Reality Check?
Major US equity indices managed to eek out marginal new all-time highs during the month, before turning sharply lower. The spectre of a world trade war under President Trump and his MAGA (Make America Great Again) team, tariff policy gyrations, and dramatic news flow regarding the ongoing activities of DOGE (the Department of Government Efficiency) all weighed on sentiment.
The American economy is suddenly facing a growth scare, a scenario considered to be an extremely low probability event at the beginning of the year according to Bloomberg surveys of professional forecasters. The Reserve Bank of Atlanta is now projecting an economic contraction in the first quarter of 2025 of -1.5%. Just ten days ago the projection was +2.3%. Four weeks ago, it was +3.9%. Wow.
In addition to slowing growth, warning signs have emanated from the labour market, where weekly unemployment claims have risen to the highest level since October 2024. Separately, recent US consumer surveys are highlighting waning consumer confidence, and a material rise in forward looking inflation expectations, which is sure to attract the attention of the Federal Reserve.
On inflation specifically, price growth is intensifying across a broad range of indicators. Costs of materials like lumber and steel have been high for several years coming out of the pandemic and are moving up again. A measure of input prices for manufacturers reached the highest since October 2022 (source: S&P Global), whilst businesses surveyed by the Dallas Fed reported that an index of prices for raw materials doubled to the highest since Septembe 2022. The spectre of tariff uncertainty is further muddying the waters.
The net effect of the above has been a continuation of the ‘great rotation’ theme that has defined global markets so far this year. Namely, leadership has shifted away from high beta, pure growth, momentum securities embodied by the stratospheric rise of the Magnificent 7 (now pithily labelled the ‘Lagnificent 7’) and towards cheaper, higher quality, more defensive regions including European markets and the UK.
Nowhere was this more evident than the latest earnings season. Market darling Nvidia, the AI (Artificial Intelligence) poster child of this post pandemic cycle, reported year-on-year net income growth of +80%, a stunning increase by any measure, let alone for a company with a market cap of over $3 trillion. The market’s reaction? Nvidia’s share price closed -8.5% on the trading day after results and remains some $25 below its all-time high price of $149.43 recorded earlier this year.
An old investment adage reminds us that it is often ‘darkest before dawn’. We noted in our previous commentary that the most notable development (in our opinion) during January was the absolute and relative outperformance of European and UK stock markets against a backdrop of broad economic malaise and a vacuum in place of meaningful policies to incentivise business investment and growth.
When aggregate investor sentiment is as poor as it was towards Europe and the UK in the fourth quarter of 2024, and valuations had been driven down to multi-decade lows, the news only needs to go from awful to slightly-less-awful to create a meaningful lift in prices. As it stands, global investors seem willing to give politicians the benefit of the doubt, betting that progress will be made in a range of strategic policy areas that can deliver much-needed growth to the respective economies.
Portfolio Positioning
From our previous January commentary: ‘we are not proclaiming imminent recession, but we do think the seeds have been sown for a potential growth scare in 2025. The US housing market remains an area of vulnerability, with unsold inventory amongst the big national developers creeping steadily higher. Separately, government employment has done the heavy lifting in terms of payroll growth this cycle but looks to be firmly in the crosshairs of the Department of Government Efficiency (DOGE) that is hellbent on showing quick and effective results.’
The American growth scare scenario is playing out more quickly that we had envisaged.
Opportunistically, we meaningfully dialled down equity risk exposure for our more conservative and balanced strategies several weeks ago, boosting cash levels, whilst shifting some American equity exposure to more unloved regions for our growth and equity risk strategies. On the topic of cash, this is very much a short-term tactical allocation, but the good news is that we are being paid to be patient whilst also providing considerable ballast to portfolios.
Bonds enjoyed a decent month, decoupling from equity markets to deliver positive returns in February and act as an effective hedge. On fixed income, our strategic views have been consistent for some time now. We remained concerned about long duration bonds against the backdrop of mounting government deficits and a wall of supply this year that could create refinancing problems for weaker companies. Our preference in the space remains high quality investment grade corporate credits.
TEAM’s framework and process suggest that we are not through the woods yet in terms of the momentum and growth unwind, and the shift from cyclical stocks to defensives. We anticipate better opportunities ahead to lean back into risk assets in meaningful size.
(Cover Image Source: Tobias Bjerknes)