both places.

JACK JANASIEWICZ: There's room to cut. And so put all these things together with a decent economy, global economy that's holding up OK, room for the central banks to ease in emerging markets, financial conditions still fairly supportive-- I think there's a pretty good backdrop in terms of what we could be seeing coming out of emerging markets.

And we're starting to finally see a little bit of movement out of Latin America, for example. Potentially maybe we get a little bit more of a-- maybe a supportive hemisphere between Canada and Mexico and maybe to Latin America, as we try to pivot away from some of the reliance on China. So you can see those things are slowly starting to reemerge. So I think there's reasons to be somewhat optimistic in here with emerging markets. And go back to the valuation story, still pretty cheap as well.

BRIAN HESS: And they've been a big beneficiary of the AI trade this year.

JACK JANASIEWICZ: The AI trade. And you could even put in the commodity cycle as well.

BRIAN HESS: Exactly. All right. Well, let's leave it there for this month. I think this was a good recap of 2025, update on what we're seeing. Enjoy the data deluge over the next two weeks. And we'll check back in December and talk about 2026.

JACK JANASIEWICZ: Awesome.

BRIAN HESS: Thanks, Jack.

JACK JANASIEWICZ: Thanks, Brian.