History doesn’t repeat itself, but it often rhymes. — Mark Twain

 

With Iran on the front page of newspapers, worries about inflation, a president pressuring the Fed to reduce rates, gold prices rising, protests cropping up and quelled with force, and federal budget deficits that seem unsustainable, we wouldn’t blame you for wondering if we were living through the early 1970s again. While the parallels aren’t exact, that period was indeed a tricky one for the markets, with big corrections followed by big rallies only to sell off again. Ultimately, the broader market went nowhere for most of the decade, though those with patience found opportunities to profit here and there.

Since our last letter, the market has experienced both a big sell-off and a substantial rally. However, when we survey the landscape, little seems to have changed in terms of risks and opportunities. On the bright side, employment has remained strong, and corporate earnings for the most part have held up. On the downside, we are once again facing a self-imposed tariff deadline, and with just a couple of trade deals finalized, there’s been little progress on reducing the biggest economic uncertainty today. The likely outcome seems to be more delays and unpredictability.

The budget bill working its way through Congress certainly seems to be big, but its impact may be anything but beautiful, as it will likely drive further increases in the deficit. It also does nothing to address the most significant fiscal challenge for the United States: the unfunded nature of Medicare and Social Security. These programs represent a $73 trillion “off-balance sheet” liability and make the national debt at $35 trillion look like a walk in the park. There is no path to sustainable U.S. government finances without fixing these programs through a combination of increased taxes, reductions in eligibility, and reduced benefits.

There is no will in Congress to cut entitlement spending, while global threat levels are as high as ever making defense spending a priority. With non-defense discretionary spending only a modest piece of the pie, the quarter of the budget going to pay interest on the government’s (mostly short-term) debt seems to be the only juicy target left for cutting spending. It’s no wonder the President is leaning so hard on Fed Chair Jerome Powell to lower rates.

However, cutting rates too low to help the government finance its deficit risks unleashing inflation just like in the 1970s. This would be a very painful outcome as inflation is a silent tax, eroding everyone’s purchasing power. It would also drive up long-term rates, making mortgages and other borrowing less affordable. Furthermore, bringing inflation back under control would necessitate raising short-term rates again, defeating the initial purpose of the cuts while undermining the Fed’s credibility. The Federal Reserve Board seems right to take a wait-and-see approach, in our opinion, especially given that inflation has still not retreated to the Fed’s 2% target and the inflationary effects of higher tariffs still lie ahead. For context, today’s rates were considered normal prior to the 2008 financial crisis, and we see no reason why they can’t stay where they are for quite a while longer.

So, for the moment, the world seems awash in macro uncertainty. We cannot recall a time when Washington has exerted so much day-to-day influence on the markets. However, as the great investor Peter Lynch once said, “If you spend 13 minutes a year thinking about economics, you’ve wasted 10 minutes.” Despite the deluge of daily news, we continue to focus on what we always do: looking for attractive companies that can grow through a variety of market environments, because that is inevitably what they will face. We have enough cash reserves to buy them when we find attractive prices. Unlike bonds with their fixed coupon payments, companies can raise prices, allowing their sales and earnings to inflate too, to the benefit of stockholders. In sum, as we have said so many times, great companies bought at reasonable prices is an all-weather investment strategy we have faith in to generate consistent results over the long term.

We remain optimistic about the future. One problem we had in the 1970s was U.S. dependence on the Middle East for oil. Through the magic of capitalism and the development of shale technology, over recent decades we have completely flipped the script and now the U.S. is the primary marginal producer of oil. We believe that companies will continue to innovate and improve our lives. We are seeing it play out in AI today, for example, where U.S. companies are leading the world by investing very aggressively to improve global productivity. Healthcare, too, continues to amaze with advancements in everything from weight loss to gene editing and immuno-oncology. Good companies solve real-world problems and people are willing to pay handsomely for their solutions. This will continue to be true regardless of macroeconomic headwinds.

Speaking of good companies, we had the opportunity to increase our position in one such company this quarter. UnitedHealth Group (UNH) is a behemoth in the U.S. healthcare industry, providing insurance for more than 50 million Americans and touching over 100 million more through the healthcare providers and facilities they own. The company recently mispriced their Medicare Advantage policies, resulting in its first earnings miss in nearly a decade. The stock went down a lot, the CEO “resigned,” and the former CEO, Steve Hemsley, was brought in off the board to right the ship. The last time Mr. Hemsley led the company from 2006 to 2017, a period that included the financial crisis, he oversaw a 400% increase in the stock price. In May, he personally purchased $25 million worth of UNH stock on the open market. While management may have various reasons to sell, there is only one reason to buy: they believe the stock is a bargain.

Health insurance is a short-cycle business, meaning that policies are mostly repriced yearly. We expect UNH to reprice their policies to better cover their costs and put this chapter behind them in relatively short order. The company continues to generate an enormous amount of cash flow despite the recent setback. While there is some focus in Congress on marginal reforms around Pharmacy Benefit Managers and Medicare, the last time UNH was this cheap people were talking about “Medicare For All” (i.e., private insurance going away), and nothing being discussed now is nearly so draconian. In the end, we see significant ongoing demand for healthcare and UNH is well positioned to get its share of the pie.

We anticipate a long, hot, and volatile summer in the world and in the markets. We have cash on hand to respond if opportunities arise, and we feel comfortable that the companies you own will continue to adapt and thrive as the world changes. We’d encourage you to shut off the news, enjoy some time by the pool or on vacation, and know that we will be working hard on your behalf to position your portfolio as well as we can. Thanks for the continued trust you place in us.

Penn Davis McFarland, Inc.
July 2025