“If I cannot reach haven, I will raise hell.” Cassandra Clare
The frenetic pace of the newly appointed administration since the beginning of the year has caused investors some rethinking of their playbook. After the results of the past November election, the consensus in Wall Street was of a repeat of the 2017 scenario.
However, a less traditional approach from the administration combined with a clearly different background in the markets has so far produced a very different scenario. We are not too surprised as we have been cautious for a while as indicated by our recent missives.
Currently, the technical aspect may open the door to a rebound given some short-term extreme readings in the fabric of the market, but it is unlikely that we have flushed out of the system all the uncertainties and the volatility.
The recent 10% correction from the previous highs caused some indicators to reach oversold levels. For example, the spread between the Bulls and the Bears in the American Association of Individual Investors has moved to past lows. This is a contrarian indicator usually followed by some reprise in the price level of equities. The Relative Strength Index of the S&P500 is also flashing oversold levels.
While the short-term picture seems stabilizing, it is hardly the case for the longer time frame. To start, the positioning of asset managers is diametrically opposed to their 2017 stance. Back then the professional community was underexposed to equities while now they are at a ten year high (source: JP Morgan, positions in US equity futures by asset managers).
We also note that Consumer Confidence has been in a downward trajectory since the end of 2024. Similar data are showing up on Main Street where the Purchasing Managers Index moved from over 55 in December to 51 currently. A reading below 50 will indicate an economic contraction is probably underway.
On a relative basis, even after the correction, US equities are still tremendously more expensive than the rest of the world. Such US exceptionalism, which has underscored markets for years, was well justified by stronger earnings, looser fiscal policy and a stronger dollar. However, many of these pillars are fading. The job market (which underpins consumer spending and therefore earnings) seems to be at best plateauing or possibly even beginning to reverse. In the background, inflation expectations remain high, and the US Dollar is weakening. Fiscal policy is being contained while in Europe it is being loosened.
This backdrop suggests that in the intermediate time frame caution is still required. An overweight in intermediate duration bonds should help lock in good yields while absorbing volatility shocks that we may encounter over the next twelve months. A higher exposure to stocks of other developed economies should also help capture a relative resizing of US exceptionalism.
We also continue to prefer value stocks over growth stocks and we do like the software sector long-term as a play on the developing AI trend. Defense stocks (here and in Europe) would seem to continue to be in favor given the heightened geopolitical risk. The problem here is valuations. If a correction were to hit the sector, opportunities would arise.
As always, we would like to thank you for your renewed confidence in our work,
Youri Bujko
Davide Accomazzo