The State of Play
Confidence, and by extension sentiment, is a fragile thing.
We are currently hitting an air pocket in risk assets as the lens of the market has turned towards policy uncertainty, growth disappointments and a weakening labour market. This is bad news for growth-related companies that are (generously) priced to grow strongly into the future.
Crypto, leveraged ETFs, high beta, and high momentum stocks, the darling trades of 2024, are being vapourised.
The news headlines (designed to create ratings and pay for advertising) are flashing red, recession chatter is now incessant, and all the talk is of how far this ‘correction’ will go.
Spoiler alert: no one has a clue.
If we rewind the clock to the beginning of 2025, we noted:
- weak underlying breadth in the major US averages,
- a chasm in US valuation (expensive) differentials vs rest of the world,
- sell side strategist FOMO, evidenced by the huge lift-off in end of year S&P targets by Wall St,
- euphoric sentiment, shown by responses to the outlook for stock market prices over the next 12M,
- elevated risk positioning, evidenced by mutual fund, hedge fund, and retail skew towards US high growth sectors
- the Trump factor, (wildly unpredictable), and
- the spectre of significant US tax-related selling into April (forced selling of winning US stocks to pay domestic tax bills)…
Now the good news.
Trump and Vance’s showdown with Zelensky in the Oval Office a fortnight ago has galvanised European leadership. Historic fiscal spending plans should ignite productivity and growth across the eurozone, led by Germany, as nations upgrade desperately needed physical infrastructure and rearm their military capability. Much will depend on execution, but investors are giving politicians the benefit of the doubt.
In the UK, PM Starmer is enjoying arguably his first sustained period of political stability following positive feedback from the domestic and international community during his negotiations with Zelensky.
Meanwhile, in China at the latest national People’s Congress, Xi’s government has radically shifted the country’s top policy priority towards domestic consumption. He was also seen publicly shaking hands with Jack Ma, the posterchild of China’s own AI revolution, which bodes well for a return to embracing entrepreneurialism and prosperity.
Embrace Volatility
It is always uncomfortable, but intra-year pullbacks in risk assets are par for the course.
Shown in the graph, the number of 5% pullbacks for the US large cap S&P 500 index since 1990:
The worst possible action for clients to take now would be to discard one’s investment plan ‘in a state of panic’. Corrections are inevitable, and it must be said, necessary to expunge excesses (greed, euphoria, valuations, unproductive assets etc.) from the system.
Outlook
We have no idea when, or where, ‘the bottom’ will occur. All we can say for certain is that this too shall pass.
We shifted our model range to a more defensive position in late January and followed that up with a meaningful reallocation of risk away from the US and towards international markets in early March.
For now, our framework has moved to keep us in harmony with the strong longer-term trends in global markets, which are currently found outside of America.
Our expectation is that this air pocket for US risk assets has the potential to continue for some time yet. We remain vigilant and ready to act should circumstances change.
As a final point, worth remembering that US mid term elections are some ways away yet. The likely Trump playbook is to hose markets and sentiment down with big policy changes now before commencing easing and delivering a host of market-friendly policies in the 6-12 months run-in.
Stay the course.
(Cover Image Source: La-Rel Easter)