Chris Iggo
Markets are back to where they were before 2 April. Economists thought a recession was a sure bet but are not so convinced now. Investor sentiment – or at least market momentum – has been very positive. The thing is, we don’t know quite how the macroeconomic outlook has changed. It is surely worse in terms of growth and inflation, at least for a while. But US equity markets are back to their valuation highs. It’s that time of year that evokes the old saying “sell in May and go away”. Or at least tilt towards credit.
Fear or greed – Investors will have had differing experiences during the last six weeks. Those who did nothing will have done fine. However, if investors took the rational decision to reduce equity weightings and, specifically, reduce US exposure, the results will have been mixed given the voracity of the equity market rally since 9 April. The market timers will have done best if they were able to sell on the tariffs and buy on the pause. Being closely tuned into the particular modus operandi of the Trump Administration will have helped.
Tariffs up, growth down – I’m not sure that I have seen such swings in sentiment amongst market participants and economists. Based on what we know today, tariffs are going to be historically high. This will impact trade flows, supply chain dynamics and business planning. American companies relying on imported consumer goods for resale or industrial inputs will be paying higher prices and still might not have the certainty they require to plan output and investment, or the ability to maintain profit margins. China might be celebrating a ‘win’ over the US, now that Trump has taken down tariffs, but they are still going to be high. This will affect Chinese exporters’ volumes with potential negative implications for employment and output, not to mention raising US consumer prices.
In our macro, valuation, sentiment and technical framework for assessing asset return prospects, the macro outlook is worse than it was. The only meaningful factor that has improved is sentiment, driven by announcements of “trillions of dollars” of deals done by Trump. Sentiment is fickle though. It could turn sour when the reality of weakening economic data becomes evident.
US equities are very expensive again. Those with sympathy for the MAGA ambitions and methods could believe US exceptionalism will continue to deliver high returns, with strong capital inflows representing a willingness to hold and increase dollar holdings amongst investors in the rest of the world. Recent events might cast some doubts on those assumptions. Perhaps selling semiconductors and airliners to the Gulf will supercharge the US expansion for another few years.
Bonds are ok – In the bond world, yields are still attractive, especially in credit. Looking at where credit indices are compared to their 20-year history, yields are generally in the third quartile of their distribution, while spreads are in the second quartile. Credit spreads are modestly expensive, but yields are on the cheaper side of average given where we are in the monetary cycle. US and UK credit markets offer the most attractive yields and returns in both markets should benefit from central bank easing over the next year.
Between two and three – Bond investors will have some concern about inflation. But the news has been good recently. It still looks like it will be difficult to get inflation to, or below, 2.0% with annual inflation rates seemingly stable at current levels in the US, Eurozone and the UK. There is also upside risk from the tariffs. Having some inflation-linked bond exposure alongside other higher yielding assets could be helpful to portfolios, capturing inflation accrual and some potential benefit from lower real rates as global monetary easing continues.
Value versus value creation – I think there is more uncertainty for investors and the global economy to face. A decade ago, the US was about the same as the UK. Now it is twice as valuable relative to GDP. Since the global financial crisis, the ratio has gone one way, with a slight interruption to the trend during the pandemic.
Various policy puts from the US government and the Federal Reserve; the monetisation of fiscal expansion; and the rapid growth of the technology sector have created the exceptional rise in equity valuations, helped by the confidence that the rest of the world had in investing in the US. Now the market is very expensive, and perceptions might have changed. There has not been enough time since the tariff debacle for the real economic data to show whether any damage has occurred. Anecdotal evidence suggests there has been some. It might be time to “sell in May” just in case this does come through.
By Chris Iggo, Chief Investment Officer, Core Investments