By Staff Report Friday, March 14th, 2025

Editor’s Note: Welcome to Focus on Finance, a new report from the Business Times. We’ve had such strong responses to our Spring and Fall forecasts that we’re adding March and August panel discussions to give you a quarterly look at the markets. In this issue, we take a timely look at investing in the Trump era. Our Q&A was conducted via email with Editor Henry Dubroff, and lightly edited. To suggest future topics, email me at [email protected]. For sponsorship and advertising email Publisher Linde le Brock at [email protected]. Our panelists are:

• Falko Hörnicke, Senior Portfolio Manager, U.S. Bank Private Wealth Management

• Drew Brahos, Senior Portfolio Manager, Montecito Bank & Trust

• Lloyd Kurtz, Senior Portfolio Manager, Montecito Bank & Trust

• Arthur Swalley, Founding Partner, Chief Investment Officer, Arlington Financial Advisors

• Dylan Minor, Co-Founder, Chief Investment Officer, Omega Financial

Q. The Trump administration has reversed course on several initiatives related to climate change and governance. What does this mean for the future of ESG-oriented investment strategies?

Dylan: ESG investing has seen varying degrees of success for the last three decades now. To be sure, there are some types of ESG investing that create subpar financial returns — something I explored in past research. Some areas of ESG align more closely with impact investing where financial returns take a backseat to mission-driven outcomes — much like donating to a charity, where the expectation isn’t a financial gain but rather social impact. However, for those investors focusing on companies that embed social factors as a core component of their business strategies, ESG investing can still generate competitive, and sometimes even superior, financial returns — regardless of political shifts. My recent research supports this, as demonstrated by the Argos AlphaESG Index (Bloomberg ticker: SOLARGN), which we developed to track such companies dating back to 2007. Notably, even under the Trump administration’s policy shifts, the index has outperformed the S&P 500 by approximately 2% this year.

Arthur: One of the beauties of American democracy is that administrations come and go, while the needs of our people and institutions are constant. Eventually, we tend to get problems solved despite the vagaries of the political winds. On climate change, we take our cues from the Pentagon and the insurance industry. Both are carefully planning how to manage the real impacts of climate change on national defense and property security. The need for more efficient and less damaging energy generation is growing due to economic and security necessity. While good governance principles have less direct economic impact, most corporations realize that they can expand market opportunities by deeply understanding all their potential customers. Good governance and social practices are good business decisions. We believe that businesses that embrace energy innovation and consider all their customers’ needs will prove to be successful investments.

Falko: Last year’s presidential election clearly led to a significant shift in the regulatory environment surrounding environmental, social, and governance (“ESG”) issues. With the new sheriffs on Capitol Hill, there will be an anti-ESG agenda for the next four years. At the same time, ESG-related initiatives from individual states in the U.S. and the European Union will also bring further changes to this area. With global regulatory frameworks evolving, it is paramount to carefully monitor these developments to adapt to new risks and opportunities. We continue to be constructive by maintaining and expanding our impact investment platform. We see these strategies as driven by investor demand since they reflect their values and investors increasingly believe that ESG-conforming companies are less risky, better positioned for the long term, and better prepared for uncertainty. While some of the government-driven benefits may be waning, investor values remain paramount.

Drew & Lloyd: Given its focus on genuine global risks, ESG will likely be with us for a very long time. It is too early to gauge changes in investor interest since the election, but the story has been a positive one so far. Flows into the overall category hit their highest points in 2021 (per Morningstar) and have continued positive. But big regional differences are emerging. ESG as discussed in the media is primarily a European phenomenon, with continental investors — mostly institutional — accounting for 80% of total assets. In the U.S., after a period of heavy promotion of ESG to the retail channel, some of the largest firms are now retreating or redefining their offerings. The political climate is one reason, but customer disappointment with me-too products and concerns about greenwashing have also been significant factors. In Asia, meanwhile, ESG is getting serious attention for the first time. This is particularly true in Japan and Singapore, as those nations see growing exposure to climate and other ESG-related risks.

Q. We’re starting to see some signs of real weakness in the economy — and a lot of it relates to tariffs and trade. Are we managing our way into a recession? Stagflation?

Falko: In times like this, we like to refer to the treadmill analogy. Over the past two years, the U.S. Economy has been running on the treadmill at a decent pace. Recently, we have seen an incline of the running deck, which means we might be running at a slower pace though not come to a full stop. The U.S. economy finished 2024 on solid footing. We have some initial concerns from January retail sales and a recent uptick in initial jobless claims. However, one-time factors could explain these weaker numbers (i.e., cold weather, post-holiday spending slowdown, etc.). The question is whether consumer and business uncertainty translate into slower spending, which was not the case for the past two years. Our base case is for the economy to continue to slow but generally avoid recession. The continuing slowing trend in shelter inflation should prevent an acceleration in inflation, but price pressures in other segments are likely to persist.

Drew & Lloyd: Picture the circus performer who, with sticks, keeps four, or more, plates spinning. The goal is to get through the task without breaking the plates. Relate that to a new Administration, that within 40 days started to tackle, as promised, tariffs, fentanyl, the borders, immigration, regulatory reform, particularly in energy, a looming government shutdown, federal budget negotiations, DOGE budget cuts, and the war in Ukraine. The past 40 days have been dominated by uncertainty and volatility. Commentaries about what could break, are hitting the media continuously. The concerns are focusing on economic growth, employment and the inflation impacts of trying to solve everything everywhere all at once. Fears of disruption of the world order, retaliation for U.S. tariffs, including alienation of key allies, the spillover effects of laying off federal workers, and delinking supply chains are top of mind. Stock and bond market levels are now reflecting caution and anxiety. Corporate planners are hesitant to give earnings guidance. Business and consumer sentiment indicators are reflecting concerns. While several indicators have come in below estimates, there is still reason to believe that the U. S. economy will avoid recession. Fundamentals in the credit market are strong, and consumer and business spending remain strong. Some indicators are reflecting price pressures ahead, but, given available details, they are not expected to put the U. S. economy in a stagflationary environment.

Dylan: Trade is an important part of our U.S. economy. In 2024, exports accounted for 11% of the GDP, whereas imports were approximately 14%. However, strictly speaking, on net last year, trade reduced our overall economy by roughly 3% (i.e., 11% – 14%). Additional tariffs could lead to less spending abroad while also dampening foreign demand for U.S. goods., However, the net impact remains uncertain, depending on the complex interplay between imports and exports. Further, many US companies rely on foreign inputs for production, making it even more difficult to forecast the overall economic effect. Nonetheless, the most critical driver of our economy is actually the US consumer; their spending represents close to 70% of our economy. Currently, consumer spending is healthy, and unemployment is low. If these conditions hold, we may still have some time before our next recession. In my view, the probability of a recession over the next 12 months is roughly 20%

Arthur: Signs of significant economic weakness are increasing. The February University of Michigan consumer sentiment index was revised sharply lower to 64.7 from 67.8, led by a 19% decline in buying conditions for durables, signaling concerns about upcoming tariff-induced price increases. If the mighty US consumers curb their spending, then the probability of a recession rises substantially. If consumers don’t stop spending, then inflation will result. Both may happen to some degree in various sectors, so the risks of stagflation have also risen. The yield curve re-inverted in late February, a strong historical indicator of an impending recession. Employment growth is slowing, with the effects of DOGE-related government firings yet to be reflected, particularly among private government contractors. Although recessions are normal, their causes often are not, and current stated policies are not normal. While economic uncertainties and recession risks are growing, sudden policy shifts could come quickly and unpredictably.

Q. What makes sense to you from an asset allocation standpoint given the uncertainties that lie ahead?

Falko: Despite the heightened uncertainty in the political and geopolitical environment, we keep our “glass half-full” perspective and favor global equities and credit over traditional fixed income. Over the past few weeks, we saw the equity valuation gap between the U.S. and international markets narrow and believe there are more opportunities outside the domestic stock market. A positive corporate earnings momentum over the past few quarters and more subdued earnings expectations for 2025, as well as a pro-growth policy backdrop present investors with a reasonably positive setup. Furthermore, we see attractive yield opportunities, especially in bond market segments like structured credit, non-government-backed residential mortgage-backed securities, and insurance-linked securities (i.e., catastrophe bonds). A combination of both stocks and bonds in a well-diversified portfolio should let investors sleep well at night. 

Drew & Lloyd: With much-improved opportunities in fixed income, and markets reflecting some concern about future fundamentals, our asset allocation positioning is neutral overall.

Arthur: To protect from market volatility, we think it’s important to reserve 6-12 months of expected expenses in cash, along with cash to cover known future purchases. We generally recommend rebalancing after large rises in the stock market, trimming back overvalued winners, and adding to quality assets that have underperformed. Right now, large US growth companies are prime candidates for rebalancing. Rebalancing is not easy to do emotionally, but it is a very productive exercise over time. During uncertain times, working closely with your financial planner is critical. A skilled planner will help you cut through the distracting media noise and keep you focused on what truly matters: your unique financial situation. Rather than reacting to inevitable market fluctuations, your portfolio’s asset allocation should be guided by your investment time horizon and risk tolerance.

Dylan: Given the current political and economic environment, we are likely to see increased protectionist policies, reduced regulation, and lower taxes. Smaller companies are known to benefit from this type of environment, as have certain private investments, including private equity and private credit. We have bolstered participation in all three of these asset classes. Others have already increased their exposure in these areas, as well. Regardless of market conditions, I am a proponent of using a significant portion of private and unconventional assets (25-45% of a portfolio) to enhance the risk and return potential of a portfolio, just as the most successful large institutions do. Looking ahead, a perhaps counterintuitive opportunity is increased international exposure. The U.S. has dominated foreign markets for over a decade now — a stark contrast to the prior decade when international markets led. Although it is difficult to get the precise timing right, due to the relatively low valuation of most foreign markets, I believe a decade from now you’ll be very happy to have maintained a significant international exposure in your asset allocation.

Q. Here’s a bonus question. The fact that government interest payments are higher than the defense budget has been described as a red flag. What would it take to have a sustainable fiscal future?

Drew & Lloyd: To have a sustainable fiscal future, we need not only price stability but economic growth through employment growth. With employment growth, the economy will collect more in taxes. In theory, less money would be needed for “relief benefits.” Therefore, shouldn’t the combination of the two lead to a reduction in the federal deficit? So, what happened with the deficit recently? As an article by the Paul G. Peterson Foundation points out, “In fiscal year 2024, the unemployment rate averaged 3.9%, well below its 50-year average of 6.2%. However, the deficit (in fiscal year 2024) was 6.4% of GDP significantly above its 50-year average of 3.8%.” The reason for the historically high deficits even with a low unemployment rate were” demographic factors, rising health care costs, high interest rates on the growing debt and insufficient revenues to cover promises that had been made,” the article pointed out. Other suggestions beyond adjusting nondiscretionary spending that have been made to ensure a sustainable financial future have included shrinking the defense budget and cutting discretionary spending. Additionally, we would need to keep inflation in check and maintain credibility throughout the process in order to keep interest rates low. A big danger would be that after surpluses were generated then politicians would go on a spending spree.